Frederick Soddy on Endogenous Money & Debt-Deflation

By Brett Fiebiger, PhD

“Soddy distilled his eccentric vision into five policy prescriptions, each of which was taken at the time as evidence that his theories were unworkable: The first four were to abandon the gold standard, let international exchange rates float, use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort. All of these are now conventional practice. Soddy’s fifth proposal, the only one that remains outside the bounds of conventional wisdom, was to stop banks from creating money (and debt) out of nothing.” – Eric Zencey, Mr. Soddy’s Ecological Economy, 11 April 2009.

Some economists are new to endogenous money though it is has long been recognised. Here is Frederick Soddy, Wealth, Virtual Wealth, and Debt, George Allen and Unwin, London, 1926, p. 147:

THE PRIVATE ISSUE OF MONEY; A CHANCE RESULT OF THE BANK CHEQUE SYSTEM

No doubt there are still many people, if not the majority, who will be frankly incredulous that money vastly exceeding in amount the total national money can be, and is created and destroyed by the moneylender with a stroke of the pen. How frequently does one still read in the Press that the banks can only loan their customers spare money! Most people still think of what money once was, “a public instrument owned and controlled by the State.”

Alas, nearly ninety-years later, the mainstream economics profession has yet to realise basic facts of how the modern monetary system functions. There is much relevance in Soddy’s work to those who deride followers of the endogenous money approach as “money mystics” and also to those who adhere to State-centric theories of money. More from Frederick Soddy, The Role of Money, George Routledge and Sons, London 1934, pp. ix-x:

“This book will show what money now is, what it does, and what it should do. From this it will emerge the recognition of what has always been the true rôle of money. The standpoint from which most books on modern money are written has been reversed. In this book it is not treated from the point of view of bankers—as those who create by far the greater proportion of money—but from that of the PUBLIC, who at present have to give up valuable goods and services to the bankers in return for the money that they have so cleverly created and create. This, surely, is what the public really wants to know about money.

It was recognised in Athens and Sparta ten centuries ago before the birth of Christ that one of the most vital prerogatives of the State was the sole right to issue money. How curious that the unique quality of this prerogative is only now being rediscovered. The “money power” which has been able to overshadow ostensibly responsible government, is not the power of the merely ultra-rich, but is nothing more nor less than a new technique designed to create and destroy money by adding and withdrawing figures in bank ledgers, without the slightest concern for the interests of the community or the real rôle that money ought to perform therein… To allow it to become a source of revenues to private issuers is to create, first, a secret and illicit arm of the government and, last, a rival power strong enough ultimately to overthrow all other forms of government [Emphasis added].”


The context is that the banking community plus orthodox economists were denying that banks can create money ex nihilo; the former knowing full well the opposite to be true; and at least some of the latter also knowing but playing along. Why? Soddy (1934, p. 7) was not unaware of class issues: “Orthodox economics has never yet been anything but the class economics of the owners of debts.” Soddy (1934, p. 51):

The Banker as Ruler.—From that invention dates the modern era of the banker as ruler. The whole world after that was his for the taking. By the work of pure scientist the laws of conservation of matter and energy were established, and the new ways of life created which depended upon the contemptuous denial of primitive and puerile aspirations as perpetual motion and the ability ever really to get something for nothing. The whole marvellous civilisation that has sprung from that physical basis has been handed over, lock, stock, and barrel, to those who could not give and have not given the world as much as a bun without first robbing somebody else of it… The skilled creators of wealth [in industry and agriculture] are now become hewers of wood and drawers of water to the creators of debt, who have been doing in secret what they have condemned in public as unsound and immoral finance and have always refused to allow Governments and nations to do openly and above aboard. This without exaggeration is the most gargantuan farce that history has ever staged.

Why was Soddy so vehemently against the Bankers/Rentiers? Remember the context. We had in the 1920s simmering tensions over war reparations from World War I being fought for whose interests: those of the creditors within creditor nations. In the UK the complaint was that international debts were not being paid at the pre-war exchange rate parity. The world had also endured a history of certain banking houses (sometimes family) influencing public policy while maintaining a sham that private bankers were not money creators (clearly, purely historical because we solved Wall Street having too much influence on policymaking objectives that would assist Main Street). Later, in the 1930s amidst the Great Depression, it was financial interests who were the most vocal in advocating for sticking with the rigidities of fixed exchange rates with gold convertibility. Soddy (1926) called for fiat money and reiterated that call in the following quote:

Free the Exchanges.—As regards its external economic transactions, both with other nations and with the members of its own family, free the exchanges and put them also under national supervision. Let them find their own level and not drag down nations to the level of the lowest. Let us forget how many dollars in America, francs in France, or marks in Germany used to go to the pound under the gold-standard… Reduce gold to the rank of a commodity merely for convenient international settlement and let it be bought and sold like any other goods (Soddy, 1934, p. 122).

Frederick Soddy is an intriguing though largely omitted character in the history of economic thought. In 1921 he was awarded the Nobel Prize for Chemistry for pioneering work on atomic transmutation (including such things predicting as the existence of isotopes). Soddy was dismissed as a “crank” by his opponents on at least two occasions. Firstly, understanding the potentials of nuclear energy, he expressed concerned that a government might do something outrageous like use the power of radioactivity to make a weapon (say a nuclear bomb). He turned to the field of economics because he saw the intense competition amongst nations (wars for resources) and control over money as was what wrong with human civilisation. Soddy (1926, p. 23, 31):

Have we obtained dominion of the major powers of Nature to fall a victim to our own machinery and ultimately to be destroyed by it? Is our civilisation to end in breeding the Robot [war machines] and the rentier, and to go down under class conflicts at home and fratricidal wars abroad? Is there much point in multiplying by a million the powers already conferred by science if the use we make of those we already have are sufficient to endanger the future of civilisation?

… What is the evil genius that perverts even the fulfilment of our sanest hopes and labours, and makes progress more like a nightmare climb among slippery slopes of ever-increasing steepness, than the mass march of humanity along a broad high road, made straight and smooth by increasing knowledge, order and law? Is it idle to aspire to a more dangerously exalted civilisation until something of the definiteness and certainty of the economics of a fuel-engine can be extended to the economy of men. So that the crying need becomes not for ever and ever greater accessions of physical power, but for the knowledge how to secure the fruits of what we already possess. The strong still plunder the weak, nations and individuals alike, whereas there is that in the growth of knowledge which would make the whole world kin. But that cannot come about until we understand what is wrong, nor whilst we attribute to an economic system mysterious powers which a physicist would laugh at.

Soddy was called a “monetary crank” for describing endogenous money. Soddy (1934, p. 62-3):

Genuine and Fictitious Loans.—For a loan, if it is a genuine loan, does not make a deposit, because what the borrower gets the lender gives up, and there is no increase in the quantity of money, but only an alteration in the identity of the individual owners of it. But if the lender gives up nothing at all what the borrower receives is a new issue of money and the quantity is proportionately increased. So elaborately has the real nature of this ridiculous proceeding been surrounded with confusion by some of the cleverest and most skilful advocates the world has ever known, that it is still something of a mystery to ordinary people, who hold their heads and confess they are “unable to understand finance.” It is not intended that they should.

Soddy and Debt-Deflation: Give some Kudos Please

Soddy (1926) proposed abolishing private bank money creation. Irving Fisher came a decade latter (Irving Fisher, 100% Money, The Adelphi Company, New York, 1935) but forgot to say where in might have read it elsewhere. Quoting now from Soddy (1926, pp. 157-8):

It is easy in criticising the monetary system to give a false impression of what it really was. Though by the creation of money and the inflation of the currency by bank credit the community as a whole are robbed of the wealth equivalent to the new creation, it must not be supposed that the banks ever had or claimed any legal title to the ownership of the money so created. They got the permanent use of it and the ownership of the interest it was issued for. The industries to which the money was lent got from the community for nothing–at the expense of the general purchasing power of money–the wealth they purchased with the new money, but had to restore it when the loan was repaid and the credit cancelled. In practice if was never more than temporarily cancelled; it was renewed to other borrowers on the first opportunity.

Soddy (1926, p. 158) then describes a “debt-deflation” process which Fisher (‘The Debt-Deflation Theory of Great Depressions’, Econometrica, vol. 1, 1933, pp. 337-57) was to claim as his own idea:

The banks traded on a monetary capital they created themselves, but made no pretensions to possessing. If they were wound up and their businesses discontinued all of the excess of their liabilities over their assets would have to be made good by those to whom they have lent money. The quantity of money would be reduced then to, say, one-sixth of the present amount or less. Prices, “in the end,” would be reduced to one-sixth unless a corresponding quantity of genuine national money were issued to take the place of the fictitious money destroyed, though, as Mr. Keynes has sagely observed in a similar connection, “in the end we are all dead.” If this were not done, the last loan to be recalled would have to be paid in money worth six times that at which it was issued, and the average for the whole amount of the loans would be over twice their initial purchasing power. This is a somewhat vital distinction between real money and the phantom money being described. With the repayment of a genuine loan the quantity of money is not affected. With the repayment of fictitious loans there is so much less money in existence, so that repayment becomes increasingly difficult as it is enforced. If issued in boom and cancelled in slump they are repaid in units of money worth more than when borrowed.

Soddy (1926, p. 174-5) informs on ‘the evils of a shortage of currency [i.e. money including that issued by banks]’ in the context of price-deflation that this is because “In general all debts would have appreciated in real amount, as money prices fell. The dead hand of the past would have been heavy on the land.” He then goes on to lay out the argument in more detail starting first by noting what economists would later call “sticky prices”:

PRODUCTION REDUCED RATHER THAN PRICES. But the really vital evils of a currency scarcity are due to its reducing production rather than prices. The quantity theory of money [in footnote: For an exposition of the quantity theory of money see Irving Fisher The Purchasing Power of Money] works beautifully one way. Increasing the quantity of money temporarily increases, but makes no very lasting difference to, the aggregate virtual wealth, and prices very quickly rise in proportion to the increase… But decreasing the quantity of money is apt to decrease virtual wealth in proportion much more permanently, leaving prices unchanged and production reduced through the ruin of those engaged in enterprise.

… Whereas an excess of money is an inducement to sale, a deficit is a fatal barrier. To the vendors, whose business if is to sell wealth for money, money is the primary consideration. To the buyer and consumer wealth is. The consumer is exposed to increased competition with others, due to an increase of the quantity of money, and is powerless to resist a rise in prices. But no one in his senses, who has produced wealth for sale or caused it to be produced, and has, over a period of past rime, incurred the charges involved in production, is going willingly to sell it at a loss to suit the quantity theory of money. If his competitors essayed to do so, they could hardly compete long. The result is that less goods are bought with the less money at the same price, not that the same goods are bought at a reduced price. Or, in the case under consideration, that the opportunity to increase production by new inventions remains for long unexploited, and, with increasing powers of production, the production of wealth, as in this country now, stagnates.

Observe the explicit reference to Fisher and an argument that his theory only works one way. The argument in the above quote was that even with a fall in the quantity of money (i.e. money destruction) that prices may not fall and instead the economy suffers a contraction due to a decline in output (or stagnates). Soddy (1926, p. 175-6) acknowledges that for a period of rising prices “the quantitative theory is a rough guide to the facts” but that for a period of deflation “it would work if it did not have the unfortunate consequence of ruining those committed to enterprise–labour and capital alike–and, in the end, in Mr. Keynes’ sense of the word, “after we are all dead,” no doubt must work.” In plainer language: it won’t work.

Here is the opening quote to Fisher’s (1933) now famous article on debt-deflation:

In Booms and Depressions [1932], I have developed, theoretically and statistically, what may be called a debt-deflation of great depressions. In the preface, I stated that the results “seem largely new,” I spoke thus cautiously because my unfamiliarity with the vast literature on the subject. Since the book was published its special conclusions have been widely accepted and, so far as I know, no one has yet found them anticipated by previous writers, though several, including myself, have zealously sought to find such anticipations. Two of the best-read authorities in this field assure me that these conclusions are, in the words of one of them, “both new and important.”

Smell a rat? There is an unusual degree of professing originality; first, admitting unfamiliarity with the literature and then proclaiming finding nothing in spite of zealous searching. The Nobel Laureate calling economists dismal scientists was perhaps not on his reading list. Was it just another coincidence that Fisher’s (1935) proposal for monetary reform was also a carbon-copy of that put forward by Soddy (1926, 1934)? This is the gist of Fisher’s (1933, p. 40-1, 44) debt-deflation:

I venture the opinion… that, in the great booms and depressions… [the two dominant causative factors are] over-indebtedness to begin with and deflation following soon after.

… The two diseases act and react on each other … deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed. Then, the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owned. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe [Emphasis in original].

I cannot see endogenous money anywhere in his version of debt-deflation. Soddy (1926, p. 174-5) told us that the problem with price-deflation is that “In general all debts would have appreciated in real amount, as money prices fell.” Soddy (1926, p. 158) already clarified in an earlier passage that with a reduction in the quantity of money by one-sixth and supposing any equal fall in prices (specifying an interrelation) that a debtor’s debts “would have to be paid in money worth six times that at which it was issued” and that with “so much less money in existence… repayment becomes increasingly difficult as it is enforced.” Fisher’s (1933) “debt-deflation” was inferior actually defective when compared to Soddy (1926) as he: (1) omitted bank money and its destruction from the story (vague “dollars” repaid not destroyed); and, (2) in the words of Hyman Minsky “did not explain how overindebtedness developed (‘Financial Instability and the Decline (?) of Banking’, Levy Economics Institute, October 1994, p. 6).“ Here is Soddy (1934, pp. 70-3) on The Credit or Trade Cycle:

1. A period in which the increase of money (through more bank loans on the average being issued than repaid) occurs faster than the Virtual Wealth increases [i.e. the amount of money the community holds thus abstaining from purchasing real wealth] and prices are therefore rising. …

2. Though all other prices are rising, that of gold is arbitrary fixed. This, in itself, means that gold falls in value relatively to goods. …

3. The banker now decreases the quantity of money in existence by not renewing his loans so fast as they are repaid. These loans, contracted in a period of rising prices, have now to be paid back in a period of falling prices so that, through the change in the purchasing power of money and quite apart from the interest paid for the loan, the goods and services that have to be given up by the borrowers to obtain the money to repay must always on the average be greater than those obtained by them with the money by were lent. Before any considerable proportion of these loans can be paid it becomes impossible to obtain the money, that is to sell goods, except at a ruinous loss to the producers. Hence a number of them are rendered bankrupt. Their collateral is sold by the bank, or, if it will now not fetch the amount to repay the loan, appropriated by them.

Is it understandable to not get Endogenous Money [Keynes]?

JMK got a lot of things right though clarity on banking was not one of them. His two major works were the Treatise of Money (1930) and the General Theory (1936). In the former we got the “bull” and “bear” lingo and the idea that deflation and economic slowdowns can accompany a decline in the velocity of money connected to bearish speculators “hoarding” “cash”. In the latter the idea of “money hoarding” was transformed into a “liquidity preference”. Quoting from Chapter 15:

We can sum up the above in the proposition that in any given state of expectation there is in the minds of the public a certain potentiality towards holding cash beyond what is required by the transactions-motive or the precautionary-motive, which will realise itself in actual cash-holdings in a degree which depends on the terms on which the monetary authority is willing to create cash. It is this potentiality which is summed up in the liquidity function L2. Corresponding to the quantity of money created by the monetary authority, there will, therefore, be cet. par. a determinate rate of interest or, more strictly, a determinate complex of rates of interest for debts of different maturities … If the monetary authority were prepared to deal both ways on specified terms in debts of all maturities, and even more so if it were prepared to deal in debts of varying degrees of risk, the relationship between the complex of rates of interest and the quantity of money would be direct [Emphasis added].

In the above quote Keynes (1936) is clearly arguing the money supply is determined exogenously by the central bank. He is also framing his arguments around the money-item “cash” (which Krugman tends to do as well) as if the money-item created by private banks is not important. There is debate as to what Keynes meant when he wrote “cash” or “money” with the short story being that such terminological vagueness was unhelpful. Turning now to Chapter 17 of the General Theory:

In the case of money, however—postponing, for the moment, our consideration of the effects of reducing the wage-unit or of a deliberate increase in its supply by the monetary authority—the supply is fixed. Thus the characteristic that money cannot be readily produced by labour gives at once some prima facie presumption for the view that its own-rate of interest will be relatively reluctant to fall; whereas if money could be grown like a crop or manufactured like a motor-car, depressions would be avoided or mitigated because, if the price of other assets was tending to fall in terms of money, more labour would be diverted into the production of money;—as we see to be the case in gold-mining countries, though for the world as a whole the maximum diversion in this way is almost negligible [Emphasis added].

Again Keynes (1936) is denying endogenous flexibility of the money supply (and, yes there was endogenous money even in commodity-paper monetary systems). From Chapter 18:

Thus we can sometimes regard our ultimate independent variables as consisting of (i) the three fundamental psychological factors, namely, the psychological propensity to consume, the psychological attitude to liquidity and the psychological expectation of future yield from capital-assets, (2) the wage-unit as determined by the bargains reached between employers and employed, and (3) the quantity of money as determined by the action of the central bank; so that, if we take as given the factors specified above, these variables determine the national income (or dividend) and the quantity of employment. But these again would be capable of being subjected to further analysis, and are not, so to speak, our ultimate atomic independent elements [Emphasis added].

At no point does Keynes (1936) get around to excluding “the quantity of money as determined by the action of the central bank” from one of the “ultimate atomic independent elements”. One can pull quotes from the General Theory or from JMK’s other works, which when looking at the words from a particular angle and adding in a qualifier, might be suggestive that Keynes recognised the endogeneity of the money supply process. Still the overriding message in the economics of Keynes on the subject of money supply determination was the assumption that it was fixed-exogenously by the central bank. Post-Keynesians thus have a mixed view on the General Theory.

While Keynes (1936) rejected the Wicksellian “natural rate” and the neutrality of money, his theory of “the” [long] interest rate invoked the notion of “liquidity preferences” as the main determinant; with the discussion framed problematically in terms of a constant money supply. The belief that monetary authorities could control the money supply sparked a thought bubble in Milton Freidman that did not turn out well (and still imbues the work of his market monetarist followers with errors). One can use the “liquidity preferences” concept in a revised sense to understand portfolio decisions and the term structure of interest rates (e.g. decisions to switch from safer into riskier assets and to go long or short). The concept remains controversial as it gave the impressions: (1) central bankers wield enormous control over the money supply; and, (2) private banks make decisions to part with liquidity rather than to create liquidity. The final word goes to Nicholas Kaldor (1982, The Scourge of Monetarism, Oxford, Oxford University Press, p. 26) who remarked that once Keynes’ assumption of a fixed money supply is dropped: “liquidity preference turns out to have been a bit of a red herring.”

So it is understandable why someone working in the Keynesian tradition might not understand endogenous money. Consider Keynes’ (1936, p. 167) Chapter 13 remarks on something seemingly as uncomplicated as a definition: 

It should be obvious that the rate of interest cannot be a return to saving or waiting as such. For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before. On the contrary, the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period. For the rate of interest is, in itself, nothing more than the inverse proportion between a sum of money and what can be obtained for parting with control over the money in exchange for a debt1 for a stated period of time.

[In footnote] 1. Without disturbance to this definition, we can draw the line between “money” and “debts” at whatever point is most convenient for handling a particular problem. For example, we can treat as money any command over general purchasing power which the owner has not parted with for a period in excess of three months, and as debt what cannot be recovered for a longer period than this; or we can substitute for “three months” one month or three days or three hours or any other period; or we can exclude from money whatever is not legal tender on the spot. It is often convenient in practice to include in money time-deposits with banks and, occasionally, even such instruments as (e.g.) treasury bills. As a rule, I shall, as in my Treatise on Money, assume that money is coextensive with bank deposits [Emphasis added].

The definition is very much disturbed to the point that what exactly Keynes may have meant when he wrote the terms “cash” or “money” in any given passage will remain guesstimates.

Is it understandable to not get Endogenous Money [Minsky]?

[M]oney, in truth, is an endogenously determined variable – the supply is responsive to demand and not something mechanically controlled by the Federal Reserve… Banking is not money lending; to lend, a money lender must have money.

– H. Minsky ([1986] Stabilising an Unstable Economy, Yale University Press, 2008 pp. 252-6)

The money flows are first from depositors to banks and from banks to firms: then, at some later dates, from firms to banks and from banks to their depositors [Emphasis added].

– H. Minsky (‘The Financial Instability Hypothesis’, Working Paper No. 74, Levy Economics Institute, Annandale-on-Hudson, NY, 1992, p. 2)

One can find quotes in Minsky’s work where he recognises the endogeneity of the money supply and even book chapters on the subject; however, it is a stretch to infer that endogenous money was a central concern of Minsky’s research or played a lynchpin role in his Financial Instability Hypothesis (FIH) (e.g. Minsky; 1975; 1986; 1992) the “core” aspects of which were developed back in the 1950s without any deliberations on the endogeneity of the money supply. It is worth quoting Marc Lavoie and Mario Seccareccia (‘Minsky’s financial fragility hypothesis: A missing macroeconomic link?’, 2001, p. 78)  at length on this issue:

While there is no doubt that Minsky has made major contributions to a monetary theory of production, there remain some obvious problems with his analysis, problems which have not often been fully recognised by those who subscribe to his analytics… [Notably, in Minsky’s 1954 doctoral dissertation and 1957 paper,] the formal macroeconomic model, which leads Minsky to conclude that economic expansions lead to higher debt and leverage ratios for business firms is, in fact, based on a loanable funds approach that stands largely in contrast to the Keynesian principal of effective demand… Minsky’s reliance on a loanable funds approach is clearly spelled out when he claims that ‘the excess of ex ante saving over induced investment will be utilised to reduce bank debt’ (Minsky, 1982, p. 243). In the Kalecki-Keynes framework, any excess of savings over investment will lead to unsold production – the profit realisation problem – and hence to increases in debt for producers. The excess savings will be lent by the banks to businesses to make up for their losses. Unfortunately, Minsky says the opposite. He claims that excess savings will help to reduce debt! This is why in recessions debt ratios should fall, unless there is a price deflation. In this regard, it could be argued that his 1957 model belongs much more to what Schumpeter (1954, p. 276) had described as the orthodox tradition of real analysis, and not to that of monetary analysis proper… Indeed, even as late as his 1975 book on Keynes, the only formal equations, which can be found on page 135, still incorporate the basic elements of a loanable funds approach [Emphasis added].

None of this is to deny the ‘real-world’ relevance of Minsky’s contributions to Post Keynesian theory; notably, that capital economies are prone to periodic endogenous financial instability. The point remains that endogenous money was not critical to Minsky’s FIH. As a final case I will quote from a 1992 Levy Economics Institute paper entitled ‘The Financial Instability Hypothesis’. On page two Minsky writes “The financial instability hypothesis also draws upon the credit view of money and finance by Joseph Schumpeter (1934, Ch.3)” which suggests that he also give much credence to the ‘Austrian School’ emphasis on the role of private banks as creators of net/new “purchasing power”. The word “money” appears 26 times in the paper (including five times in a quote from Keynes) though the phrases “endogenous money” and “purchasing power” are both absent. When Minsky (1992, pp. 2-3) starts to discuss money he provides a long quote Keynes (1972, p. 151):

A considerable part of this financing [of entrepreneurial activity] takes place through the banking system, which interposes its guarantee between its depositors who lend it money, and its borrowing customers to whom it loans money wherewith to finance the purchase of real assets [Emphasis added].

The italicised section gives the impression that Keynes thinks banks are mere intermediaries that borrow money from depositors in order to lend to customers. Not only does Minsky (1992, p. 3) raise no objections to Keynes’ mistake he goes on to write in a passage quoted above but certainly worth reiterating: “The money flows are first from depositors to banks and from banks to firms: then, at some later dates, from firms to banks and from banks to their depositors.” There are no further clarifications or retractions forthcoming on this issue in Minsky’s (1992) albeit condensed version of the FIH. Point to take: as Keynes and Minsky were not exemplary adherents of the endogenous money approach then perhaps everyone should be a little gentler with those who are old to economics but new to understanding it. It may be understandable to misunderstand endogenous money; though as to whether it is acceptable, I would say that it is unfortunate and unhelpful to not.

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JKH
3 years 5 months ago

Brett,

Excellent post.

It’s my impression that some people seem to think that 1971 was the tearing down of the Berlin Wall that held back the flow of endogenous money. I’m not referring to those who don’t understand that we have endogenous money now – rather to those who do understand that, but who characterize pre-1971 as some sort of absence of endogenous money.

How might 1971 related to Soddy’s observations 90 years ago?

How should 1971 be interpreted in terms of endogenous money, in your view?

And would you have any comments on this, from my last post, as it might relate to Soddy’s observations, or otherwise:

“The monetary system and the financial system are constructions of double entry accounting. It has been this way for a long time. This did not start in 1971. The fact that there was gold serving as a fixed value backstop for certain monetary assets shouldn’t obscure the fact that a monetary system is a fiat construction at its foundation. Gold at one time was a hard constraint on the behavior of the monetary authorities. But the authorities will inevitably create paradigms of operational constraint and guidelines in any monetary system. These restrictions include central bank balance sheet constraints (e.g. gold backing; Treasury overdraft constraints; supply and pricing of bank reserves that are consistent with the monetary policy interest rate target) and other guidelines (such as the reaction function of the policy rate to various measures of inflation, output, or employment). The full category of potential constraints is broad and varied. But none of this alters the fact that a monetary system is basically a bookkeeping device for the intermediation of real economic activity. It is a construct that enables moving beyond a barter economic system that can only be imagined as a counterfactual.”

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BF
3 years 5 months ago

“But none of this alters the fact that a monetary system is basically a bookkeeping device for the intermediation of real economic activity. It is a construct that enables moving beyond a barter economic system that can only be imagined as a counterfactual.”

JKH, how Soddy described ‘Virtual Wealth’ is I believe the counterfactual you describe. Soddy (1934, p. 36):

“Virtual Wealth.—This aggregate of exchangeable goods and services which the community continuously and permanently goes without (though individual money owners can instantly demand and obtain it from other individuals) the author terms the Virtual Wealth of the community.”

‘Money’ gets us beyond barter; however, Soddy thought economists were silly to count ‘money’ (abstract for real wealth) and tangible wealth as ‘wealth’. He also thought it silly that economists thought just because debt can grow at simple or compound interest on the books of the creditor, then, so must real wealth and welfare be growing. Debts (negative non-existing wealth) can multiply to infinity subject to the laws of maths not thermodynamics. Obviously, real wealth rots; and when a debtor cannot repay for whatever reason then bankruptcy is the only fair option (but we do not have international bankruptcy proceedings only IMF exploitation for western creditor nation interests).

Soddy likened economists understanding of capitalist economies as akin to a vulgar perpetual motion machine where society is somehow meant to live off its own mutual indebtedness (only a few can live off interest). I like to use ‘virtual wealth’ because it exposes the folly of policymakers pleading monetary poverty.

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JKH
3 years 5 months ago

“which the community continuously and permanently goes without”

out of the box thinking

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BF
3 years 5 months ago

Certainly, a bit abstract, but I think money be that. James Tobin’s ‘fiduciary issue’ is similar. All individuals within a society cannot simultaneously exchange “money” into real wealth as someone must end up holding the “money”.

The illusion otherwise “can be maintained unimpaired as long as the society does not actually try to convert all of its paper wealth into goods.” Add in bank deposits and like Soddy. Counting fiat ‘money’ as wealth not as a claim to wealth does seem confused to the mindset of a physicist.

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BF
3 years 5 months ago
Hi JKH, Thanks. Yes, when Nixon closed the gold window in 1971, some would say that money became for the first time truly fiat. The subject can be confused by different understandings of ‘fiat’. If by the term ‘fiat’ one means that it is centralised authorities (not necessarily a nation State) who write the dictionary on what is accepted as money within society, then, money has been fiat for a long time. (And the State can by decree pass over its sovereign right to issue the community’s money to the private sector). However, when most economists think of the term ‘fiat money’, they mean a monetary system in which money is irredeemable directly from the money-issuer for real wealth (say a commodity). There were substantial monetary reforms in the US during the 1930s with the relevant one to the discussion the demonetarisation of gold at the domestic level. According to the second definition, then, from that moment on we have at least partial fiat money in a legalistic sense. Indeed, there is a need to invoke a distinction between legal and practice, because while the law may well proclaim something is redeemable on demand from the issuer the issuer may issue more ‘virtual wealth’ money tokens than the underlying real asset held in their possession. I cannot recall the exact dates; however, gold was demonetarised at the international level during the turbulent years of the 1930s and 1940s. Eventually, in the US dollar-gold Bretton Woods System of Fixed Exchange Rates, gold again occupied a role as an underlying monetary asset for the international system in a legalistic not practical sense. 1971 was the legal instatement of fiat money at both the domestic and international money. Though for all practicalities money had long been only notionally redeemable from the money-issuer for… Read more »
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JKH
3 years 5 months ago

“the issuer may issue more ‘virtual wealth’ money tokens than the underlying real asset held in their possession.. Though for all practicalities money had long been only notionally redeemable from the money-issuer for real wealth (and practically irredeemable); not at the individual level of market exchange, but certainly in aggregate. When the few individuals who desired to redeem the abstract symbol for real wealth (money) into real wealth directly from the money-issuer, became many in number, there was usually insufficient ‘precious metals’ in stock to do so.”

I think this is how I’ve intuitively been interpreting fiat as wider in scope – including the case of a non-real-backed fiat component that becomes a sort of monetary/real multiplier – if you’ll excuse the crudeness of that characterization.

And in that sense, we’ve always had fiat.

Here’s a question for you Brett:

Is there any analogy between today’s “reserves later” reality, and a possible yesteryear “real backing later” transmission in response to INDIVIDUAL bank credit creation?

I’m scratching my head trying to figure out how endogenous bank money creation could have been operationally constrained or slowed by a relationship to gold rules of whatever kind – other than by after the fact interest rate tightening as a function of a gold squeeze on the monetary authority.

Maybe we’ve already answered that here in general terms, but I’m interested in more detail on the nature of the transmission mechanism of a macro gold constraint to individual bank endogenous money creation. Somebody must have written about that transmission mechanism.

If you can answer this authoritatively, I will consider the answer to be a Black Swan of economic thinking.

Guest
3 years 5 months ago

In the post WWII period, nations ran their economies using Keynesian principles.
In addition to monetary policy, fiscal policy was also used during the Bretton Woods era. A stop policy would reduce domestic demand and lead to a tightening of credit. So when inflation tended to increase or when balance of payments started getting out of hand, nations would slow down demand using both fiscal and monetary policy and the 50s and the 60s were the days of the “stop-go” policies in Britain. Devaluation was also possible because a well calculated devaluation improves the trade balance and brings the money in in the expectation of a revaluation sooner or later.

Of course the system was far from perfect and it all broke down and nations started to freely float their currencies. Unfortunately, the new regime was no panacea to the “balance-of-payments problem”. The Monetarist counter-revolution completely took the focus away from all this because there was high inflation and there was all the debates about controlling the money supply etc.

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BF
3 years 5 months ago

Thanks JKH, actually thanks not, for you could not but try to ask more demanding questions I believe.

My reply will a post (next week): I cannot profess it will be authoritative account and thus at most can only promise a speckled duck.

At present I can only but tease the subject matter with the working post title “‘Fiat Money’ and ‘Endogenous Money’: Two sides of the same Plutocratic coin?”

Guest
3 years 5 months ago

Was endogenous money creation constrained by the gold standard because it eventually brought everything back down to earth through defaults and foreclosures and fire sales of foreclosed real assets? Endogenous money caused everything to bubble up as now but when the bubble eventually popped it went all the way back down to what could be settled in gold and balance sheets were wiped clean.
I guess if there was no government deficit spending, then the consequently limited stock of risk free financial assets would in principle also eventually constrain the banking system in our non-gold standard system???
I think in England in the 1800s, the Bank of England used to lend bank reserves (at very high interest) through the discount window in exchange for real assets such as land. That avoided the bank wipe outs that used to happen in the USA at the time (where there was no central bank) but did bring prices firmly back down to earth. Banks would not actually get very much money for the foreclosed land and would have to pay ruinous interest to the Bank of England in order to get that money.
I think the very fact that debts that could not be paid were not paid might have caused banks to think twice about the loans they made. Furthermore in the early 1800s, shareholders of a bankrupt company could be sent to a debtors prison. That in itself presumably led to caution. The industrial revolution consequently was funded by informal equity financing and bank financing was restricted to funding merchants where there was minimal enterprise risk and so the loans were fairly sure to be repaid on time.
I’m very unclear on this and just tossing these thoughts into the discussion.

Guest
3 years 5 months ago

Your historical account seems to put a lot of emphasis on gold. Isn’t it true that the bulk of the monetary base in medieval England at any rate was in the form of tally sticks (wooden, tax token, money)? The Bank of England was founded using a capital stock of tally sticks. Gold being the monetary base is just something that occasionally crops up in history. Even when precious metals were used, wasn’t silver more typical eg the ancient middle east had a fixed barley to silver exchange rate, Alexander the Great paid his army in silver, Vikings used chopped silver as money and, during the 1500 to 1800 period, Spanish pieces of eight were the global currency used across Asia, the Americas and Europe?

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BF
3 years 5 months ago

Have a read of S. Zarlenga ‘The Lost Science of Money’ (Valatie, NY: American Monetary Institute, 2002). I did mention ‘precious metals’ so substitute gold for silver, bronze to your liking. The Gold Standard obviously enshrined a big role for gold which the gold-bugs today dream or is it delude about. I recall gold being important to cultures in antiquity; apparently, it was a commonly found metal in a valley somewhere in the Middle East. Common folk just gave it to the Temple Priests as an offering when they had nothing of value to give (say food) but over time the Priests loaded with ornamental gold decided to make it the monetary medium making themselves rich (or so I have read).

And let us not forget silver too. The English running a trade deficit for tea at one point in history not so long ago, nearly drained all their silver; and responded by enforcing the sale of opium through war and territorial acquisition. Today that would be like Columbia invading the USA to sell cocaine. One is taught often that the American Revolution was about trade (again tea important) though it was also about the Crown interfering in the monetary affairs of her then colonies (yes mints were prohibited for a while and fiat paper issues also revoked).

The Shekeh was an interesting money though you can read up on that one. Money has certainly taken different forms at different times; nonetheless, in much of the history of the Western Civilisation ‘precious metals’ have played a major part.

Admin
3 years 5 months ago
BF, this comment is a great post all its own. People are using “fiat” as a kluge word for “endogenous”, and they really don’t mean it either way! “Consequently, while there are lagged reserve requirements for a tiny portion of transaction deposits in the US, that should confuse the analyst from recognising that private banks lend first creating deposits along the way and look for reserves later (which the central bank provides in order to hit its overnight interest rate target and to preclude a payment system gridlock” I am very concerned about the “lend first” clause, because it seems as though it is very important exactly how the underlying real asset is used as the basis for the money creation. We spend tons of time here concerned about the “lend first” part of the modern endogenous system. Just getting that part straight seems to be extremely difficult for many people. But that’s not the only errors they are making, people are also making errors in how they think about the lending. If we think about what is broken in our system today, it isn’t that we can’t create money. It’s that we don’t have viable assets against which to lend. Even if nobody understood how the process worked before, it did work! Now, today, we’re forced to understand the process a bit better so we can fix it. The part of the process that is broken is on the lending side, but it takes a wider understanding that the lending happens first to make progress on the problem. “That is, to money issues not in some mechanical proportion either to those issued by State, or to the legal underlying real asset.” This seems to be much like our modern banking system as well. Banks can lend against real assets… Read more »
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JKH
3 years 5 months ago

I think I’ve been guilty of semi-conflating fiat and endogenous from time to time – deliberately perhaps – with the hopes of drawing out someone like Brett to focus on the distinction.

🙂

But there does seem to be some flexibility around the idea of fiat.

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BF
3 years 5 months ago

Hi Mike,

I knew not of the confusion of ‘fiat’ with ‘endogenous’ (should be easy enough).

PK theory of EM is that private bank money creation requires dual willingness on the part of banks and creditworthy borrowers. Creditworthy subsumes the debtor’s collateral (along with other things).

You are correct that the US economy along with others have become ‘housing/mortgage-based economies’, that is, over-burdened debt pyramids (including quasi-debt derivatives) surrounding non-fecund real estate. Even the proportion of mortgage finance which goes into new housing is still money lent and spent on non-productive capital assets (I consider residential investment as quasi-consumption because beyond the construction it does employ or yield an income other then rent say relative to a factory). There is also a proportion of mortgage finance ‘locked up in the buying and selling of existing structures’ that just goes to maintaining or inflating prices which is what it is.

Many if most macro models I see still exclude real estate lending. If household borrowing is included it is done as if it were like consumer credit. Big hard issues; need to get cash flows going in real estate to lift the economy, but housing will always be a faulty rudder compared to debt-financing for proper capital assets.

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BF
3 years 5 months ago

I do need an editor “I consider residential investment as quasi-consumption because beyond the construction it does {NOT} employ or yield an income other then rent say relative to a factory).”

Admin
3 years 5 months ago
“If household borrowing is included it is done as if it were like consumer credit. ” Another wrinkle is that it is not a pure real estate standard. It’s more like a 60% real estate, 30% capital improvements, 10% consumer credit standard. And another problem is that we cannot easily loan against all of the potential real assets we have. We lend against residential real estate because it’s relatively easy to package, compared to things like the Sears tower. The frictions involved with loans against other real assets are gigantic, even compared to the huge administrative losses in lending against residential real estate. “Big hard issues; need to get cash flows going in real estate to lift the economy, but housing will always be a faulty rudder compared to debt-financing for proper capital assets.” It’s totally true. What the banks lend against have hard constraints, and it makes a difference to what and how everything happens in the real world. If real estate was massively undervalued right now, we would not be in a balance sheet recession, no matter the absolute nominal level of interest rates. We could just juice housing prices by cutting interest rates and be done with it, and this is something which the current dominant economic structure could do tomorrow. Then another even larger problem is the one of the foundational ideas of progress is “doing more with less more quickly”. Lending against some huge steel mill made sense when there were huge steel mills that would last for 50 years. Now, far smaller properties with less “stuff” on them makes better consumer goods. It’s smart to lend against AT&Ts millions of miles of wires connecting every house in the U.S., not as smart to lend against smaller, less expensive cell towers which could be obsolete… Read more »
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JKH
3 years 5 months ago

perhaps in parallel with all this is the misinterpretation of the Volcker tightening as the suspension of the operation of endogenous money – something that in my impression Volcker himself (and his Fed) didn’t entirely understand at the time

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BF
3 years 5 months ago

I made at least one typo at February 20, 2013 at 9:29 pm: “that should [not] confuse…”

Certainly, the experiment with monetarists operating procedures in the 1980s was nothing less than an unmitigated disastrous; for the US economy (and developing nations caught up in an external debt crisis) and for Friedman. Someone clever said words to the effect that monetarism suffered the indignity of having its postulates put to the test in practice.

Unfortunate that most economists do not understand EM. The economic system has moved onto near-monies (derivatives, repos, CDS) with a frightening degree of endogeneity while its theorists lag not yet understanding the cheque system.

Admin
3 years 5 months ago

This is very much my view as well. Money is always and by nature endogenous; it cannot be otherwise. We just usually put some constraint on the creation of money. The real estate money system we live under now has the same basic idea as a gold standard behind it, where we create money against real estate instead of gold. But in any case, the creation of money involves changing numbers in a ledger somewhere, and thats how and where money gets created. The backing behind that money can be extremely important to the ongoing effects to the overall system, but that consideration is all about the constraints.

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JKH
3 years 5 months ago

The scary thought for me has always been:

If mainstream is so lost in general about the nature of endogenous money in 2013 – then what are we to think about mainstream’s efforts to record the history of money and the history of how banks worked?

And that goes for certain modern heterodox interpretations that emphasize 1971.

🙂

And that’s on top of historical disputes such as those Brett has noted.

Back to the drawing board, boys.

Admin
3 years 5 months ago

We’re drawing on the board, aren’t we? 😉

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JKH
3 years 5 months ago

how true

🙂

Admin
3 years 5 months ago

Steady as she goes.

🙂

Well, we’re pissing off the Austrians, the MMTers, the monetarists, the Keynesians. ( I saw that tweet and really laughed today, and I needed it!)

“Govt is a social construct to help facilitate private sector life. And a powerful tool it is. ” Yep. Same with money. It’s just a tool to make us real world richer.

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beowulf
3 years 5 months ago

“Well, we’re pissing off the Austrians, the MMTers, the monetarists, the Keynesians.”
Yeah, its funny how they get pissed for so many different reasons that , in aggregate, they cancel each other out.

Admin
3 years 5 months ago

Yeah, and not just money. The system itself is endogenous. The idea that there’s even an exogenous portion is the result of an extension from the inherent endogeneity of the system itself. That is, the money system exists for private purpose primarily. Resources precede taxation. Govt is a social construct to help facilitate private sector life. And a powerful tool it is. If more people understand these basic points we’d probably get a lot more out of the whole system….

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Geoff
3 years 5 months ago

Excellent stuff by Soddy and a great post by Dr. Brett. My first exposure to the idea of endogenous money was the essay “What is Money” by Mitchell Innes, written in 1913. I know Innes is recommended reading by certain MMTers like Mr. Mosler, but it seems to fit MR like a glove.

Admin
3 years 5 months ago

Mosler is like the intro drug to endogenous money. I got my start over there.

Also, I’ve got a “Soddy guy” who will show up here at some point I hope. He’s been on me to read Soddy and never did.

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Clonal Antibody
3 years 5 months ago

I have most of Soddy’s books on my computer. Makes for interesting reading.

Guest
3 years 5 months ago

Herman Daly is a Soddy guy.

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Geoff
3 years 5 months ago

Thanks, Michael. I’m going to have to read up on this Soddy, dude, too.

Brett, if I somehow implied that Soddy was MMT, then I clearly didn’t express myself well. My apologies.

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BF
3 years 5 months ago

Sorry, Geoff, I have seen the work of Innes used sometimes to infer positions on how the modern monetary system operates today rather than say before the Federal Reserve System Act of 1913. Note also that Soddy is the father of ecological economics, that is, the reality that natural capital and ecosystems are part of the Wealth of Nations (not “externalities” as per orthodox economists).

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beowulf
3 years 5 months ago

I guess Soddy really was the first Nobel Prize winning economist (even if it was for Chemistry).
Great piece Brett, that’s sort of cold that Fisher didn’t cite Soddy.

Guest
3 years 5 months ago

Probably understandable since Soddy was regarded as an economic crank in his time, and Fisher didn’t want to create the association. Keynes didn’t cite Marx either, for similar reasons.

Guest
3 years 5 months ago

Kalecki’s work was nearer to the General Theory wasn’t it? Bill Mitchel says, “The issue of whether Keynes had been influenced by Kalecki’s earlier work remains unresolved. Staunch followers of Keynes say no, whereas those scholars who do not see Keynes as being the central figure in the development of the theory of effective demand, such as me, lean to the view that the transition from the Treatise (1930) to the General Theory (1936) was so great that it is likely that Keynes knew what Kalecki had written and published and was influenced by it.”
http://bilbo.economicoutlook.net/blog/?p=11127

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BF
3 years 5 months ago

I would not make apologies for Fisher. Soddy was after all correct on how banking worked. He was a monetary system revolutionary and threat to the moneyed-powers of his day; hence, the labeling of ‘crank’ was nothing more than a bastardised means to discredit without considering his arguments.

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BF
3 years 5 months ago

Thanks Geoff. Innes was in the Chartalist tradition. He wrote some interesting analysis that was perhaps appropriate for the monetary system in which he resided. Certainly, little has changed regarding the efflux of bank money (creation) followed by reflux (destruction), though with the US Federal Reserve System Act of 1913 (and with the Fed operative in time for the war) it soon became inappropriate to use similar language for State Money (except in explicit reference to the activities of the central bank undertaken typically for monetary policy purposes).

Obviously, as the federal government is a now currency user (with its budgetary operations requiring dual-clearing in central banks and private bank monies), it is highly misleading to suppose that federal government spending creates money while taxation payments destroy money. It could be argued that such ventures increase or decrease the stock of money circulating outside of the government’s coffers; nonetheless, as the Treasury’s deposits at the Fed are “money” the language of efflux/reflux or creation/destruction make little sense. A claim that federal budget deficits lead to ‘net credits to bank reserves’ (with T-bonds sold to drain excess reserves) is alas a failure to do or to appropriately understand the balance sheet accounting of the US Federal Reserve System.

Soddy does not fit MMT like a glove. The former described the monetary system for what it is (i.e. a virtual-monopoly of private banks and private interests). Respectfully, I hope the comments section does not degenerate into something about MMT; when the post is about Soddy getting endogenous money (which cannot be said for Keynes and not always for Minsky).

Guest
3 years 5 months ago

Efflux and reflux. That’s banking school jargon — Tooke, Fullarton, and good old Adam Smith’s territory.

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