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Antii

You’re right - maybe my point on banks is not that relevant to your analysis. I picked that up from your rhetorical question – “What kind of entries does a bank make in its ledger in different situations?”

I think if you convert loans and overdrafts in the real world to red money in Nick’s world, you’ve got things pretty well covered in your analysis and you can make accounting for both the real world and Nick’s model mutually consistent.

P.S.

I personally wouldn’t get too carried away with the triple/quadruple/etc. stuff.

Double entry reflects the adjustments on a single balance sheet. Quadruple entry reflects the adjustments on the balance sheets of two counterparties to a single transaction. That kind of counterparty interaction is generally necessary for a transaction (or even a non-transactional revaluation) to take place as an economic event captured by accounting. From there, the sky’s the limit in term of multiplicity and higher order, depending on how much is going on and what range of transactions is to be captured “simultaneously”. This includes the case where banks are involved.

I also think it is possible to subdivide particular basic transactions into further artificial or hypothetical “elementary” transactions that can no longer be subdivided. I happen to think of accounting in this way. For example, in the case of the bicycle sold for cash, you can focus in on the marginal effect of just the transfer of bank deposits from one bank to another. With nothing else considered, that hypothetical would include double entry adjustments to deposits and equity for both counterparty banks. Then add in the fact that bank reserves are transferred as well, and that first hypothetical equity effect gets reversed out for both banks. You can do the same for those kinds of effects on the balance sheets of the buyer and the seller, looking at the demand deposit transfer alone with the corresponding hypothetical equity adjustment. Then do the bicycle transfer and the hypothetical equity adjustment gets reversed out for both non-bank counterparties. I find decomposing accounting in this way to its constituent hypothetical elementary sub-transactions makes the interaction between assets, liabilities, and equity much clearer from a logical construct perspective.

Above I meant:

"wouldn’t get too carried away with the sextuple/octuple/etc. stuff."

JKH: It seems you and I agree on overdrafts and loans. I'll anyway write a post about it, where I articulate my view more explicitly, in hope that it would help to bring all discussion participants closer to a common understanding on that issue as well. Sounds OK?

"wouldn’t get too carried away with the sextuple/octuple/etc. stuff."

Again, I fully agree. These are just multiples of the basic element, which is double-entry (not single-entry). "Sextuple-entry" was more like a quip from my side. The point was that neither "sextuple-entry" nor "quadruply-entry" is more than double-entry bookkeeping which is being multiplied or "mirrored".

"that hypothetical would include double entry adjustments to deposits and equity for both counterparty banks"

This is interesting. I think your point is more valid in case of non-banks than it is in case of banks. Why would it be equity, not customer deposits (checking accounts) that is affected on the RHS?

JKH: I would say that my having a loan is different from my having red money, in the same way that my having a bond is different from my having green money. If I get rid of the bond I own, I accumulate green money (or decumulate red money). If I get rid of the loan I owe, I accumulate red money (or decumulate green money).

Non-money assets (and liabilties) are promises to be paid (or to pay) green money (or to accept (or have accepted from me) red money).

Antii

"Why would it be equity, not customer deposits (checking accounts) that is affected on the RHS?"

It’s both. I'm just subdividing into elementary components. It's artificial. It answers the question - what would be the effect of a transfer of deposits from one bank to another without considering the accompanying transfer of reserves. So a transfer of deposits alone from bank A to bank B would involve:

Bank A
debit deposits (reduction)
credit equity (increase)

Bank B
credit deposits (increase)
debit equity (decrease)

This is a hypothetical - other things equal. It’s a benefit to Bank A - it loses a liability which means its equity increases. Of course, this doesn't normally happen in practice without the corresponding reserve transfer (which reverses that hypothetical equity effect) - but it is how the transfer of deposits alone would be reflected. It's what I referred to as an elementary decomposition. And it’s not entirely nonsensical in a practical sense. Sometimes banks sell parts of their branch systems along with the deposits - and they have to pay out some amount of equity in order to get the buying bank to take on the deposit liabilities.

Nick

" JKH: I would say that my having a loan is different from my having red money, in the same way that my having a bond is different from my having green money. If I get rid of the bond I own, I accumulate green money (or decumulate red money). If I get rid of the loan I owe, I accumulate red money (or decumulate green money).

Non-money assets (and liabilties) are promises to be paid (or to pay) green money (or to accept (or have accepted from me) red money). "

Understood.

Just to be clear, “your loan” in that context is your loan liability.

And to be additionally clear, that loan is a loan of green money.

You can repay it with green money or repay it by incurring (“accumulating” in your language) red money.

So my observation would be that you have introduced an asymmetry into your red/green world by allowing loans of green money.

Such an asymmetry doesn’t exist if you exclude that type of loan.

Or perhaps you wish to include loans of red money as well?

I’d be interested if you really want to go down that path.

My assumption without looking back at your posts was that it is purer to exclude either type of loan from the red/green money world.

BTW, Negative TARGET2 balances at the ECB are red money. Anyone know the spread between positive and negative TARGET2 balances? It's clearly not large enough to cover the risk-spread between (say) Italian and German bonds. Unlike Bank of Canada settlement balances, where the 50bp spread is enough for commercial banks with positive balances to lend to commercial banks with negative balances, so red money is very rare (except intraday??).

I think that example also illustrates the difference between red money and loans.

JKH: I want to go down that path, and make it symmetrical. I was trying to make it symmetrical in my above comment, especially in that bit with all the parentheses.

If I have accepted a loan from Andy (a liability on my books) I have an obligation to either: give green money to Andy; or accept red money from Andy, to pay off that loan.

If I have made a loan to Andy (an asset on my books) I have a right to either: be given green money by Andy; or to give red money to Andy, to pay off that loan.

I think it's symmetric.

Nick

It's been a while since I looked at TARGET2, so I may be a bit rusty.

But TARGET2 is a clearing system for the reserve liability positions of the national central banks. The constituent national central banks that develop surplus TARGET2 positions do not actively "lend" TARGET2 money. Their positions are the passive result of inter-central-bank clearing and are taken on without any material attempt to actively manage them in a direct way. This is quite different from the case of commercial banks dealing in their reserve markets. So the interest rate formula and mechanism for the transfer pricing of TARGET2 surpluses and deficits is not really an issue in that context. (I believe there is a small spread, as you infer). In fact, national central bank specific risk is mostly shared through a capital allocation/risk sharing formula, where all central banks share in the financial result of the aggregate EZ national central bank balance sheet (the Eurosystem balance sheet). The system is designed not to reflect the credit quality differences on central bank balance sheets to which you refer. Hans Werner Sinn has written a lot about the potential breakup risk because of this. It’s complicated to be sure.

That said, I think that TARGET2 liability positions are like overdraft or red money positions in their own way.

But to be clear again, TARGET2 money is not the same as the reserve money of the national central banks – quite apart from your distinction between loans and red money. Your red money concept at TARGET2 level would not be the same kind of red money that might reflect the same concept at the level of commercial banks dealing with their respective central bank.

Nick,

I meant the path of red money loans.

It’s asymmetric in the sense that in the world of green and red money, there are only loans of green money.

(Notwithstanding that those green money loans can be paid off with either green or red money adjustments.)

Perhaps that asymmetry is quite OK.

So you created red money but so far you allow only loans of green money. That’s the asymmetry to which I referred.

Unless you are allowing loans of red money.

So I would be interested if you are doing that - and if so how you would explain that.

Without that, it is also interesting that loans of green money can be paid off with red money adjustment, but that there are no loans of red money.

Unless you specify that somehow.

Over to you.

JKH: thanks for the target2 stuff. Will think about it.

Assume a pure red money world (no green money, to keep it simple). You can't sell anything unless you have enough red money to cover it. I want to sell you my car for $1,000, but my bank balance is at $0. So I borrow $1,000 of red money from Andy, who has a large stock of red money. Andy's overdraft falls by $1000, mine rises by $1000, and Andy gives me a signed note promising to accept $1,050 in red money from me next year. I sell you my car, my overdraft falls back to $0, and yours rises by $1,000. The bit of paper signed by Andy is a loan (my asset, Andy's liability) but not red money. It can't be used as a medium of exchange, because I know and trust Andy, and recognise his signature, but other people don't.

Tyger, tyger, burning bright
In the forests of the night
What immortal hand or eye
Could frame thy fearful symmetry?

back a little later

JKH: TARGET2. Suppose BMO became a bit risky. More than 50bp risky. And suppose BMO had a negative settlement balance at the BoC at the end of the day, while BNS had a positive balance. If BMO were safe, BNS would lend to BMO on the overnight market, because there would be a 50bp gain from trade they could split between them. But if BMO is risky, the overnight market dries up, because BNS won't lend at any rate BMO would accept. So BMO's negative balance might keep on growing day after day. Their positions would be the passive result of interbank clearing, just like TARGET2.

@ Nick
A red money only world is a strange place. I can't help thinking of the origins story that MMTers sometimes come up with where the first act of a colonial government consists of imposing a tax liability on its subjects. In Nick's colony, the subjects would have an initial overdraft imposed on them. On top of that, they would then be forbidden to move their accounts beyond 0 at any time. But anyway.

In your terminology, is money (red or green) that which banks create while loans (red or green) are promises of payments between non bank agents? A red loan would then be a promise to be paid, which you say cannot be? If you do establish red money as a medium of exchange, I don't see why that would be a problem (that's the symmetry that JKH is talking about, I think. More of a contradiction in terms, if you ask me). I do think it would be a problem, practically speaking. But that's precisely why I wouldn't, and nor would most others, consider red money a medium of exchange.

Nick 9:05

That’s excellent.

Is that the first time in writing on this topic that you’ve been specific about loans of red money – or did I miss that before?

P.S.

Although not quite sure about the language here:

“So I borrow $1,000 of red money from Andy … and Andy gives me a signed note promising to accept $1,050 in red money from me next year … the bit of paper signed by Andy is a loan (my asset, Andy's liability) but not red money.”

A small point of semantics, not important - you say that you borrow but your stock of borrowing is the loan asset. Is that how you intend it?

Nick,

I think your TARGET2 /BMO analogy is partly true.

In your example, where the BMO becomes helpless as a result of market forces, it does resemble a case somewhat like the Greek central bank having problems preventing the migration of money to other Eurozone areas.

However, I think TARGET2 operates with systemic passivity. As I understand it, there is no overt attempt for each national central bank to square its TARGET2 balance in the best of times. So for example, if the Bundesbank were to have a surplus balance in “normal times”, I don’t think it would be in the market buying assets from counterparties that operated in the geographic area of other NCBs just in order to encourage an outflow of its reserve liabilities to other central banks in the Eurozone. I don’t think it would be driven by the economics of TARGET2 balance compensation to do that. I think it comes down to the fact that the NCBs are government creatures and that the compensation or cost for risk taken by individual NCBs is shared by formula across the entire spectrum of Eurozone NCBs.

JKH: Thanks!

I can't remember if I have talked about loans of red money before. If I did, probably less clearly.

But yes, I'm still not 100% clear (either mentally or in words).

"A small point of semantics, not important - you say that you borrow but your stock of borrowing is the loan asset. Is that how you intend it?"

I *think* so. Because I'm borrowing a thing that has negative value. Like borrowing garbage. A minus times a minus is a plus.

Nick: Interesting that you mention TARGET2. When I first introduced my "gift economics" idea, in Finnish, a very knowledgeable Finn -- who's an avid reader of yours, and might be reading this as well -- brought almost instantly up TARGET2. So there's yet another thing that connects my view with yours.

I'll come back to both you and JKH tomorrow! No time for deep thoughts now. You're having an interesting conversation again!

This quote from the Central European Bank webpage "Payment transactions in TARGET2 are settled one by one on a continuous basis, in central bank money with immediate finality." contains the definitive words "central bank money".

I think that understanding what "central bank money" actually is would help this discussion.

I think you’re right Nick.

From a non-bank perspective:

If you’re borrowing an asset (i.e. green money), then the borrowing is a liability.
If you’re borrowing a liability (i.e. red money), then the borrowing is an asset.
Non-banks can lend and borrow either green or red money without creating new money or destroying old money.

From the bank perspective:

If you’re lending a non-bank asset (i.e. green money), then the lending is a bank asset and the green money it creates is a bank liability.
If you’re lending a non-bank liability (i.e. red money), then the lending is a bank liability and the red money it creates is a bank asset.
Banks can lend either green or red money by creating it and they can borrow either green or red money by destroying it.

Commercial bank reserve settlement balances held with a central bank are a higher order of money than money held by non-banks with a commercial bank. So in the money relationship, the commercial banks are to the CB as non-banks are to the commercial banks. That means the commercial banks would have green money reserve assets and red money reserve liabilities. And the CB would have green money reserve liabilities and red money reserve assets.

And in the case of the Eurozone, the NCBs would have green money TARGET2 assets and red money TARGET2 liabilities. And the ECB would have green money TARGET2 liabilities and red money TARGET2 assets.

As I said above, just as non-bank holdings of commercial bank green or red money are not the same type of money as commercial bank green or red reserve settlement balances held with the central bank, green or red reserve settlement balances held by Eurozone commercial banks with the NCBs are not the same type of money as green or red TARGET2 balances held by Eurozone NCBs with the ECB.

That’s quick revisit – not sure, but I think it may cover the set of symmetries for green and red money and loans of green and red money in the cases of non-banks, a singular (central) bank, a central bank with a set of commercial banks, and a super-central bank with a set of central banks.

This is my post on TARGET2 from a few years ago:

http://monetaryrealism.com/target2-window-on-eurozone-risk/

As I mentioned way above, I think Nick has created a monster with his red money concept.

Other than the mental gymnastics involved, I can't see the point of it.

Unlike green money, red money is not a feature of any monetary system. For instance, I can't walk into a coffee shop and purchase a cup of coffee by accepting red money with the cup of coffee from the vendor. The day this happens will be the day I begin to worry about red money.

Green money has evolved naturally in our monetary systems, why hasn't red money?

And of course, as Nick has mentioned several times, if red money did exist, the aim in life of every individual would be to depart this world leaving behind a mountain of red money (after having consumed or given away all his assets). We could all die billionaires, except we won't mention the fact that we're talking about red money. And potential legatees will not be welcoming of that bequest from a red money rich uncle.


JKH: I think we are on the same page.

I'm re-reading your good long post on TARGET2. Along with your sources. God those guys make it complicated. That's why red/green helps, to simplify! But I still don't understand what stops gross money in TARGET2 growing without limit (net money is fixed at zero, it seems).

Henry: my father used red money for most of his life. He nearly always ran an overdraft in his chequing account. As long as the balance came close to zero after he sold the wheat every year, the bank manager seemed relaxed about it.

Nick,

I don’t think there is a limit – other than the size of the outstanding money supply at a particular point in time in a weak country that is susceptible to outflows to stronger countries.

For example, here is a possible highly theoretical worst case for Greece relative to Germany:

Suppose at a particular point in time all deposits in the Greek commercial banking system flee instantaneously to Germany via some combination of a current account deficit and net private capital outflows. Call that money supply M.

So the German commercial banking system gains deposits of M and gets credit from the central bank Bundesbank for bank reserves of M. The central bank Bundesbank now has new reserve liabilities of M. It “clears” that new incoming liability position with the ECB by obtaining credit in the form of a TARGET2 positive asset balance of M with the ECB.

On the other side, the Greek commercial banks lose deposits of M and reserves of M, driving their reserve position hopeless negative. They back into their LLR facility with the Greek central bank in order to bring their reserve position back to square. And the LLR funding they obtain now serves to fund their assets instead of the previous deposit funding. Finally, the Greek central bank, having lost M in reserve liabilities, backs into the ECB for what is in effect replacement funding (i.e. a red money overdraft) of M. The use of the term “funding” may sound a bit artificial at this point, since this all happens through accounting entries for the clearing process. But that’s not much different than the plain vanilla process accounting process that occurs with any central bank clearing system.

I think that unlike commercial banks dealing with CBs, the required Greek NCB red money position is technically not even an LLR loan – it is more of an automatic overdraft (and without limit) - so I think you are particularly correct to draw the analogy to your red money idea.

I think there is no technical limit to these sorts of imbalances. The Eurosystem was designed this way. And it is in fact technically sustainable – unless there is an exit event. That’s when resolution of the risk gets more complicated. And that’s the risk that Sinn was warning about concerning the German position. And he faced big push back from many other economists who focused on the “don’t worry be happy” mode of indefinite sustainability without thinking about possible exit complications.

P.S.

One further interesting technical point. Sinn used to point out that when the German central bank was flooded with incoming money that it had to credit in the form of reserves for the commercial banks, it was then faced with the dilemma of how to manage those excess reserves in the context of domestic commercial banking system requirements. That led him to sound the alarm that the Bundesbank would have to sell assets domestically to drain those reserves – and that in the worst case it might run out of assets to sell. It’s an interesting concern, except that the Bundesbank could have started to use liability management to drain those reserves if so desired – or pay interest on them – or whatever. I never followed up on that because I think the German Target2 position gradually peaked out, and I haven’t followed it much since.

JKH: Useful comment for me.

"I don’t think there is a limit – other than the size of the outstanding money supply at a particular point in time in a weak country that is susceptible to outflows to stronger countries."

I'm not even sure there's that limit. For example, commercial banks in the weak country could allow their customers to have bigger overdrafts.

" I never followed up on that because I think the German Target2 position gradually peaked out, and I haven’t followed it much since."

It's growing again, looking like it will set a new record. It's now Italy and Spain with the growing negative balances. Click on SDW Report Sheet.

As far as I can tell, from a quick search, Eurozone National Banks neither earn nor pay interest on their positive or negative balances, so the spread is 0%. (But foreigners do). And the ECB itself now has a negative TARGET2 balance (due to its doing QE).

"my father used red money for most of his life."

A bank overdraft is not quite red money, is it - there is no interest (positive or negative) with red money - there is no identified/nominated creditor as such - the issuer of red money has no obligation to the holder of red money - and I presume your father never attempted to sell his overdraft with his wheat.

All of the above presumes I understand what you mean by red money - perhaps I still don't understand it?

Henry: there can be interest with green money (though interest on green *paper* money is administratively difficult to pay or collect). Same with red money.

With green money: we normally treat it as a liability of the bank that issues it, though with fiat money the exact nature of that liability is debatable.

With red money: we normally treat it as an asset of the bank that issues it, though with fiat money the exact nature of that asset is debatable.

My father always sold his overdraft with his wheat. The buyer of the wheat now had a larger overdraft, because the bank transferred the red money from my father's account to the buyer's account.

"A bank is not a storage facility for currency. And I'm talking about a bank."

I still want to see how a storage facility for currency works.

Nick,

I think you are stretching this red money too far, and creating a good deal of confusion to boot. I can't see the point of introducing the concept of red money. It's fun mental gymnastics but really you are just playing with definitions with no practical value at all. The way you are using money you may as well say an asset is an asset, a liability is a liability. Colour is a red (green, blue, pink, yellow etc,) herring.

"If I have accepted a loan from Andy (a liability on my books) I have an obligation to either: give green money to Andy; or accept red money from Andy, to pay off that loan."

What happens if you (Nick) defaults?

"With green money: we normally treat it as a liability of the bank that issues it, though with fiat money the exact nature of that liability is debatable.

With red money: we normally treat it as an asset of the bank that issues it, though with fiat money the exact nature of that asset is debatable."

Green money is usually an asset of some entity.

What entity has red money as a liability?

Thanks for the intresting discussion.

"It's growing again"

The ECB (https://www.ecb.europa.eu/pub/pdf/ecbu/eb201607.en.pdf):

Asset purchases from counterparties located in a different country from the
purchasing central bank can directly affect TARGET balances. Counterparties
whose NCBs are connected to TARGET use their accounts at those NCBs,
while counterparties located elsewhere can use an account at a correspondent bank with
access to TARGET. Banks based outside the euro area tend to make payments in
TARGET via branches or correspondent banks in countries with claims in TARGET,
such as Germany or the Netherlands. It follows that when an NCB purchases
securities from a non-domestic counterparty, whether it is located in another euro
area country or outside the euro area, the purchase is likely to give rise to cross
- border flows of central bank money.

Hah, I can see the red / green money analogy coming alive in context of unlimited, both way TARGET2 balances!

As a matter of interest, is there anything comparable in the context of a 'normal' bank / central bank arrrangement anywhere? Say between the different branches of the FED in the US?

TMF:
What entity has red money as a liability?

The holder.

Nick,

“I'm not even sure there's that limit. For example, commercial banks in the weak country could allow their customers to have bigger overdrafts.”

Agreed.

I was constraining against that (to pin things down just for illustration purposes) by assuming instantaneous outflow at a fixed point in time

“other than the size of the outstanding money supply at a particular point in time … flee instantaneously”

But I agree there is no technical limit (other than the usual prudential constraints such as capital adequacy) against banks creating more money in the bathtub even as it is draining.

Nick,

A further thought on your idea of borrowing red money.


For illustration purposes - back to the case of a single (central) bank with no commercial banks.

Suppose we are constrained to a red money only system.

There is no stock of green money.

Suppose customer X has a 0 money balance to start.

He wants to sell something for $ 1,000 so he requires a red money balance to sell it.

So customer X borrows $ 1,000 in red money.

The customer then has a red money liability with an asset representing the borrowing.

That’s where we left off in defining red money borrowing.


Here’s the anti-symmetric way (a good thing actually) of looking at that.


The customer starts with a 0 balance.

He requires a red money balance.

So he lends $1,000 of green money to his bank.

That creates $ 1,000 of red money for the customer, because he is lending from a starting green money balance of 0.

So his asset is a loan of green money.

His liability is a stock of red money.


In that way, I would say that borrowing red money is equivalent to lending green money. The immediate balance sheet entries are the same – a $ 1,000 red money liability for customer X, and an asset which you can refer to either as a borrowing of red money or a loan of green money.


This equivalence of interpretation can hold under the assumption of a system with a specified green money stock of zero – i.e. green money stock is simply not allowed.

That’s because the green money loan in the example represents a realized flow of green money – but is not a stock of green money, rather a loan of green money.

So no problem with that interpretation in a red money stock only system.


I think this connects back to a basic point I made earlier.

Which is that in a dual system, red money (a bank asset) creates green money (a bank liability).

For example, when customer X creates a red money balance of $ 1,000 by spending from a starting money balance of 0, this in turn creates $ 1,000 as a green money inflow for the seller.

In an unconstrained dual money system, and assuming for illustration that the seller starts out with a 0 balance of either green or red money, this flow of green money will show up on the balance sheet of the seller as a green money asset and on the balance sheet of the bank as a green money liability. The green money expenditure and inflow has created a green money stock.

In a red money stock only system, that green money flow will show up first as a reduction in any red money stock outstanding held by the seller. But if that pushes the red money stock of the seller back to the point that it threatens to create net green money stock, the seller will then either have to buy something that spends that residual green money flow or lend the residual green money flow to the bank. For example, suppose the seller starts out with a red money balance of $ 500. Then his $1,000 green money inflow would create a $ 500 green money balance if the system were not constrained to red money stock. To prevent this from happening in the assumed red money system, the seller lends that $ 500 of green money to the bank. The full result is that he has reduced his red money liability balance from $ 500 to 0 and he now has an asset of $ 500 which can be interpreted as either a green money loan or red money borrowing. Nevertheless, his actual money balance at that point is $ 0 for both red and green money.

I think another interesting interpretation of that last example is that in order to prevent a stock of green money being created in the system, the bank has done what amounts to a “reverse repo” that supplies an asset of some sort to drain what would otherwise be the creation of outlawed green money stock. The bank is obligated to do this under the rule of no green money stocks.

Henry,

“I can't see the point of introducing the concept of red money. It’s fun mental gymnastics but really you are just playing with definitions with no practical value at all.”

In a generic sense, I feel your pain.

I think it’s a matter of personal preference. In my own case, I find it quite challenging to try and map Nick’s logic on this one to a conventional interpretation of the actual monetary system as it works. I don’t know why this is so in this particular case, because in general I consider myself to be no slouch when it comes to understanding the mechanics of the real world monetary system. But for some reason, I find this one to be a useful challenge in that it causes me to think harder about how the actual system works.

You may find it to be of no use whatsoever. That’s understandable. I’ve been there, depending on the modelling situation. But that’s not to say that some people may find this one quite useful as the result of personal interpretation.

Nick,

One can imagine a world specified as:

Only green money

Only red money

Dual green and red money

But it is also possible to specify the world more flexibly in terms of the restriction on the type of stock, restriction on the type of flow, or both.

I think you are specifying a world of red money only as including a restriction on both stocks and flows. Only red money stocks and only red money flows.

In my earlier comment, I implied a red money world that specified a restriction to red money stock, but allowed for either type of flow.

This is logically possible.

For example, consider a given amount $ 500 of household red money stock.

The sale of $ 1,000 of stuff can be achieved with either a red money outflow or a green money inflow in this world. Both reduce the red money stock.

But once the red money stock has been reduced to $ 0, the residual $ 500 green money inflow or red money outflow can only be achieved by lending the same $ 500 residual in green money or borrowing it in red money.

Asymmetry in stock specification; symmetry in flow specification

on that very last point -

a green money loan is not the same thing as green money, so it could still be permissible in concept under such a red money stock system

Hold the press!

I got inspired by JKH's and Nick's discussion, started writing a comment, but it became a (long) blog post. I've been writing it for four hours now (including thinking), but don't yet see an end to it. I hope it will offer you a whole meal for thought.

Oliver, should the holder be considered a borrower?

"Which is that in a dual system, red money (a bank asset) creates green money (a bank liability).

For example, when customer X creates a red money balance of $ 1,000 by spending from a starting money balance of 0, this in turn creates $ 1,000 as a green money inflow for the seller."

It appears to me that customer X has a liability of $1,000 and that customer seller has an asset of $1,000.

I believe the result is the same with an overdraft as a loan, where loans create deposits. The “red money” is actually the loan/bond part.

"In a generic sense, I feel your pain."

JKH,

It's bemusment rather than pain.

For me, the interesting question is why no red money system has arisen naturally in preference to or in conjunction with a green money system.

Although, I think Nick would argue there are elements of red money in our green money system. But I don't think calling an overdraft, or the like, red money of any practical or even theoretical use. It's a both a liability and an asset depending on who's balance sheet is under consideration, and that's all that needs understanding.

I also understand the mental gymnastics required to process the notion of red money can lead to new modes of understanding the money system we have. So it has pedagogical value.

My blog post became a series of blog posts. Perhaps we should write a book together: "Monetary Economics in a Red Money World"?

Here's the first post: In the Land of the Color Blind, Neither a Borrower Nor a Lender Be: Part 1. It doesn't live up to the coherence standards I've tried to set to my blog posts (and those are not high). But that shouldn't keep you from finding some interesting points in it, I hope!

Btw, here's Nick's dad, threatening his bank with a withdrawal.

"It's bemusment rather than pain"

Could have fooled me.

In fact you did.

But I'm so pleased you recognize the pedagogical value.

I learned a lesson: Never publish a post in a hurry.

I just wrote an update:

"As you might have already realized, if X in JKH's example is severely credit-constrained (totally unworthy of credit in the eyes of the DFRW) he can neither buy first nor take out a loan of red money (from a non-bank). The latter would involve a debit balance on his checking account, and the DFRW wouldn't approve of it. From this it follows that collateral must play a decisive role in a red-only world. Logically, one must be able to sell first even if one's promises are valued at zero."

In red-only world, IF one is credit-constrained and needs to borrow red money to effect a sale, one has to post the goods one wants to sell, or other goods, as a collateral to the the central authority/bank (because the loan involves incurring a liability, even if the borrower ends up holding an asset, too). Right?


That red world is pretty imaginary, Antii, so I think it’s up to you as to what credit constraints you want to build into it.

Red money is like an overdraft, and regular overdraft facilities in the real world don’t necessarily require collateral. It would depend on credit quality assessment and the size of the exposure.

And as I said before, I would view borrowing red money as equivalent to lending green money. From a starting balance of zero, both interpretations create a resulting red money balance. Both interpretations result in a liability called red money and an asset that can be viewed as either borrowing red or lending green. And lending green could still be permissible in a world that outlawed net green stocks of money.

But I'm so pleased you recognize the pedagogical value.

You were right about that and I was too quick to dismiss it, just like Henry. There is pedagogical value in science fiction. And I mean that in the best possible way.

JKH: I mean that collateral is required from un-creditworthy agents, even though they only want to SELL. That's a problem with the restriction that says you need to have red money to be able to sell goods. It's not a (theoretical) problem if the goods to be sold are accepted as collateral at market value, or "face value" (no haircuts).

This makes "red borrowing" different from "green lending". In green lending, the asset is a "general credit" (in centralized ledger) and the liability is in a private ledger, while in red borrowing the liability is a "general liability/debit" and the asset is in a private ledger. In other words, in green lending the lender can judge the borrower's creditworthiness, while in red borrowing a central authority has to judge the borrower's creditworthiness, while the borrower is the judge of the lender's creditworthiness. Read that one carefully :-) Makes sense?

If collateral is accepted, then creditworthiness doesn't matter.

The buyer, and the un-creditworthy seller without red money, could meet at the central bank and finish the transaction there, under the eyes of the "central banker". That way it would be possible for the central bank to first debit the seller's checking account (and credit the lender's account), and then immediately credit the seller's checking account while debiting the buyer's account.

Antti

First, on the issue of credit assessment:

Suppose I have a real world personal overdraft facility with my bank.

Banks put a limit on this type of overdraft.

For example, $ 10,000.

And they don’t require collateral.

The fact that they don’t require collateral is a matter of credit assessment.

They probably won’t give me a limit of $ 100,000, because that sort of size will require collateral, and probably force conversion to a regular loan.

There is a direct analogy obviously between an overdraft and red money.

The same credit assessment process would apply.

There is no reason for it not to apply, because red money is a bank asset, and banks still need to manage their equity worth in that world.

In fact, all of the discussion so far seems in general agreement about the nature of this exposure and the need for credit limits.

So collateral requirements would be a function of credit assessment, and small exposures may require no collateral within specified limits, just as in the real world.

Next, on the issue of borrowing and lending, red and green:


Restrict real world green balances to $ o (or essentially non-existent).

Now we are in Nick’s red money only world.

Suppose my starting balance is $ 0

Nick identified the bookkeeping early on for borrowing red money.

Suppose I borrow $ 1,000 of red money

Then the borrowing is my asset of $ 1,000 and the money is my liability of $ 1,000

And I’m now free to sell $ 1,000 worth of stuff


I said that red money borrowing was equivalent to green money lending

Here’s how:


We are in a world of red money balances only

But I’m going to allow green money flows in that world – because it is a feasible payment mode option even when constrained to green money stocks of $ 0, and because it will help explain my specific point here


Detour back to the real world for a moment

Suppose I have 2 bank deposit accounts, both with a $ 0 starting balance

I write a (green money) cheque for $ 1,000 on Account # 1

I take that cheque to Account # 2 in another bank

(Could be the same bank, but this is more illustrative I think)

Instead of depositing that cheque, I ask to purchase from that second bank a financial asset called a “loan”, wherein I lend $ 1,000 to the bank as a financial claim on green money

(A real world bank may well credit my Account # 2 first, and then debit for the purchase)

So I now have a non-monetary financial asset (loan) of $ 1,000

The cheque them clears back to the bank where I hold Account # 1

And I now have a $ 1,000 overdraft in that bank

So I have an asset called a loan

And a liability called an overdraft


So we’re still in the real world at this point

The real world maps naturally to green money

My liability to the first bank is an overdraft created by a green money outflow

My asset just created with the second bank is a green money loan


Now back to Nick’s red money balance only world

The real world situation I just described is essentially isomorphic/homomorphic to an exclusively red money world

My overdraft liability maps to red money

My asset maps to red money borrowing

And that red money borrowing is isomorphic/homomorphic to green money lending in the way I described above for the real world, where the matter of acquiring a non-monetary financial asset with that green money flow is automatically enforced by an imposed restriction on green money balances being $ 0

Antti, TMF et al

I have not had time to read in detail your replies to my earlier comments or Antti's separate post. I will try to reply later, either here or on Antti’s blog, but it won’t be today.


In the meantime, note that my adoption of Nick's green / red terminology does not imply that I think his model is correct. I don't. My version is in my slides. I am interested only in describing the real world. My version is not the same as Nick's green world, or his red world, or his green / red combined world which he claims describes the real world.


Also, note that, in any discussion of the real world versus models, language itself is a model as is ANY form of accounting. An apple does not know it is an apple, and it would still exist in the real world even if we were not around to call it an apple. Everything in this discussion is a model. Language and accounting describe the real world. They are not the real world. A ledger is not the real world.


In particular, money is a logical construct WITHIN an overall accounting model. Accounting is a pedantic but useful set of methods for describing aspects of the real world, so it follows agreed rules (with variants e.g. cash accounting, accrual accounting). Economics describes the complex behaviours that arise inside this world of agreed accounting rules e.g. recessions, bank runs.


Unfortunately, most of the economics profession (particularly the New Keynesian school) thinks that accounting and money are unimportant. If these economists were chemists, they would be saying that they are important people studying macro effects such as explosions, and that the logic associated with micro-structures like atoms and sub-atomic particles are not important.


Nick thinks that money IS important but he thinks that he can understand it separately from the rules of accounting, so what happens is that Nick creates his own personal logic to support his view of money, and the rest of us try to understand his rules and how they might diverge from conventional accounting. For example, he says that an overdraft is negative money, but it is not. The fact that you need money to pay off an overdraft does not mean that the overdraft is negative money. Otherwise, a bicycle would also be negative money as you need money to pay for the purchase of a bicycle.

JKH: I agree with most of what you say. I think I disagree partly on the "green lending"/"red borrowing" equivalence, but perhaps it's not a real disagreement. We'll see.

My point about collateral was very specific, and I feel you missed it. Let's say one morning an unknown merchant, James, arrives in Red Money Town. When the evening comes, he will be already on his way to the next town. He has goods to sell, fine goods, but first he would like to eat in the local restaurant. James tries to barter, but the restaurant owner is not interested in the goods James is selling, and tells him that he can get a dinner only by accepting red money from the restaurant. But because red money is a liability of its holder, and James is a stranger no one yet trusts, he cannot possess red money. He doesn't even have a checking account at the local Red Money Bank.(See my blog post for an argument regarding feasibility of "red paper money". It would require enormous restrictions on personal freedom, or full trust. Neither is feasible, so red money can exist only in the form of an overdraft on a checking account.)

James decides to sell the goods first, then buy the meal.

In green-only world, James would sell goods for green paper money, then buy the meal. No problem.

In red-only world, James can only sell goods if he has red money (a restriction set by Nick, and repeated by you). But as a complete stranger, not having earned people's trust, he cannot possess red money (a liability of its holder). So he can't eat at the restaurant. UNLESS he delivers to the Red Money Bank goods which will serve as collateral (the bank takes possession of the goods). That would allow quite a lot of flexibility. James could eat first or sell first; the bank would probably use some dummy account to record James's side of the transactions. In the end of the day, the result would be that the restaurant had got rid of X amount of red money on its checking account and the buyers of James's goods would have acquired X amount of red money, in total, on their checking accounts.

Do you see the problem? If you don't see the problem, it must be because you just assume that James can acquire some red money, either by buying goods or borrowing the money. Perhaps red paper money? That would require a totalitarian state, with James in full surveillance, or high morals and full trust among strangers. I don't think we should assume away this problem even in a thought-experiment.

Antti

I don’t think I overlooked it.

I prefer to say I temporarily ignored it

:)

I.e. temporarily ignored it at the particular hierarchical level of stocks (versus flows) that I was first describing.

I knew it was lurking in the background as one of your concerns about this subject.

That said, I’m going to give you just a quick response before thinking about it much – so I may well overlook something in this particular response. Let me know.

I think in general this is the mobility problem in transferring (i.e. conducting flows of) a red money liability requiring a credit risk assessment for any transferee who takes on new red money.

To suggest it require collateral is a somewhat arbitrary judgement. I think this all depends on the institutional design of the payment system.

E.g. the diner may have a phone app that proves he has an uncollateralized credit risk limit for red money approved by some agency or some bank or some banking system.

I don’t think this requires a totalitarian state. Just think of the mobility of the credit risk and limit information that is inherent in a real world credit card. I think it amounts to pretty much the same payment system technology issue. The restaurant owner just needs to be able to transfer red money to the merchant diner. That’s essentially the same credit risk assessment as happens with a real world credit card. The merchant should have a limit and technology should allow him to utilize that limit. Moreover, the restaurant owner doesn’t even need collateral. He just needs the credit risk go-ahead to transfer red money to the merchant diner. With that approval, he’s done with the transaction. He doesn’t care about collateral if the limit technology is effective.

I think the problem you’re getting at relates mostly to cash as opposed to technology facilitated electronic money. Red cash versus green cash is a problem. Red cash, unlike green cash, cannot be used with the same anonymity inherent in green cash transactions.

That was quick. But if it sounds OK, you can take the app idea and create a micro-finance start up for red money. Throw in some block chain and let me know how it goes.

:)

:)

I wasn't talking about the relationship between the restaurateur and the merchant. I was talking about the (non-existing) relationship between the merchant and a bank. I assumed that no bank has extended credit to the merchant, at least not in the country where he finds himself now (he could be a foreigner). So I assumed away the possibility to use the app (which is how we should assume that all transactions are effected -- electronically). That's why the restaurateur cannot transfer red money to the merchant.

A new post on financial investments (loans) in red-only world: In the Land of the Color Blind, Neither a Borrower Nor a Lender Be: Part 2. It's directed mainly to you, JKH. If you have time to read it, let me know what you think?

Jamie, Oliver and Roger Sparks: I'm falling behind on answering some good comments (here and in my blog) you've directed at me. I'll get back to you a bit later (tomorrow and early next week)!

Antti

I took a quick look at your post.

Looks interesting.

Although I expect to disagree with a few things. Similarly with your comment above.

I'll spend more time and give you a less rushed response at some point tomorrow.

Antti said: "In red-only world, James can only sell goods if he has red money (a restriction set by Nick, and repeated by you)."

Let's say James does get some "red money". James wants to sell the goods and "sell" the "red money" to the buyer. No entity/buyer wants to take on the "red money". What happens?

Antti

“I was talking about the (non-existing) relationship between the merchant and a bank”

You’re imposing the arbitrary assumption by example that the merchant is simply not equipped to transact in a world of electronic red money. He has no access to it. And if he has no access to electronic red money, he has no access to red money at all, because red money in the form of cash without (electronic) credit risk mobility means he can’t transact in cash either. This sort of assumption of a stranded, disconnected wannabe purchaser just shuts down everything in the red money world. To use somebody else's word in another discussion, its not that interesting.

Regarding your post, I’ll have to disagree with much of it and stick with what I’ve already written in earlier comment. For example:

“The bank cannot differentiate between you buying goods or borrowing red money; the accounting entries are identical.”

No.

The accounting entry for buying goods is either a real asset (durable) or no asset (non-durable) and a liability consisting of new red money.

The accounting entries for borrowing red money are a particular type of asset and a liability consisting of new red money. The asset consists of a liability issued by the bank. That asset is in the form of a loan or a bond issued by the bank to the borrower of red money. The nature of that bond is that the red money borrower must redeem that bond with the bank when he repays his red money liability. He surrenders an asset in order to extinguish his liability.

These are both red money transactions that are isomorphic/homomorphic to green money transactions.

The equivalence in the first case is simple. A buyer pays by incurring a red money liability (i.e. the seller transfers a red money liability to the buyer.) That is directly comparable to the buyer paying with green money and creating an overdraft from a starting balance of 0. (Everybody has agreed that red money is comparable to a green money overdraft.)

The second one can also be replicated with green money. A green money customer adds to his green money asset balance by borrowing from the bank. That borrowing is like a bond issued by the borrower to the bank. It is the customer’s liability to repay it with green money. Now invert that exchange. Suppose the customer comes to the bank with a green money balance of 0. He lends to the bank by buying a bond issued by the bank. This bond is the customer’s asset and the bank’s liability. The customer pays for the bond by going overdraft on his chequing account with the bank. He now has a bond as an asset and an overdraft in his chequing account. He has lent green money to the bank in the form of a bond to create that overdraft. Now convert that to a red money interpretation. Everybody is agreed that a red money balance translates to an overdraft in the green money world. And we have already stipulated as Nick first noted that red money borrowing creates an asset. That asset is the bond. QED. Red money borrowing equates to green money lending the way I’ve described it.

I’ve added nothing new here to what I already said. I’ve just restated it by example. And I’ve made a clear distinction between pure banking transactions that create new assets and liabilities versus commercial transactions that have a subsequent effect on the new money created by those transactions. So I can’t accept this general statement in your post:

“The position of a red money borrower is comparable to the position of a green money lender only after the former has sold goods and got rid of the liability (red money) he acquired.”

I’ve described how the two are equivalent without any reference to commercial transactions.

Obviously the red money world requires access to a (mobile) credit facility that allows the creation of new red money by a bank – as I described above. How that is sort of facility is offered is a matter of institutional design. But somebody stranded in the desert looking to buy something and who has no access to that sort of credit approval is just out of luck in the red money world.

So I’ll stick my interpretation.

TMF said: "No entity/buyer wants to take on the "red money"."

This just means that red money is not a medium of exchange. But we are discussing a world where red money IS a medium of exchange. So you're off-topic :-)

JKH:

"The accounting entry for buying goods is either a real asset (durable) or no asset (non-durable) and a liability consisting of new red money."

I was talking about the entries the bank is instructed to make. I also mentioned that this was about borrowing from a non-bank. In that case, do you disagree on what I said? I wanted to highlight the fact that the bank, which has to assess your creditworthiness, doesn't care whether you are buying goods "on credit" or "lending green money" in red-only world (that is, borrowing red money).

JKH:

"This sort of assumption of a stranded, disconnected wannabe purchaser just shuts down everything in the red money world."

Wannabe purchaser or wannabe SELLER. In the green money world this wannabe seller doesn't face such difficulties, because there is no problem related to "bearer instruments" (cash) -- or, in cashless green economy he might use an app with no need for credit check (central banks are already working on the concept). That was the point I wanted to make. And I didn't shut down everything, but showed the (transaction-cost heavy) way out of the impasse.

JKH: When it comes to the "equivalence issue", I think we are talking past each other.

You are correct when you show that the position of a red money borrower can be replicated in the REAL WORLD by a green money lender. (Not in green-only world, though?) But my point was that the positions of a green money lender who starts with a positive balance, and incurs no liability at any point in time, -- I take this to be the base case or at least the "textbook case" in green money lending -- cannot be replicated by the red money borrower.

Perhaps what I say is obvious and uninteresting for you, but I'm just trying to study every aspect of the matter.

Jamie: I agree with most of what you say. I've been thinking along the same lines. For instance, what you say here

"A ledger is not the real world. [...] In particular, money is a logical construct WITHIN an overall accounting model."

resonates with what I say in my second post ("Records Schmecords"). I've also mentioned earlier that I feel that some people take a balance sheet to be more real than it really is.

What you say about Nick has some truth in it, but I don't think your assessment is entirely correct.

You said: "Nick thinks that money IS important but he thinks that he can understand it separately from the rules of accounting"

I feel that Nick is actually following the rules of accounting, or at least the actual accounting, very closely, but tries to describe the accounting using "counters" (red and green bits of paper). Those "counters" are a device which can be used, in the real world, to make record-keeping more de-centralized. So, Nick tries to interpret centralized record-keeping (one ledger with many accounts) in terms of "counters" which belong to de-centralized record-keeping. I see a problem with that, but perhaps this is just "mental gymnastics" on Nick's part.

You said: "The fact that you need money to pay off an overdraft does not mean that the overdraft is negative money."

Nick is actually stating more or less the opposite: He says that you don't need money to pay off an overdraft -- you pay it off by selling goods. You get rid of "red money" (overdraft) by selling goods. How do you get rid of "green money"? By buying goods. This is what makes an overdraft "negative money" for Nick. I personally think that this is an important insight from Nick, but instead of concluding that this makes an overdraft "negative money", I conclude that we should put our assumptions (or "facts") around (positive) money to the test. (I'll offer more details in my coming post on the equivalence of an overdraft and a "traditional bank loan" -- btw, is there a better word for the latter?)

Nick and I encountered the same problem when we were trying to make sense of the real monetary system.

Nick ended up building a world of positive and negative money (as the media of exchange).

I ended up building a world without money (as the medium of exchange).

The record-keeping system in my world is an exact copy of the record-keeping system in Nick's world. In both worlds the system is based on checking accounts which can be "overdrawn".

Antti

Sorry. I’ve been doing this quickly so I might have missed some context.

“The bank cannot differentiate between you buying goods or borrowing red money; the accounting entries are identical…

No.

The accounting entry for buying goods is either a real asset (durable) or no asset (non-durable) and a liability consisting of new red money.”

OK. For the bank entry and for borrowing from a non-bank, the bank sees a transfer of red money into your account (I think) in both cases and that is all. Sorry - I took that out of context.

“Wannabe purchaser or wannabe SELLER”

I’m puzzled as to why you tweaked that story with the sell side. Why would a stranded traveller who needs food and therefore needs red money credit feel the urgent requirement to immediately get rid of the red money liability he must first take on to buy the food? Why does that matter to the story?

“You are correct when you show that the position of a red money borrower can be replicated in the REAL WORLD by a green money lender. (Not in green-only world, though?)”

The overdraft is equivalent to green money borrowing in the real world and it is actual green money borrowing in the green money only world. It is only a red money equivalent in the mixed green/red world and the red money only world.

“Perhaps what I say is obvious and uninteresting for you”

It’s not obvious or uninteresting actually. But I’m still puzzled by that example.


i.e. on that last point

an overdraft is not "negative money" in either the real world or the imagined green only world

it is a form of borrowing in either of those

maybe try a fresh example if you disagree with some of my general points

JKH said: "I’m puzzled as to why you tweaked that story with the sell side. Why would a stranded traveller who needs food and therefore needs red money credit feel the urgent requirement to immediately get rid of the red money liability he must first take on to buy the food? Why does that matter to the story?"

I built the story badly. The point wasn't that he needs the meal FIRST. The point was that he cannot buy the meal either way. I said:

"James decides to sell the goods first, then buy the meal."

This would work easily with green money, but doesn't work in red-only world.

I might know what causes confusion here... Let's see. You think that selling goods is not (as) problematic (as I suggest) for our stranger, because he can take out a loan from the bank (not non-bank), sell his goods and then buy the meal? By doing it in this order, first selling and then buying, there's no real credit, or net liability, involved. That's because our stranger has a liability and an asset which are both recorded in the bank ledger, and he gets rid of the liability first.

I was so fixated on thinking about a loan between non-banks -- where only the borrower's acquired liability is recorded in the bank ledger -- that I somehow overlooked that option.

I'm actually embarrassed. I did consider the possibility for a bank loan, but I didn't go through it carefully enough. Yes, it involves a liability, but not in any real sense because the borrower's net balance is zero in the bank's ledger. This is something which is very clear to me in the real world, but my thinking got blurred when I travelled deep into the red-only world :-)

I hope I don't confuse you more, but this got me thinking:

We, of course, need to introduce overdraft into red-only world. This is no ordinary overdraft, but it's symmetrical opposite. It doesn't involve any credit. If you have an overdraft in the real or mixed world, you can buy without ever having a positive balance on your checking account. If you have an overdraft in the red-only world, you can sell without ever having a negative balance on your checking account -- that is, without possessing "red money" prior to the sale.

Nick might protest by saying that a positive balance on a checking account is not allowed in red-only world. But here you, JKH, and I should agree: a positive balance should be allowed, because that balance is not "green money" in red-only world. It's a non-monetary asset, just like a negative balance is a non-monetary liability in the real world.

JKH: “I find decomposing accounting in this way to its constituent hypothetical elementary sub-transactions makes the interaction between assets, liabilities, and equity much clearer from a logical construct perspective”

This is a VERY important point IMHO. It’s what I mean when I talk, more generally, about describing the underlying logic of a system. We need to take great care to create an accurate model.

Consider a simple example. Suppose an alien visits earth and decides to study Nick’s car. He conducts an experiment where he measures the state of the car at the start and the end of the experiment and uses the measurements to draw some conclusions.

At the start of the experiment, the alien sees that Nick’s car has travelled 10,000 miles and that the fuel tank is half-full. At the end of the experiment, he sees that Nick’s car has travelled 11,000 miles and that the fuel tank is half-full. The alien concludes that the car has travelled 1,000 miles during the experiment and has used no fuel. Hence, fuel is not relevant to explaining the travelling of the car.

The alien has made a mistake but it is the nature of the mistake that is important. The alien conceives of the car in terms of just one type of event: travelling. However, we know that there are two types of event that are relevant: travelling and re-fueling. The underlying logic of this system requires us to understand that there are two distinct types of event.

This is obvious to us in my car example. However, it is not obvious in larger systems such as large businesses and government departments (my area of expertise) or the banking system (JKH’s area of expertise) or the whole economy (Nick’s area of expertise).

We ALL simplify systems to understand them. However, we make similar mistakes to the alien by focussing on some types of event and ignoring others. Also, we make different simplifications. This causes disagreement and confusion. And we align our personal views by joining teams whose members make the same simplifications as us. This convinces us that we are right.

For example, the New Keynesians have simplified the economy by removing money and banking. They believe that these things are not important to the underlying logic of the economy. Hence, anyone who believes that money is important in the economy will not believe in New Keynesian economics. Also, New Keynesian economists must maintain their belief in their assumptions to maintain their belief in their own theories, so they will defend their assumptions vigorously even though there is no evidence that their assumptions are correct. Also, as New Keynesian economists all believe that their assumptions are correct, and as they believe that all New Keynesian economists are very intelligent, they will support each other in defending their assumptions against all-comers.

Or take another example. The MMT gang DO think that money and banking are important. However, they make certain detailed modelling assumptions which (although not wrong in a logical sense) are, nevertheless, inconsistent with conventions used elsewhere. For example, they describe the economy as though the central bank is not important and can be considered merely as part of a larger modelling entity called “government”. Hence, anyone who thinks that the central bank is a fundamentally important part of the logic of the macro-economy will almost certainly reject MMT.

JKH: “My own impression of Nick’s green and red money world is that the idea of a normal loan of money in the real world is fully displaced by the idea of red money. Red money takes the place of that kind of real world loan. It also serves the purpose of real world overdrafts. I think if you allow both red money and “loans” (of some type of money) to exist in Nick’s world, you get unnecessary ambiguity in the logical structure of his model. Maybe I’m wrong in that interpretation. Only Nick knows for sure”

I agree with this in two senses. First, I am sceptical that Nick’s green / red combined model represents the real world. Second, Nick is inconsistent in his definition of his model(s), so only he knows for sure. For example,

Nick: “I would say that my having A LOAN IS DIFFERENT FROM my having RED MONEY, in the same way that my having a bond is different from my having green money. If I get rid of the bond I own, I accumulate green money (or decumulate red money). If I get rid of the loan I owe, I accumulate red money (or decumulate green money)” (Jamie’s capitalisation)

And

Nick: “my father used red money for most of his life. He nearly always ran an overdraft in his chequing account”

I read Nick’s two statements as being inconsistent with each other. An overdraft is just a type of loan which can be activated by the customer at any time (up to a pre-agreed limit).

Jamie: "This really ought to be called the first law of macroeconomics."

Jussi: “Agreed, and based on that you need to check Godley & Lavoie book JKH was refering to”

I have the G&L book and have skim-read it. However, it is a book by academic experts for academic experts and people in finance. I want the intelligent schoolchild’s version.

We all see ourselves as experts in our chosen fields. However, for every one field where we are expert, there are 1,000 where we are not. We all understand almost everything about the world at the level of an intelligent schoolchild. If you wish to explain any technical subject to non-experts, that is the level of understanding you must assume. However, the Post-Keynesian literature about money and banking seems to cater only for people who are already specialists in money and banking.

I have no ambition to be an expert in the operation of the monetary system. I want to understand enough to be able to explain the basics to other non-economists in easy to understand language.

My assumption is that an intelligent schoolchild book on money does not exist. If it did exist, all economists would read that book and would understand the basics of money; non-economists would read that book rather than reading blogs; and there would be no need for Nick to create his own logic of money.

Antti: I will reply to you on your blog as your points are quite specific - but not today.

TMF: “Households could manufacture things that are exchanged. I could grow some apples and sell them”

If you grow apples and sell them, you are a business. Many people are both businesses and households. The two roles are not mutually exclusive. There is no point in distinguishing the terms “business” and “household” only to allow them to merge back together.

Also, the objective is to design a relatively simple model which handles most situations. It is not to re-build the real world complete with every imaginable exception condition. If we try to do that, we lose sight of the main objective. However, that requires judgement and people make different judgements. There is never one “correct” model. Rather, models should be useful and easy to understand for whoever is the target audience.

Jamie said: "My assumption is that an intelligent schoolchild book on money does not exist. If it did exist, all economists would read that book and would understand the basics of money; non-economists would read that book rather than reading blogs; and there would be no need for Nick to create his own logic of money."

I fully agree. (With your other comments as well.)

I haven't talked about an "intelligent schoolchild" -- that's a nice and accurate way to put it! -- but I think I'm saying the same when I say that there is hole in economic theory. No one has been able to explain money so that intelligent people would understand it, and could agree on what money is. For instance, many New Keynesians really are very intelligent people (on average probably more intelligent than Post-Keynesians), so it cannot be that they just "don't get it". Even though Post-Keynesians get a lot of things right when it comes to money and the monetary system, they haven't been able to provide a coherent explanation on how it connects to the "real economy" -- at least not in the language of neoclassicals (I'm not saying they should provide a mathematical model -- but they should be able to make New Keynesians understand where exactly they go wrong.)

So, if we really understood money, then an intelligent schoolchild should understand it too. This is because money is a human invention; we're not talking about the theory of relativity or quantum mechanics.

"Nick ended up building a world of positive and negative money (as the media of exchange).

I ended up building a world without money (as the medium of exchange)."

Jamie, I would say there is a 3rd possibility.

Loans/bonds (including overdrafts) create demand deposits. Demand deposits are assets of the holders. Demand deposits (and currency) are used for asset swaps for exchanges in the real world. There is no negative (red) money. Demand deposits and currency are MOA and MOE with a fixed exchange rate "both ways". The loans/bonds "back" the demand deposits (the loans/bonds can be used to remove the demand deposits from circulation in the real world).

"i.e. on that last point

an overdraft is not "negative money" in either the real world or the imagined green only world

it is a form of borrowing in either of those"

And, "Nick: “I would say that my having A LOAN IS DIFFERENT FROM my having RED MONEY, in the same way that my having a bond is different from my having green money. If I get rid of the bond I own, I accumulate green money (or decumulate red money). If I get rid of the loan I owe, I accumulate red money (or decumulate green money)” (Jamie’s capitalisation)

And

Nick: “my father used red money for most of his life. He nearly always ran an overdraft in his chequing account”

I read Nick’s two statements as being inconsistent with each other. An overdraft is just a type of loan which can be activated by the customer at any time (up to a pre-agreed limit)."

I totally agree that an overdraft is just a type of loan. I would say owing red money, owing a loan, and owing a bond are the same thing (owing means it is that person's liability). Owning red money, owning a loan, and owning a bond are the same thing (owning means it is that person's asset).

I would also say Nick's dad had a "home equity line of credit" (more like a land equity line of credit). That is just another case of loans create demand deposits. No red money.

"We all understand almost everything about the world at the level of an intelligent schoolchild. If you wish to explain any technical subject to non-experts, that is the level of understanding you must assume. However, the Post-Keynesian literature about money and banking seems to cater only for people who are already specialists in money and banking.

I have no ambition to be an expert in the operation of the monetary system. I want to understand enough to be able to explain the basics to other non-economists in easy to understand language."

I totally agree about the intelligent schoolchild. Jamie, one thing you need to understand is how a levered hedge fund works. That can be applied to commercial banks. That can be applied to central banks. There a few "rule changes" along the way. Have you ever done the accounting for a levered hedge fund or for starting a new bank?

“If you grow apples and sell them, you are a business. Many people are both businesses and households. The two roles are not mutually exclusive. There is no point in distinguishing the terms “business” and “household” only to allow them to merge back together.

Also, the objective is to design a relatively simple model which handles most situations. It is not to re-build the real world complete with every imaginable exception condition. If we try to do that, we lose sight of the main objective. However, that requires judgement and people make different judgements. There is never one “correct” model. Rather, models should be useful and easy to understand for whoever is the target audience.”

I believe you can have a simple model with a self-employed business/household and a “shareholder” business. I believe you will need that distinction in your model to help describe what is going on in an economy.

Antti: “many New Keynesians really are very intelligent people (on average probably more intelligent than Post-Keynesians)”

Almost all economists are intelligent and well-intentioned. The ones I have interacted with certainly are. I don’t think that there is any evidence that one group is more intelligent than another. Maybe a few individuals are more intelligent, or have superior skills, but that is about the merits of specific people rather than a school of thought e.g. Paul Krugman is the only economist, in my experience, who seems to understand my point about writing for intelligent schoolchildren (although I’m sure he would not use that phrase).

From my perspective, the issues are mostly cultural. To use an economics analogy, academic economists behave like the worst sort of monopolist suppliers – the culture is closed, stagnant and unresponsive to changes in demand from the rest of the population. Academic economists are the Soviet Union of academia. In the UK, we have student groups (supported by the Bank of England!!!!) demanding change in the curriculum but the academics are mostly unresponsive.

Antti: “it cannot be that they just ‘don't get it’”

Yes it can. The different schools make different assumptions about what is important and what is not, and build logic on top of these assumptions. If you take the assumptions away, the logic falls apart. Each school looks at the other schools and sees assumptions they don’t agree with, so they switch off and don’t think about the logic further. You can see that in the way they argue with each other. Intelligent people tend to believe that their assumptions are “true” whereas they are just assumptions. I have seen that in many situations – including in your comments here! A key indicator for this is that economists almost never state their assumptions. If you state an assumption, anyone can say that they don’t agree with the assumption.

“Let’s assume that the central bank doesn’t matter much”! “No, let’s not”! End of debate.

Another point is that in terms of team roles, there seem to be few team leaders or consensus builders in economics, so the groups don’t seem to mix much or build relationships.

Finally, I have read your blog posts. I tried to post a comment as Jamie, as I do on other blogs, but it wouldn’t let me. It wanted a specific user id. I prefer using a pseudonym. It’s the quality of the argument that matters – not the name on the tin. If you want me to post, you’ll need to change the security settings. I know that is easy to do on a blogspot blog, but it’s up to you if you want to.

TMF,

You quoted someone saying “I ended up building a world without money (as the medium of exchange)” and then addressed me. However, it was not me who said that. The real world, including money as the medium of exchange, is ok by me.

TMF: “one thing you need to understand is how a levered hedge fund works”

No, I don’t think I do. The simple examples in my slides cover loans by commercial banks, bond issue and deficit spending by governments, and the creation of money for QE by central banks. I might perhaps extend my slides to illustrate what economists mean by terms like “helicopter money” (and its variants), settlement via the central bank, and the basic structural/governance difference between a national central bank and the ECB, but that’s more than enough for my intended audience. I’ll leave leveraged hedge funds to JKH and other full-time experts.

TMF: “I believe you can have a simple model with a self-employed business/household and a “shareholder” business. I believe you will need that distinction in your model to help describe what is going on in an economy”

As I said before, that’s a judgement call. I have other slide sets which contrast different business categories, but the categories I have in mind are different from yours. For example, I can contrast manufacturing businesses against service businesses including the differences in basic accounting, and I can show how Keynes’s basic I + C = C + S identity builds up on a transaction by transaction basis. And I can explain sector balances using the same simple examples.

Anyway, I’m signing off now. I have gleaned enough from JKH’s comments to meet my basic objective and there is no sign of a wider consensus building this time round. No doubt, we’ll meet again in a future Groundhog Day!

"You quoted someone saying “I ended up building a world without money (as the medium of exchange)” and then addressed me. However, it was not me who said that. The real world, including money as the medium of exchange, is ok by me."

True. I wanted you to look at those possibilities.

"No, I don’t think I do. The simple examples in my slides cover loans by commercial banks"

1) What if the commercial bank sets up a levered hedge fund to buy the loans on its books?

2) Is the commercial bank acting like a levered hedge fund with some different rules?

"TMF: “I believe you can have a simple model with a self-employed business/household and a “shareholder” business. I believe you will need that distinction in your model to help describe what is going on in an economy”

As I said before, that’s a judgement call. I have other slide sets which contrast different business categories, but the categories I have in mind are different from yours. For example, I can contrast manufacturing businesses against service businesses including the differences in basic accounting, and I can show how Keynes’s basic I + C = C + S identity builds up on a transaction by transaction basis. And I can explain sector balances using the same simple examples."

Can you see a difference if there is a productivity gain between a self-employed business/household and a “shareholder” business?

Jamie said: "Anyway, I’m signing off now. I have gleaned enough from JKH’s comments to meet my basic objective and there is no sign of a wider consensus building this time round."

Despite all the sensible things you say (I mostly agreed with your reply, which means that my particular comments weren't meant in the way you intepreted them -- which can be my fault), this made you sound like a jerk. You're aware of that?

Jamie said: " Intelligent people tend to believe that their assumptions are “true” whereas they are just assumptions. I have seen that in many situations – including in your comments here!" ?

I find it very impolite to say that "you say stupid things" without pointing at those things.

And then you don't comment on anything I brought up in my blog post aimed at you (which JKH agreed on, which means that you and I should agree?), blaming me because I have not enabled anonymous commenting (I thought I had). You couldn't post your comment here?

Talking about schoolchildren...

Nick, or anyone: Is my description of what Nick has done correct?

I don’t have much to add to the specifics at this point. Among other dilemmas, I’m not clear on who has what worlds, not having followed the entire discussion in sufficient detail to do that.

I’m cautious about spending too much time on “thought experiments”. This one is interesting, partly because it is a tester when it comes to the language of stocks and flows for both physical money and electronic money. I think the historical transition from physical money to electronic money makes this language/logic discussion very challenging.

The idea of “electronic” goes beyond carrying physical cash or physical securities around by hand or guarded truck. But the essence of it I think is that it greatly magnifies the reliance on bookkeeping – i.e. accounting.

I’m always perplexed when it comes to the perception of the economics profession about the role of accounting as it relates to the subject of economics. It seems like a kind of professional paranoia where the mere fact that accounting serves as a platform for observing the measured effects of economic behavior poses some kind of threat to the importance of or focus on the study of behavior itself. That is fundamentally irrational in my view. But that’s another story, probably for another planet. Maybe as a future afterthought to a Mars mission. Because I see it as a hopeless concern here on earth. I see absolutely no signs that the profession is budging on this deeply rooted bias – notwithstanding outside attacks from the heterodox (attacks that are still only oblique on the role of accounting in economics, IMO) and some of the correlated internal hand wringing coming from the mainstream profession since the financial crisis.

(I say all that - not with Nick in mind or directed at him - but with the overall profession in mind, including “heterodox”.)

Anyway, whether you frame the money story in terms of balance sheet stocks, debits and credits, loans, deposits and overdrafts – or in green and red money – it is difficult to deny that one is using some sort of accounting system such that stuff adds up (i.e. gets “counted”) in come coherent way across the total picture.

Green and red money, among other things, is an accounting system. Just like TARGET2 is an accounting system.

But we should consider that, along with real world money, there is a real world accounting system.

And there is a specific type of accounting known as “flow of funds” (source and uses of funds at the micro level).

So the idea of “flow” fits in there.

And the idea of “stock” fits into balance sheet accounting.

This is where the heterodox chant of “stock flow consistent” actually comes from.

It doesn’t come from the idea of a flow of physical money.

Flows are merely changes in balance sheet stocks for a given accounting period.

This is comprehensive, so it covers both physical and electronic forms of money.

If your starting point for understanding money is the original stuff of physical money, I think making the transition to the incorporation of and integration with the idea of electronic money becomes problematic. Notwithstanding the arc of historical evolution, I think following this arc directionally in trying to put together a coherent story for money ends up muddied. Given the complex nature of the integration, it becomes necessary to start where we are in the electronic world, and if anything work backwards logically to the idea of physical flows where they exist. And that's really because of the role of accounting in economics.

I think I mostly agree with JKH here.

Any(?) accounting system has both stocks and flows. The flows are just the rates at which stocks are changing. Whether there is some sort of stock or flow of "things" is a separate question.

"Green and red money, among other things, is an accounting system. Just like TARGET2 is an accounting system."

Or maybe "record keeping system"?

I remember reading a story about a railway tunnel. For safety, they needed to make sure only one train entered the tunnel at a time. So they made a special stick, that the train driver had to carry before entering the tunnel. Think of that stick as like a very simple computer program. Physical paper money is like that stick.

Antti,

I apologise if I have upset you. That was not my intention.

One of the odd things about people (ALL people, including me) is that when we talk generically about “people”, we really mean “other people”. We (ALL, including me) imagine that we are not “people”. We are sitting outside of ”people” passing judgement on “people”.

All of the arguments on here include a healthy dose of assumptions, including my arguments. My slides attempt to make my assumptions explicit – something that my training tells me is important in this type of debate as, otherwise, the assumptions go unspoken and other people make assumptions about my assumptions which are also unspoken.

Others disagreed with some of my assumptions. For example, TMF said that my assumptions wouldn’t account for certain situations. I have a note to myself to extend my assumptions when I update my slides to take account of these issues. My assumptions, like anyone else’s assumptions, are not facts, so it doesn’t make sense to defend them as though they are facts.

When I say that “Intelligent people tend to believe that their assumptions are ‘true’ whereas they are just assumptions”, most intelligent people agree that what I say is true of “intelligent people”. However, when I point out (as I did here) that Antii is an intelligent person, so the rule applies to Antti just as much as to everyone else, I am told that I am a “jerk” (I am not offended by the way – I have been called much worse things) and that I am saying that “you say stupid things" even though I didn’t say that or anything like it. I wouldn’t debate with you if I thought you were stupid.

Take a trivial and very recent example. You said: “many New Keynesians really are very intelligent people (on average probably more intelligent than Post-Keynesians)”.

You presented no evidence for this statement, so it is an assumption. It doesn’t bother me that you think that Post-Keynesians are less intelligent that New Keynesians, as I am not an economist of either school. However, I imagine that any Post-Keynesian economist reading this thread would disagree with your assumption, and possibly consider you a “jerk”. (I am sure you did not intend this any more than I did).

I am still happy to come over to your blog to have a more specific debate. There is no point in us having that debate here as others will not be interested, and no-one here would be able to follow the debate if I am replying here to points you have made somewhere else. However, I prefer to comment using a pseudonym and as I said previously, “it’s up to you if you want to” allow me to do this.

If you prefer, I will make a general comment here. However, I think that detailed points are better taken offline, so I’ll stick to generalities. Some of your points require me to explain the background to my own thinking e.g. why do I use the term “manufacturing” in this debate and that is miles off-topic for this thread.

Finally, when I say “I have gleaned enough from JKH’s comments to meet my basic objective”, I am talking about JKH’s comments on how things work in the real world, which is my main area of interest. In your discussions with JKH, you seem to be talking about Nick’s red world, and I have not thought about that world too much as it is not my main interest. I agree with some of Roger Sparks’ recent points on your blog on that matter.

"Others disagreed with some of my assumptions. For example, TMF said that my assumptions wouldn’t account for certain situations. I have a note to myself to extend my assumptions when I update my slides to take account of these issues. My assumptions, like anyone else’s assumptions, are not facts, so it doesn’t make sense to defend them as though they are facts."

Jamie, here are one or 2 other things. It appears your commercial bank starts with no capital.

I tried that once with JKH.

JKH said starting a new bank requires capital (usually stock issuance).

Also, state assumptions. Run the model. If reality disagrees, then maybe the assumptions are wrong. Economists like to leave assumptions unstated. Then when reality disagrees, they don't question the assumptions.

All,

I agree with JKH too but I suspect that we all agree with him on different things. Some general points.

In the larger game, everyone who is still reading this is on the same side of the great money debate. Money matters in macroeconomics! That always gets lost in the detail of these debates.

However, the dominant group of academic economists – the New Keynesians - do not agree, so what do we need to do?

First, ask who would agree that money matters in macroeconomics if only we could explain it to them?

Answer: Everyone on the planet except New Keynesian economists (and probably a few economists from other schools). So, why start by trying to convince the New Keynesians? It will be easy to persuade everyone else, and almost impossible to persuade the New Keynesians. Imagine if Samsung started to market their phones by persuading Apple employees that Samsung phones are better. It wouldn’t happen. Apple employees are the last people on earth who will be persuaded of the merits of Samsung phones.

Leaving aside all the technical rights and wrongs of the matter, this is how Steve Keen markets himself. This is also why non-economists who are interested in economics tend to support Steve Keen even if his colleagues suspect the technical merits of his work. It’s also why many non-economists end up focussing on Post-Keynesian economics, more broadly, even though the rest of the economics profession ignores the Post-Keynesians. Unfortunately, Keen aside, Post-Keynesian economists have no idea about marketing themselves (except Cullen Roche, but he is not an economist).

Second, set out a description of money at the intelligent schoolchild level, as that is the level that the rest of the planet will be able to understand. (It’s also the level that the New Keynesians would understand, if they were listening).

The problem with this is that there are a few people, like JKH, who know the right answer to how money works, but they talk about the answer as experts talking to other experts, rather than trying to address a more general audience who would be receptive to a simple answer but who glaze over at the first mention of anything complex.

I remember a debate on UK TV between Paul Krugman and a couple of austerity bugs. The discussion went nowhere and, at one point, Krugman lost his cool slightly and said something like “Look, my spending is your income, and your spending is my income. That is why austerity doesn’t work”. What I don’t understand about economists is why Krugman didn’t START the debate by making this point. Why wait until you are frustrated to make the single most powerful yet simple point that a general audience might understand?

Note also that, in accounting terms, Krugman’s quote is about quadruple entry. In my terms, it’s about seeing the world from multiple perspectives at the same time. Also, the Paradox of Thrift is not a paradox from this perspective. It is obvious – which is why it is such a powerful point.

Third, focus on what non-economists understand and simplify the message ruthlessly until they DO understand. The quality criteria are that non-economists (including policy makers) can understand the message. Ignore technical experts, and others, who want to make the answer more complex than necessary to demonstrate their own technical prowess. Don’t ignore them when they are talking about whether the core message makes sense though!

Fourth, think outside the box. For example, I didn’t fully understand Keynes identity I + C = C + S until I used a thought experiment where I imagined an economy where only a single transaction occurs anywhere in the economy in an entire accounting period. The identity MUST then be consistent with the accounting for that transaction. I have some examples of this if anyone is interested. I would also be interested in how economics students reacted to these examples and whether they helped them to understand the identity.

This is a VERY simple idea. However, economists think about Keynes identity at the total economy level, so it doesn’t occur to them to think about how the identity builds transaction by transaction. Also, they don’t understand that, as it is true for every transaction, the identity is true always and everywhere (this is a point that JKH often makes in other contexts).

Fifth, keep it simple. The objective is to explain the real world. Introducing several alternative worlds is unnecessarily complicated. Nevertheless, keeping it simple might involve using simplifying ideas like green and red money, as long as everyone agrees precisely what is meant by these terms. For example, if green = asset = positive value and red = liability = negative value. In my experience, most people (including me) can never remember what is a credit and what is a debit in accounting, so using green and red removes the need for non-accountants to remember this detail and allows them to focus on the core message.

Sixth, manage the team. Invite people into the team who might help in a specific way. For example, I am sure that Steve Keen would love to help market this type of idea. Face up to disagreements in the team which are essential to the message. For example, Nick’s dad’s ongoing overdraft was a loan. It was not money. A loan is not the medium of exchange. When this type of issue arises, focus the debate on the issue until it is fully resolved. Rehearse the core message within the team before issuing it to the wider world. Think, in advance, about possible criticisms and develop agreed responses, so that the message is not derailed by the first simple question that anyone asks.

TMF: "It appears your commercial bank starts with no capital"

I agree that this is a missing assumption. However, I would prefer an assumption here that restricted the scope of the model to ongoing banks with sufficient capital. I always imagine that capital is about the limits of what a bank can do e.g. how many loans it can make at one time whereas this model is just trying to explain the very basic operation of a single loan.

Again, this is a matter of judgement. In my mind, models are intended to help solve specific problems. If we are trying to explain basic concepts like lending then capital is an extra complication that might take away from the key message.

You are certainly correct that, if we were discussing a more advanced model of a bank, that capital should definitely be included.

One of the uses of assumptions is that you can use them to keep a problem simple. However, they are also a memory jogger. For example, in a real world project, after we had solved the initial problem where we had assumed an ongoing bank, you would be able to point out that we had not solved the more general problem where we removed the assumption. We could then debate what to do about that and whether it was important.

I always get the impression that you want to solve lots of problems all at the same time. Unfortunately, in my experience, that doesn't work in the real world. Increased complexity almost always means increased risk of failure. Again, this is about judgement so there is no right or wrong answer.

Nick: “I remember reading a story about a railway tunnel. For safety, they needed to make sure only one train entered the tunnel at a time. So they made a special stick, that the train driver had to carry before entering the tunnel. Think of that stick as like a very simple computer program. Physical paper money is like that stick”

Yes, that’s a nice example. The logical problem is how to make sure that only one train enters the tunnel at a time. That requires a logical device. However, it doesn’t matter whether the physical form of that device is a stick or a flag or an entry in a computer system. The underlying logic is the same.

Jamie: An interesting perspective. I think I agree, even if I find some of the parties hard to localize.

I think I will focus only on the disagreement example "For example, Nick’s dad’s ongoing overdraft was a loan. It was not money. A loan is not the medium of exchange. "

I know that Nick will disagree with my perspective but I think that when Nick's dad brought in the bank by creating an overdraft, Nick's dad was bringing a third party into his system of business. That third party brought in a real physical tool called money, which Nick's dad used to further his business. Now, we can argue whether money is real or not. For me it both is and is-not; we need to define the field of reality very carefully.

Those who are interested can probe my view of reality further in Antti's blog at

http://gifteconomics.blogspot.com/2016/11/in-land-of-color-blind-neither-borrower_26.html?showComment=1480429550953#c639412785478754457

One very good thing about Nick's green/red money concept--It certainly has provoked a lot of thoughtful discussion!

Jamie

“What I don’t understand about economists is why Krugman didn’t START the debate by making this point.”

Funny story. The truth comes out.

Reminds me of some related cross currents with Krugman in the middle. Like his skirmish with Steve Keen a few years back when (appropriately) he questioned Keen’s mix up of income/expenditure and debt flow of funds accounting in proposing a laughably dysfunctional new age definition of aggregate demand. Like his related skirmish with the MMTers when astonishingly he seemed not to be able to wrap his head around the fact that commercial banks create money in the process of new lending. Like the MMTers taking national income accounting (appropriately) as raw material and then mangling the exercise with ambiguously misleading statements about the definition of saving and spinning recklessly about "consolidation" as if the manager of the Fed SOMA account was the same guy who wrote the social security cheques. Like most everybody (I think) not appreciating that Keynes anticipated national income accounting as the sine qua non of completing the General Theory and absolutely necessary for framing crucial concepts like the paradox of thrift. Like Krugman being a leading sponsor of the greatness of the General Theory.

What a swirl.

"TMF: "It appears your commercial bank starts with no capital"

I agree that this is a missing assumption. However, I would prefer an assumption here that restricted the scope of the model to ongoing banks with sufficient capital. I always imagine that capital is about the limits of what a bank can do e.g. how many loans it can make at one time whereas this model is just trying to explain the very basic operation of a single loan.

Again, this is a matter of judgement. In my mind, models are intended to help solve specific problems. If we are trying to explain basic concepts like lending then capital is an extra complication that might take away from the key message."

I will try to keep it simple with a message about "money".

I save $50 in demand deposits. I lend $50 to someone else who spends it. Aggregate demand remains the same in the present.

I save $50 in demand deposits. I start a bank with a 10% capital requirement with the $50 of demand deposits. Instead, I now lend $500 to that same person who spends it. Aggregate demand increases in the present by $450.

That can depend on the time period chosen.

There is a capital multiplier. Ask JKH.

I hope that is simple enough.

JKH: I agree that it is important to keep in mind the monetary history. I think that explains how we think and talk about money.

You said: "I think the historical transition from physical money to electronic money makes this language/logic discussion very challenging."

I don't know what exactly you mean by that transition: That we used use more cash, now we use less? The way I'd look at this transition is this (I don't think you need this lecture, though...):

We have had physical money and account money -- both are record-keeping systems, and are often but not always intertwined -- side by side for thousands of years. For long, account money was reserved mainly for businesses and larger transactions involving wealthy individuals, although it had its place also in tight-knit communities where it didn't even always require a bank.

Advances in information technology have allowed us to move from physical money to account money on a scale never seen before. Account money has replaced physical money in areas where the latter used to rule. I wouldn't call the former "electronic money", because to me that suggests there's a link between physical money and "e-money", as if the latter was the former's electronic version. No. The latter is an electronic version of account money, and what makes this simple is that we don't need to call it by any other name, because it is still account money just like it has always been -- only the recording medium (of the ledger) has changed from clay tablets to papyrus to modern paper sheets to silicon.

You said: "Given the complex nature of the integration, it becomes necessary to start where we are in the electronic world, and if anything work backwards logically to the idea of physical flows where they exist. And that's really because of the role of accounting in economics."

That is exactly how I approach this. Accounting is primary, currency is secondary. Once one understands the accounting, one will understand what kind of role currency plays as part of the accounting.

You said: "Flows are merely changes in balance sheet stocks for a given accounting period."

I understand this. But I'm on a mission against this kind of figurative flows as well :-) So I don't suggest that you see a physical object moving when you talk about flows. By the way, what are "funds"?

Why do I want to scrap the implicit model -- this includes money, or funds, flowing from an account (or holder) to another; never balance sheet, which just reports account balances -- most of us use when we try to make sense of the monetary system? Take a look at my second and third post.

In the framework/theory I'm building it would make no sense to talk about any flow of anything else than goods. There was no flow of "money" or "funds" from/to/between Andy's and Betty's account.

I know very little about physics, so the next example is inaccurate and most likely outright wrong, but I proceed anyway. I've understood that one example of "spooky action at a distance" could go something like this: we give a positive spin to particle A and at the same instant particle B, automatically, gets a negative spin -- although particle B is so far from particle A that not even light could have travelled between the particles between the two events (positive spin created -> negative spin created). So, no information, nothing, "flowed" between the particles and still B got a corresponding negative spin when A was given a positive spin. (I don't even know if one "gives" "spins" to particles... All this is from my memory, perhaps I read something like this in Isaacson's Einstein biography.)

There you have it: Account A is credited and Account B is debited, without anything travelling between the accounts. (All physicists who are reading this: Think hard if accounting could tell you something about "spooky action at a distance"!)

TMF: Good example BUT I think you can only lend $450. Then you add the original $50 to $450 to get $500 in total deposits. Your capital requirement is 10% so the original capital of $50 is adequate for $500 in deposits.

The unmentioned assumption here is that the deposits all remain in your new bank. If the loan is spent into another bank, a capital transfer will need to occur.

Does this make sense?

I said: "the implicit model -- this includes money, or funds, flowing from an account (or holder) to another; never balance sheet, which just reports account balances -- most of us use"

I was wrong. The model we use includes balance sheets. We are used to think in terms of a balance sheet which represents reality to us, because the balance sheet is a useful model of reality. So nothing wrong in thinking in terms of a balance sheet, as long as one keeps in mind that it is a model.

Roger, I am pretty sure "MY" bank can lend $500. When "MY" bank buys the loan part/bond from the borrower, the loan part/bond gets a capital requirement.

$500 times 10% is $50.

Maybe I should say I save $50 in demand deposits and use it to buy $50 in stock that "MY" bank issues. I own "MY" bank.

I hope JKH can verify.

Here's finally the post on overdrafts I've wanted for so long to write: A Bank "Loan" Is An Overdraft; It Is Not a Loan.

I'd be happy if Nick could confirm some parts where I speculate about his thoughts (I mention you by name in those parts). And could you also confirm if this describes the way you interpret an overdraft (not involving "green money"):

"By agreeing[1] with his bank on an overdraft facility (a "credit line") connected to his checking account, the customer can spend money he doesn't have[2]. The customer incurs debt by using the overdraft – in the textbook case – to purchase goods[3] and repays that debt by selling goods."

Antti

“We have had physical money and account money -- both are record-keeping systems, and are often but not always intertwined -- side by side for thousands of years.”

Point taken. I was looking for terminology other than electronic money. But physical money is also reflected as a balance sheet account, so that distinction seems a little blurred as well. Also, I mean electronic money in a generic sense – like the stuff that can appear on a bank or household computer screen – not the more recent so-called e-money concept. Anyway, not perfect terminology.

I define “funds” implicitly in the context of flow of funds (macro) or sources and uses of funds (micro) accounting. This is generally about the flow of money, without getting too cute about the definition of money in its various forms. Because there are different forms of money. It is contextual.

That also allows for examples that may seem somewhat counterintuitive at first. Here’s one that’s illustrative:

Suppose a bank creates a new deposit from a new loan. Suppose nothing else happens immediately. No spending. No further acquisition of financial assets such as bonds, etc.. Then the flow of funds report for that accounting period will show the deposit as a source of funds and the loan as a use of funds. This is a counterintuitive example for some people to absorb – particularly those who get hung up on the MMT/post-Keynesian chant of “loans create deposits”. My point would be that there is nothing wrong in fitting such a simple banking transaction into a common framework that can accommodate all transactions. The fact that the money creation process is a little unique in this context shouldn’t prevent it from being captured consistently in such a framework. There’s nothing to preclude the interpretation that deposits fund loans in the here and now, even though “loans create deposits” at the point of origin. The argument against this interpretation depends mostly on a lack of imagination in my view. Such a common framework is a starting point in terms of understanding aggregation in money, banking, and economics.

The reason I highlight this example is that it is a very important one in the context of Keynes’ General Theory. He basically debunked the loanable funds approach by introducing the idea of “financing”. The example above is about financing. It is logically prior to the action of investment and associated saving. Loanable funds is a theory of how the rate of interest is determined by some sort of “equilibrium” whereby realized saving equals realized investment. But Keynes pointed out correctly that actual saving and investment are always equal in value, so there is no meaning to the idea of a realized equilibrium of saving and investment and there is no way that such an idea could account for the rate of interest. So the dynamics of financing – which occurs in an elementary way when “loans create deposits” – is where to look for the determination of the interest rate. And so with the introduction of financing, as distinct from saving and investment, Keynes anticipated national income accounting and flow of funds accounting and the distinction between the two of them, and how they come together in a complete accounting framework. Loanable funds by contrast mangles a mix of national income (which includes saving and investment) and flow of funds accounting. Keynes undid that mess. (Although Hicks went on to immediately re-mangle it by using loanable funds as a sub-component of ISLM)

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