Originally posted on May 5, 2019 at the New Economic Perspectives blog.
I’m expanding an earlier essay into a short, book-length piece I hope will be useful in the unfolding public debate about MMT. The piece will utilize the “operation” of a “diagram-machine” to illustrate how our modern money system actually works. My hope is that it will be accessible and easily understood by people who have a genuine interest in MMT, but little time or patience to delve into its operations and implications. I’m posting the narrative here at NEP for comments and suggestions. Efforts to keep things simple and focused on basics might lead to some errors, or important omission—which I’d like to avoid. The diagram-machine, itself, I’m still working on—but I think the narrative, for now, can be followed (and evaluated) without it.
This book has a purpose
Modern Monetary Theory (MMT) has burst into public awareness with a surprising message most people find hard to comprehend or believe:
The U.S. government can afford to spend a lot more dollars to achieve public benefits and collective purposes than our current political-economic narrative tells us is possible.
The result has been a back and forth of claims and counter-claims. Mainstream media and political-economic leaders tell us MMT is “hogwash” and a formula for economic disaster. America, they say, will become like Venezuela!
Modern Monetary advocates tell us that a sovereign nation which issues its own currency can never fail to pay any bill that is denominated in that currency. Consequently, America can afford to undertake much larger expenditures for the public benefit than is currently imagined or calculated.
Naysayers respond: this prescription is just “printing money”—it will destroy trust in America’s credit and lead to the hyper-inflation and political corruption of a banana republic.
Much depends on the outcome of this economic debate: Are we—or aren’t we—able to provide universal health-care for all Americans? Are we—or aren’t we—able to provide universal pre-school day-care and early childhood educations? Are we able to provide our high-school graduates with debt-free secondary educations or technical training? Are we able to provide a job-guarantee—with a living wage—for every citizen who is unemployed by private commerce? Can we invent and build, fast enough, the new energy systems, infrastructure, and ecological interventions necessary to mitigate and adapt to the coming climate change? And to accomplish these goals, is it true that America must become a “socialist” state with dramatically higher taxes and ever-expanding, intrusive bureaucracies?
How can we answer these questions? How can we know who is telling us the truth? How can we know if America does, or does not, have “enough money” to effectively address, in a decisive way, the big, unfolding challenges of our times?
Unfortunately, most Americans have little interest or time for delving into and understanding the underlying topic of monetary economics. Instead we must rely on talking-heads, poorly explained economic jargon, and intuitive memes that often hide reality rather than explain it. This book is an effort to change that.
It’s important to note at the outset that MMT does not propose a “new” monetary system, but simply that we truly understand the monetary system we are using every day. My goal, in the following pages, is to illustrate how that system actually operates—and to do so in a way that can be quickly grasped and understood by anyone—using their own power of observation—who is willing to dedicate thirty minutes of focused attention to the task.
To facilitate this “short-cut” to the heart of something (the American monetary system!) that’s so dry, convoluted, and tedious most people don’t even want to think about it, we’ll build what I call a “diagram-machine”—a dynamic diagram we can “operate” and tinker with to observe and understand its workings. It will be a highly simplified version of the real economic “machine” that is operating behind the scenes in our daily lives.
Running this simple diagram-machine through a few basic operations, I hope, will reveal the basic mechanisms of the real machine—and, in doing so, will make clear what MMT wants us to truly see and understand. And if MMT can be generally understood and accepted by the American public, the unfolding and crucial debate over the future of American society can go forward in a more rational and constructive manner. So, let’s begin!
It will be useful to start with an overview of the diagram-machine’s purpose and how, in general, it achieves that purpose.
The most important parts of our machine are the Combustion Chambers, and the “fuel” that circulates through these chambers that enables it to operate. The “fuel” our machine uses is money. When money (fuel) flows into either of the two Combustion Chambers, something happens: goods and services are produced and consumed.
These goods and services—and the consumption of them—are the sole purpose of our machine-diagram.
In other words, the purpose of the diagram-machine is to produce what the American people—individually and collectively—need to live their lives (and pursue their happiness) in relative safety and comfort: food, water, clothing, houses and apartments, electricity and fuels, cars, buses and highways, law enforcement and courtrooms, education, medical care and medicines, Givenchy luggage and chocolate eclairs, etc. All these things are produced and paid for in the Combustion Chambers via the exchange of money—and then are “consumed” by the American people in the pursuit of their happiness.
The money (fuel) for these exchanges in our diagram-machine is fed into the Combustion Chambers from two different sources. Spending source #1 is a bank account in the Private Banking system. (Our machine has two of these.) Spending source #2 is the U.S. Treasury Reserve account at the Central Bank of the Federal Reserve.
After an exchange takes place in the either of the Combustion Chambers—producing and allocating goods and services—the money (fuel) flows out of the Combustion Chamber and into another private bank account, ready to be used again. That’s the basic operation. And the net result of the operation is that needed or useful goods and services are produced and consumed by the American people.
In operating our diagram-machine, what we want specifically to observe is how (and when) the fuel that runs the machine is produced. One of the central mysteries of our current political-economic debate is whether there is “enough” money to accomplish our collective goals—or, as it’s often framed: “That’s a nice idea, but how can we pay for it?”
The first thing you’ll notice when we go to the next page—“Parts and Pieces”—is that our diagram-machine doesn’t have a gas-tank! What we want to observe and understand is how the machine, itself, produces the gas it needs to fuel the Combustion Chambers. It is this understanding that is the essence of what MMT wants us to “see.”
To help us observe this, the components of our diagram-machine have been given a “fuel flow-meter” showing three different tallies: (1) a beginning tally, (2) a change, and (3) an end tally. We’ll keep it simple, but it’s important to take the time to follow along and keep up with the tallies—to observe how the fuel is flowing in the machine.
Parts and Pieces
Our diagram-machine is a very simplified version of the real machine that runs our economy. Even though the real machine is an enormous, sprawling complexity, its logistics are driven by a few key parts, components, and operations which are, in themselves, relatively simple mechanics—though they might well surprise you! If we can see how these key parts and components operate, individually and in concert with each other, we will have a surprisingly robust understanding of the entire grandiose and bewildering operation—enough of an understanding, at least, to form a useful opinion of what the machine can, or cannot, be expected to accomplish.
As illustrated, our diagram-machine consists of four major components. The first two components produce and direct the fuel (“money”) that powers the machine:
- Central Bank of the Federal Reserve System
- The Private Bank System
The second two components are the “combustion chambers” in which the fuel is converted to work that accomplishes the goals of production and consumption for American Society:
- Private Combustion Chamber
- Public Combustion Chamber
Within the Central Bank we have the following subcomponents:
- The Federal Reserve account (FED)
- The Treasury Reserve account (TSY)
- Bank#1 Reserve account (B1Ra)
- Bank#2 Reserve account (B2Ra)
Within the Private Bank System, the subcomponents are:
- Private account at bank#1 (B1a)—this is a private bank account belonging to a person or a business.
- Private account at bank#2 (B2a)—ditto
- Promissory Note to Bank#1 (PN1)—this is a promissory note held by bank#1 in exchange for a loan.
- Promissory Note to Bank#2 (PN2)—ditto
Connecting these components and sub-components are flow channels through which fuel (money), or things related to money, flow.
That’s our diagram-machine. Simple as it is, virtually all the realities of America’s modern money system can be observed and understood by operating it. So, let’s see if we can start it up!
>>> Part 2
4 RESPONSES TO “ZEN AND THE ART OF MODERN MONEY”
- Newton Finn | May 5, 2019 at 9:38 am |Looks like a promising beginning. Hope you go on to clarify as simply and concisely as possible the difference between secondary bank money, which most everyone uses in their day-to-day lives, and primary federal money, which is created by fiat (spending decisions) but then unnecessarily transformed into debt-linked money before it can reach the citizens. As I see it, that crucial distinction both underlies MMT theory and explains why people have a hard time in grasping it. The only context in which the vast majority of citizens deal with money is in its secondary debt-linked form. Thus, they naturally think of ALL money in these terms and mistakenly apply the household paradigm to the federal government. The central bank accounting and distribution system (federal reserve) seems designed to reinforce that misapprehension by unnecessarily linking fiat money to federal debt accruing from bond sales, thereby blurring the crucial distinction between primary and secondary forms of money. Break the conceptual link between money and debt on the primary level, and the constraints of the household paradigm evaporate, replaced only by the inflation-avoiding limitation of available resources.
- F. Thomas Burke | May 5, 2019 at 10:52 am |This looks promising! Sure would like to see a picture.
- Graham Paterson | May 5, 2019 at 5:10 pm |An excellent concept JD, which I hope will help clarify a lot of the misinformation being spread about MMT. As your posts get a much wider distribution outside of the US it could be helpful to explain that MMT can be applied to any nation with monetary sovereignty.
It may also help if you were to show how important money is and why it has become so necessary in today’s society.
I see “money” as an essential tool for everyone’s survival in today’s world. It is a fact that if a person does not have access to “money”, in whatever form it takes, their chances of survival are very limited.
Also, the reason “money” is so important is that it has become, over its long history, the simplest and most convenient medium for the exchange of good and services. As long as the “money” supply is acceptable within any given society and as long as the token designated can come with a relative guarantee that it is not a false token, then the medium of exchange will serve its purpose.
I think it might also help your “machine-diagram” if you were to point out that all profit comes from consumption. Production itself does not produce any profit, although, of course, production is essential and must come first – the profit only occurs when the products and services are sold.
This fact leads to an obvious conclusion. It is absolutely pointless to produce anything, anything at all unless it is going to be consumed.
That obvious fact leads to another conclusion. Your machine-diagram should also focus on the importance of delivering the money supply to the consumers in order to make sure the producers can achieve their profit, which is the basic foundation of the capitalist system.
We all know that the capitalist system determines what can happen and what can’t happen and that is dependent on the profit potential of the undertaking.
What this means is that there needs to be a relative balance between the amount of money spent on production and the amount of money distributed for consumption. Both factors are very much dependent on the nation’s population and its available resources.
These are relatively clear and simple facts relating to every nation’s need for a supply of money. I think your “machine-diagram” needs to include the purpose for having a money supply and not just focus on how the “money” is created.
- Roger Sparks | May 6, 2019 at 10:26 am |Two key questions regarding reserves:
1. If all Central Bank loans are repaid, will ‘reserves’ drop to zero?
2. If all Private Bank loans are repaid, will ‘reserves’ drop to zero?