The Medium of Account Dominates the Functions of Money

Scott Sumner says something interesting about money being the medium of account:

“I argue that money is the medium of account.”

I agree. We spent a lot of time ere at MR with the equation S = I + (S-I), and one of the conversations about this idea (Thanks again Steve R.) was about how there are tons of assets sitting on the balance sheets of the world, all valued using the medium of account, where the medium of exchange has very little impact on what happens with these assets. These assets all matter for S and I.

Many of our more important transactions in the financial world do not involve exchanging the medium of exchange. They involve the valuation of assets in the medium of account, and promises to provide (possibly) some medium of exchange later in compensation. For example, an interest rate swap doesn’t involve much or any exchange of the medium of exchange at the initiation of the trade. Yet, plain vanilla IRS define much of our financial world.

IRS are bookkeeping entries until something changes in the real world, so how can they be considered to be using the medium of exchange? IRS use the medium of account.

Then, taxing agencies don’t just tax transactions which use the medium of exchange. They also tax transactions which involve gifting of real estate, compensation received as options on corporate equity, or payment in kind. These transactions must be given values in the medium of account, which then require taxes paid in the medium of exchange.

Also, much of our current recession has been caused by transactions which did not involve the medium of exchange. The revaluation of ABS – clearly one of the precipitating forces of the tragedy in 2008 – were simply bookkeeping entries on non-traded bonds. The reason banks stopped lending the medium of exchange was due to changes in valuation on untraded bonds in the medium of account. Similar bonds may have traded, but some large majority of the ABS revaluation happened in a few dozen (maybe a few hundred) spreadsheets around the world, not in millions of recorded exchanges of these bonds for money. There were literally no trades for these ABS, no “exchange of medium” for specific bonds, so the valuation changes must have come from valuation changes which happened in the medium of account.

Note these spreadsheet-only valuation changes directly caused the lending problems in 2008.

My take is the accounting function of money dominates the exchange function. It’s hard to see when you don’t think about accounting much, but accountants rule our world, because they define it.

(Update: The internet bubble was an MoA driven phenomenon, and the mid 2000′s refi-boom was a MoA phenomenon.In the intenet bubble, many transactions were exchanges of equity with zero MoE involved. Any refi equity extraction involves guessing the market value of a parcel of real estate and then giving someone MoE in exchange for that new value. The MoE is available when the MoA valuation changes. )

 

 

 

 

Comments
  • Greg November 1, 2012 at 8:30 am

    I must confess to not really being sure why anyone ever wanted to distinguish between the two “properties”. What use comes from separating?

    If you cant account for it, it didnt happen.

    • Tom Hickey November 1, 2012 at 10:04 am

      “I must confess to not really being sure why anyone ever wanted to distinguish between the two “properties”. What use comes from separating?”

      Chris Cook has pointed out that money is more properly conceived as credit than debt. Money is created when accounts are credited, and most money in modern economies comes from banks’ crediting deposit accounts with loans they extend. This is the use of money as a unit of account. There is no use of money as a medium of exchange at this point, since nothing has been exchanged but promises.

      If the borrower withdraws funds for a transaction by cash or writes a check that must be cleared with rb, then money comes into play as a medium of exchange.

      However, if transactions are settled by netting, all that happens is shifting numbers signifying units of account. There is no use of actual “money” (cash or rb) as a medium of exchange involved.

      • JKH November 1, 2012 at 11:09 am

        Tom,

        You’re behaving too much like a bean counter.

        There’s enormous philosophical scope available in answering this question.
        :)

        • Tom Hickey November 1, 2012 at 11:43 am

          :)

          I was just putting forward Chris Cook’s observation, which I thought was well taken if we restrict the def. of “money” to govt money and bank money. Do you think he is correct?

          • JKH November 1, 2012 at 11:57 am

            To be honest, Tom, I haven’t had or taken the time to think much about this question. On cursory view, I initially favored the medium of exchange emphasis. But I like Mike’s post here very much. And I think your comment here is also fine.

            I wasn’t being entirely facetious on the philosophy reference. I think this is one of those issues where you have to be very precise about exactly what the question is in order to get full value from the discussion. I haven’t looked at either the Rowe or the Sumner posts closely enough to know whether this has been done in either case – or at the comments in either case, which might be equally revealing along these lines.

            At the 40,000 foot level, it is interesting to note the density with which the “medium of account” occupies the economy’s balance sheet structure and various stresses on that balance sheet structure – as well as the rapidity with which the “medium of exchange” enables daily transactions – just look at the FX market for example.

            Money clearly has both characteristics, or at least enables both characteristics – accounting and exchange.

            So I think the precise question and the meaningfulness of that question does become philosophical.

            I trust I have made myself perfectly obscure.
            :)

            • Greg November 1, 2012 at 1:21 pm

              “Money clearly has both characteristics, or at least enables both characteristics – accounting and exchange.”

              Yes, but if the exchange isnt accounted for isnt it then a “black market exchange”?

              And if it is accounted for doesnt the accounting and exchange properties morph into one?

              • Tom Hickey November 1, 2012 at 3:14 pm

                Accounting is an ex post record of transactions, and not all transactions involve exchange of assets or goods. For example, when a loan is extended and a deposit account is credited, what is exchanged is a set of promises. The bank promises to provide means of settlement as the borrower desires, either by cash at the window or clear a check or electronic transfer. The borrower agrees to repayment plus interest on time.

            • Michael Sankowski November 1, 2012 at 1:52 pm

              This is really more of a provocative statement and a tool to drill deeper into how money works than any type of definitive statement on the essence of money.

              We may have strayed from the path a bit here, because this statement (and the related statements and questions) isn’t/aren’t as empirical and reality driven as we typically prefer around here at MR.

              On the other hand, all of those statements by Greenspan about the “wealth effect” start to seem like fumbling attempts to come to grip with the medium of account effects of monetary policy.

              If you do the simple accounting, I think you find net money creation is far easier under our system if we take into account balance sheet effects.

              Think about a collateralized loan, a loan backed by real estate. One person owns this property outright which they created at a value of V, and someone else wants to purchase it at V. The net wealth of the entire system remains the same before and after the loan. Is the entire system more likely to engage in further trade now that the loan has been created? Yes, but the person who sold the house isn’t truly any wealthier.

              But if the value of loan is written for V + X, the person holding the property can either sell the property to get money X, or simply go to the bank and borrow X.

              Of course this is greatly simplified, and the bank wouldn’t lend full value of X. But I’d argue this world is far more likely to have more economic activity than the first world. It seems the amount of activity in the second world won’t be simply V+X, but rather V+ X^(some exponent>1).

              So when X goes negative, economic activity falls rapidly. When X is positive, economic activity expands rapidly.

              This world is entirely driven by what’s happening with the medium of account, due to wealth effects, and it seems to resemble the world we actually live in.

              • Greg November 1, 2012 at 2:32 pm

                “We may have strayed from the path a bit here, because this statement (and the related statements and questions) isn’t/aren’t as empirical and reality driven as we typically prefer around here at MR.
                On the other hand, all of those statements by Greenspan about the “wealth effect” start to seem like fumbling attempts to come to grip with the medium of account effects of monetary policy.”

                Yep. I tell the guys I work with that their 401K statement with 500,000$ on it is NOT the same as a 500,000$ bill. It might be better, it might be worse, a lot worse.

                “Think about a collateralized loan, a loan backed by real estate. One person owns this property outright which they created at a value of V, and someone else wants to purchase it at V. The net wealth of the entire system remains the same before and after the loan. Is the entire system more likely to engage in further trade now that the loan has been created? Yes, but the person who sold the house isn’t truly any wealthier.”

                I dont know. As we define wealth, here and now, in US$, on a balance sheet, that person may truly be wealthier. He may be able to demand significantly more of the available resources after the sale than before. It might not be that way for long but certainly for a period of time it is true, it seems to me.

                “Of course this is greatly simplified, and the bank wouldn’t lend full value of X. But I’d argue this world is far more likely to have more economic activity than the first world”

                I agree. People will exchange as long as they arent OBVIOUSLY losing the exchange. Once enough people start obviously losing the exchange, the exchanging stops. Especially when there is one entity consistently on one side of the exchange, like ” the banks” or “the govt”.

                “This world is entirely driven by what’s happening with the medium of account, due to wealth effects, and it seems to resemble the world we actually live in.”

                Well stated.

              • Tom Hickey November 1, 2012 at 3:53 pm

                Then there were seconds and thirds, and probably some fourths, based on what the bank was willing to loan against the same collateral based on a rising market. Then after the crash, at least some of that “collateral” was just bulldozed as less then worthless. All that’s left for the bank to sell in order to recoup is an empty lot.

                Not to mention all the securitization that leveraged the leverage.

              • beowulf November 1, 2012 at 4:13 pm

                “On the other hand, all of those statements by Greenspan about the “wealth effect” start to seem like fumbling attempts to come to grip with the medium of account effects of monetary policy.”

                The guy who really dived into the wealth effect is Per Gunnar Berglund (“The grand-ratios model is a formalization of ideas formulated by Vickrey and foreshadowed by Godley and Cripps”) He’s described it in slightly different ways over time (links are from 1997, 2001 and 2006 respectively).
                http://archives.econ.utah.edu/archives/pkt/1997m10-e/msg00037.html
                http://www.newschool.edu/scepa/publications/workingpapers/archive/cepa0212.pdf
                http://books.google.com/books?id=jztO57DobxQC&lpg=PA149&pg=PA149#v=

                The meat of it is this [from first link]:
                “The limit of the debt/GDP ratio is set by the spending propensities, i.e. by
                the wealth-to-spending turnover rate. The lower the turnover rate, the
                higher the debt/GDP ratio limit. It seems that the capital asset/GDP ratio
                varies around 4:1 in the long run [i.e. GDP usually 20% of capital stock]. Now, suppose that the private wealth-to-spending turnover rate is 5:1, and that the whole stock of assets is privately owned. This means that there will be a spending shortage of 20% of the GDP, only 4/5 of the GDP will be purchased. Hence the gov’t must “fill in” with another 20% of GDP of demand, to balance the GDP and the spending.”

              • JKH November 1, 2012 at 4:57 pm

                sorry – which is the provocative statement Mike?

                • Michael Sankowski November 1, 2012 at 6:56 pm

                  The claim money is the medium of account, and nothing else.

                  • Tom Hickey November 1, 2012 at 8:03 pm

                    As I recall, Chris Cook was responding to the idea that “money is debt,” i.e., somebody’s IOU. He said it was more accurate to say that money is credit in that money is created by crediting accounts.

                    Compare Warren’s idea of currency as a tax credit, and bank money a franchise that the govt gives banks to generate tax credits within the franchise rules. He calls this “leveraging” the currency, that is, expanding the amount of tax credits over what the govt itself creates through fiscal policy and cb lending.

                    I think he would say that once money is created through credit, then it can function as a medium of exchange, a store of value, and a record of non-bank credit denominated in the unit of account. But these are subsidiary to money creation, which occurs by crediting accounts.

                    But this is only my understanding of Cook’s view expressed in my words.

                    • Michael Sankowski November 4, 2012 at 6:54 pm

                      I really like Chris Cook’s ideas and views. I don’t always agree with them – for example, I don’t agree with his idea that an energy based money system would be a good idea.

                      But he’s an insightful guy, and this is a good point. Money isn’t really debt – it’s a credit. It starts off as a credit, because someone somewhere is crediting an account.

              • JKH November 1, 2012 at 6:09 pm

                Here’s one, Mike, along the lines of a stock/flow consistency riff:

                In favor of medium of account:

                The value of the medium of account function correlates with balance sheet scope.

                The value of the medium of exchange function correlates with income statement and flow of funds statement scope.

                Balance sheet scope is generally larger than income statement or flow of funds statement scope (how much larger is an interesting question).

                (Macro and micro)

                In favor of medium of exchange:

                The physical or electronic stuff of money is inherently present in the income statement and flow of funds statement.

                This is not the case for the balance sheet – except for those asset categories that fall under the chosen definition of money.

                • Michael Sankowski November 1, 2012 at 7:08 pm

                  This is a great way to start picking apart this gordian knot. Wow.

                  Think about what a change in MP/FP does to each of these statements. It’s a much clearer way to think about money.

                  I’ll have to sleep on this, because this is a good idea. Heres a story – I thought of some other function of money about 12 months ago. I was geeking out on it, but never wrote it down, and forgot it 2 days later. It’s my Kubla Khan, but I suspect thinking about the three statements is a path to recovring this idea.

              • JP Koning November 2, 2012 at 11:10 am

                I’ve been following this debate and I think it makes more sense if you ignore any claims that Sumner/Rowe have about “what is money.” Just pretend that the word “money” doesn’t exist. If you do then the debate boils down to an interesting exchange on the interaction between the MOE, MOE, and various assumptions about stickiness.

                The word money should be banned from the economic vocabulary because its use tends to causes more fights than forward progress. Words like MOE, MOA, and unit of account are far better specified.

                • Fed Up November 2, 2012 at 11:56 am

                  “The word money should be banned from the economic vocabulary because its use tends to causes more fights than forward progress. ”

                  Exactly!!!!! I suggest going with currency, central bank reserves, and demand deposits.

                • JKH November 2, 2012 at 11:56 am

                  That debate revolves most around competing interpretations where the MOA and the MOE are not the same. Mike has expanded the scope to what may be described loosely as Minsky balance sheet proportions and effects, which I don’t see addressed in the Rowe/Sumner debate.

                • Michael Sankowski November 2, 2012 at 9:33 pm

                  Yes, I find their ideas hard to follow in some ways. It’s probably because they mostly use thought experiments.

            • Tom Hickey November 1, 2012 at 3:25 pm

              The philosopher’s question is about criteria, most especially, criteria of meaning and truth. When the subject matter is tightly bounded by clearly defined rules upon which all agree, it is usually possible to decide any dispute based on the rules.

              But if the rules are not clear, e.g., criteria concerning how to apply them is in question, then the answer may be up in the air if the parties cannot agree. Of course, when quality is involved, then the matter become subjective and “de gustibus non est disputandum” applies.

              While it is true that some appeal to “transcendentals” that mediate between subjectivity and objectivity, the existence of transcendentals is also in dispute with no agreed upon criteria. As a result most interesting questions are undecidable based on universally agreed upon criteria.

              To obscure the issues further. :)

              • JKH November 1, 2012 at 6:10 pm

                “As a result most interesting questions are undecidable based on universally agreed upon criteria.”

                Now THAT’s what I’m talking about.

                Thank goodness for a legitimate escape hatch on this one.

                “de gustibus non est disputandum”

                This is a good one to know also.

                I intend to insert it in family conversation, ASAP.

                P.S.

                (seriously)

                Did the Socratic method include searching for the right question?

                • Tom Hickey November 1, 2012 at 7:45 pm

                  “Did the Socratic method include searching for the right question?”

                  That’s a very prescient question itself. Socratic dialectic is a logical approach quite different from Aristotle’s analytical one. Dialectic is about honing the question, since questions determine the type of answer they elicit. Due to cognitive bias we tend to frame questions that lead to an answer in terms of how questions are framed . Being stated within a frame of reference, questions contain implicit assumptions. The dialectical method is designed to elucidate this by evoking different perspectives. The analytical method doesn’t deal with it, since it operates within a frame, although inconsistency and anomaly reveal issues in the approach.

              • Michael Sankowski November 1, 2012 at 7:32 pm

                One of the reasons we harp on the SBE and Godley’s work is to provide a consistent framework, so we can answer at least some questions. Of course, the framework is semi-arbitrary, so it ignores some questions so we can answer others.

                That’s fine. We don’t need to answer everything. Answering 1 or 2 hard questions in any field with limited scope over the course of a lifetime makes you a winner.

      • Greg November 1, 2012 at 11:25 am

        “Money is created when accounts are credited, and most money in modern economies comes from banks’ crediting deposit accounts with loans they extend. This is the use of money as a unit of account. There is no use of money as a medium of exchange at this point, since nothing has been exchanged but promises.”

        Every loan Ive ever obtained required some sort of collateral. You have to “have” something to get a loan. And you lose that something if payments dont get made No one who has nothing to their name will get a loan from a bank. Maybe a friend will lend you something but that is an entirely different dynamic than what we are usually discussing here. When I get a mortgage Im still about 180 months form actually taking ownership from the bank.

        Id be interested in your answer here JKH.

        The whole separation seems entirely unnecessary in todays world, which may put me in agreement with Scott Sumner (*chills*)

        • Tom Hickey November 1, 2012 at 11:39 am

          Yes, but collateral is a “pledge” not an exchange.

          • Greg November 1, 2012 at 1:15 pm

            Could it not be thought of as a conditional exchange.

            Additionally its a condition which under most circumstances is compulsory.

        • jt26 November 1, 2012 at 11:42 am

          What you normally need is a high paying job … something that sources MOE! ;-)

        • Fed Up November 1, 2012 at 2:41 pm

          “Every loan Ive ever obtained required some sort of collateral.”

          What about credit card debt?

          • Greg November 1, 2012 at 4:06 pm

            Yes credit card debt is collateral free, but it is almost 20%. Might as well have collateral

            • Fed Up November 1, 2012 at 4:17 pm

              My mom got one before the 2008 crisis at fed funds plus 3%. She is paying it down because CD’s now have a very low interest rate. Lower interest rates have caused her to spend less (message to bernanke).

              • Michael Sankowski November 1, 2012 at 7:34 pm

                Sure – how much of the world runs off of credit card debt? A small amount, and this is typically secured against the cash flows from some source of income.

                • Fed Up November 1, 2012 at 10:38 pm

                  World? Not sure. USA? Not sure but thinking 800 billion to 900 billion. I believe that is expected future (mostly wage) income, which may or may not come true.

                  • Michael Sankowski November 4, 2012 at 7:04 pm

                    The Collateral is future earnings.

                    • Greg November 5, 2012 at 6:22 am

                      Yes. Essentially what people are borrowing when they go into debt is their OWN future earnings. Which is why, as I see it, that the private money system is unstable. Every person involved in borrowing must be able to accurately forecast their future earnings. And the banking system is motivated to encourage us to be over optimistic about our futures, which makes them more likely to blowup.

                      Its a trade off between living in the present and paying off the past. I just finished a refi and was able to take $2100/month worth of house/car/vacation prop payments and reducing them to 750$. Now if I make the minimums and pay the term I will pay much more in total now but I now have over 1300$/month of present consumption I can do. I want to live more in the present so its worth paying more overall to not be paying off past debts faster. Living for today, living in the present moment has a cost.

                    • Tom Hickey November 5, 2012 at 11:03 am

                      Greg “Essentially what people are borrowing when they go into debt is their OWN future earnings. Which is why, as I see it, that the private money system is unstable. Every person involved in borrowing must be able to accurately forecast their future earnings.”

                      And when employment was stable, with people staying in the same job, perhaps for life, it was possible to assess future earnings with some degree of assurance. That model of employment security has now shifted pretty radically, even in paternalistic Japan, making such assessment more difficult, if not a stab in the dark wrt lots of workers.

                    • beowulf November 5, 2012 at 1:22 pm
                    • Michael Sankowski November 5, 2012 at 2:37 pm

                      Did we ever get in contact with Tay?

                    • Fed Up November 5, 2012 at 6:10 pm

                      “The Collateral is future earnings.”

                      I don’t consider that collateral. Future earnings is about making the interest and principal payments. I consider collateral to be an asset that can be seized and sold to repay the debt if people default. With most? credit card debt, there is no asset to seize.

  • jt26 November 1, 2012 at 11:32 am

    But based on Nick Rowe’s discussion, http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/10/medium-of-account-vs-medium-of-exchange.html
    … MOE seems to be most important since “An excess demand for the medium of exchange causes a recession”. But, you’re right, the financial crisis could be due to “changes in expectations” because the value of an asset in MOA is 0, but these expectations are related to not getting back your MOE at some point in the future.

    • Michael Sankowski November 1, 2012 at 2:07 pm

      I’d counter a bit here. Essentially all loans are pledges of collateral in exchange for cash. Is the problem there is less cash in the economy, or there is more demand for cash?

      We know loans create deposits, so it can’t be that there not enough money to go around. Anyone can always get money if they have collateral. It’s just the amount of money they can get for the collateral isn’t enough to justify the desired loan amount.

      So talking about the demand for cash going up obscures the economic activity of money entering the economy. The mismatch of collateral value against required loan values increases during recessions, causing loans to be pulled or not made in the first place.

      Usually the fed roughly controls this by changing the discount rate (via the FF rate), but it can be done via the private sector as well. The value of the collateral is directly related to the discount rate (via typical NPV of cash flows) from the collateral.

      This kinda helps to explain why monetary policy seems so weak at times and other times just insanely powerful. That iceberg of assets changes value quite a lot as the discount rate changes. And at lower rates, the difference between going from 2% to 1% is a massive increase in wealth, vs. going from 6% to 5%.

      • jt26 November 1, 2012 at 6:07 pm

        I see your argument. In essence, your point is if liquidity is not an issue how can the MOE function be more important than the MOA function.

        • Michael Sankowski November 1, 2012 at 7:05 pm

          Yes, if creating loans are not constrained by deposits, then what constrains loans? Nearly every loan in the U.S. is made against some form of collateral. The collateral isn’t widely or frequently traded. The valuation happens on a medium of account basis, not a medium of exchange basis.

          The constraint is all balance sheet, and not liquidity. The banks don’t need cash money to multiply – they can get it any time from the fed. They need collateral which can hold or increase its value, so they feel secure in making the loan.

          • Greg November 2, 2012 at 5:03 am

            “The constraint is all balance sheet, and not liquidity. The banks don’t need cash money to multiply – they can get it any time from the fed. They need collateral which can hold or increase its value, so they feel secure in making the loan.”

            Kind of getting back to “why” a bank creates money in the first place. It seems its simply for it to acquire real stuff (collateral) the same reason any entity creates money, to move a resource to their (the money creators) sector. Dont banks intend to keep a certain portion of their collateral? They know there will be a 2-3% default rate and they look to have the highest quality of collateral.

            You may have stated this somewhere already but couldnt liquidity be thought of as the ratio between the MOA “value” and the MOE “value”. Cash is always 100%

            • Oilfield Trash November 5, 2012 at 1:55 pm

              Collateral can take many forms and is used to reduce the loss of profits to the bank due to a default by the borrower. I would argue CDS, and MBS are a form of collateral. Most MBS carried the same AAA rating as US treasuries; some would even make the argument that if not for this AAA rating the growth of RE and CRE loans could have never happened.
              Having worked around a lot of loan officers in banks, if you ask them what motivates them to make a loan they will tell you it is to generate profits for the banks they work for. Their main tool for this is the interest rate they charge for the loan, and the three considerations for the rate they offer is the risk of default by the borrower, the value of time, and of course the profit motive.
              I have not run into any many bankers who loan money to acquire the collateral that backs them. Not saying this does not happen, but would suggest it is not significant.
              The FIRE sector makes loans to move at a profit some % of the income flows in a monetary economy to its sector.

              • Michael Sankowski November 5, 2012 at 2:33 pm

                I fully agree. Bankers are out to make money, and they do this by making money on the interest rate spread.

                The collateral is part of the “trade” which makes the entire loan work. The trade cannot happen without the collateral – it’s a necessary part of the transaction. The loan happens because the collateral exists and has a value.

                My claim is that this is the important part of the loan. Of course people want loans, and bankers want to make money. I cannot imagine otherwise. But a bum walking into a bank doesn’t get a loan why exactly? Because he has no collateral is the reason.

                So yeah, we can go back and forth about confidence fairies, or we can look at the impact of policy on the most important part of the loan, the underlying collateral which allows loan officers to make money out of a few keystrokes.

                Scott S does not consider this function to be important – that somehow there is always enough good collateral. Gorton destroys this idea in his writings – absolutely destroys it.

                • Tom Hickey November 5, 2012 at 3:43 pm

                  But, Mike, what about during the height of the housing bubble, when banks were lending on dodgy collateral, inflating appraisals, and doing NINJAs?

                • Oilfield Trash November 5, 2012 at 4:53 pm

                  I guess the point I am trying to make very poorly, is banks do not care much about the form of collateral. They only care about what it will cost them to settle a default.
                  Collateral IMO is nothing more than an insurance policy for payment of the money borrowed, and to maximize the profit of a loan banks prefer the insurance policy with the lowest premium over the duration of the loan.
                  I do not want to speculate on what Scott is talking about, but I think he could make the argument that if the FED was the lowest cost premium to settling the default of private debt enough good collateral would be available to support loans; or at least the haircut is smaller on the collateral the banks would accept, which should allow for an increase in purchasing power for the borrower.
                  The bum who walks into a bank did not get a loan because he has no collateral, since he would pledge the same home if that is what his loan is for. He is denied a loan because he has no income or not enough to service the cost of the debt, which makes him a huge profit risk.

              • Greg November 5, 2012 at 3:28 pm

                Dont take my statement to concretely. I dont mean to suggest that any individual banker simply wants your house when he makes a mortgage to you, but the fact remains, he HAS your house til you make the last payment, and if you stop making payments he gets it, it wont happen otherwise. Additionally it is the house which makes the loan possible. Maybe control of asset, is a better word than ownership. There is plenty of property controlled by banks right now (and at most times) and they will likely make profits off the property by mortgaging it to someone new in the next few years.

                I agree they are in the business of making money but they do that by leveraging real assets that they get control of. Is this not so?

                To paraphrase Mikes comment

                You have to have money to borrow money.

                • Tom Hickey November 5, 2012 at 4:56 pm

                  ” There is plenty of property controlled by banks right now (and at most times) and they will likely make profits off the property by mortgaging it to someone new in the next few years.”

                  What they are doing is bundling it and selling it off to deep pocket investsors for rental and eventual flipping. So the properties don’t come on the market and undercut existing prices. Some developments are just being bulldozed.

                • Oilfield Trash November 5, 2012 at 5:13 pm

                  “You have to have money to borrow money.”

                  No all you have to do is prove to the bank they can make a profit on the money they loan you and you get the loan. The bank runs the risk of being wrong but hedges this risk with some form of collateral, the cost for all of this is priced in the interest rates they charge you.

          • beowulf November 5, 2012 at 2:04 pm

            “Yes, if creating loans are not constrained by deposits, then what constrains loans?”
            Capital requirements.

            “Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth. In addition, Basel III introduces a minimum 3% leverage ratio and two required liquidity ratios. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.”
            http://en.wikipedia.org/wiki/Basel_III

  • LVG November 1, 2012 at 12:13 pm

    Look at this disaster. This MMT person Paul, who never understood the S=I discussions think corporations can’t make a profit without government spending.

    http://mikenormaneconomics.blogspot.com/2012/10/paul-meli-sectoral-balances-within.html

    • beowulf November 1, 2012 at 2:39 pm

      Well, to be fair, if there’s NO govt spending, corporations will be too busy fighting off savages in dune buggies to book a profit.
      http://50ansdecinema.files.wordpress.com/2011/04/mad_max2.png

      • Cullen Roche November 1, 2012 at 2:43 pm

        Ha. I’ve been watching this great series on the History channel called “The Men Who Built America”. What really happens without govt is that the capitalists keep almost ALL of the profits and they basically submit their workers to the equivalent of death by labor due to horrid work conditions. That was the wild wild west back in the 1800s! If anything, the govt came in and made things harder for the corporations by forcing them to treat their employees like human beings. :-)

        • Michael Sankowski November 1, 2012 at 2:52 pm

          haha! Until the invention of finance, “nasty, brutish, short” was what we got out of life. Finance plus government = pretty nice life and Watson computers after 200 years.

          • wh10 November 1, 2012 at 4:01 pm

            heh that’s of course broad and sweeping but a compelling, balanced viewpoint at 40K

        • beowulf November 1, 2012 at 5:02 pm

          I’m reading Eric Foner’s Reconstruction book. Its fascinating how after the Civil War, the pro-civil rights party (the Republicans) had guys who were basically socialists wanting to nationalize railroads and banks as well as robber barons like Rockefeller and Stanford. All they really agreed on was political and, for the most part, social equality for African-Americans.
          That’s one of the reasons economics was such a mess during this period (the depression that started in the 1870s ran on pretty much continuously to the end of the century). Since there was no legitimate political opposition*, once the low wage gold bugs took the reins of the GOP, elections couldn’t do much to change direction.
          *The Democratic party at that time was basically the political arm of the Ku Klux Klan, the first thing they did when they took over Congress in 1893 was repeal the Reconstruction laws protecting black voting rights.

      • Michael Sankowski November 1, 2012 at 7:36 pm

        The CEO is dude in the leather shorts, wearing a hockey mask, firing a gun at the helicopter.

    • Michael Sankowski November 1, 2012 at 8:17 pm

      We can’t go there. ;)

  • Fed Up November 1, 2012 at 2:22 pm

    What about this post too?

    When we have internecine battles, you know that market monetarism has arrived

    http://www.themoneyillusion.com/?p=17412

    • Michael Sankowski November 1, 2012 at 7:37 pm

      Haven’t got to that one yet. Well, I agree with him, but question his method of arriving at a good answer.

      • Fed Up November 1, 2012 at 10:46 pm

        When you do get to that one, check my questions at the November 1, 2012 at 2:28 p.m. post.

  • Fed Up November 1, 2012 at 2:28 pm

    From above:

    Scott: “Ms is set by the Fed.”

    Not if M is currency plus demand deposits.

    Scott: “Also assume a dual MOA, with paper currency being the MOE.”

    What if MOE is currency plus demand deposits?

    Scott: “Ms is set by the Fed.”

    What if people decide to stop using currency and use only demand deposits

    ***Saturos said: “The stock of demand deposits is constrained by the stock of bank reserves (even without reserve requirements).”

    That is not right?

    Scott: “The economy is swimming in money. The base has tripled. There is no “shortage” at all. The increase in the demand for base money has reduced NGDP.”

    I don’t believe you have your “medium of exchanges”/”moneys” correct.

    Monetary base = currency plus central bank reserves

    Currency can circulate in the real economy. Central bank reserves do NOT circulate in the real economy.

    Demand deposits can circulate in the real economy.

    Thoughts about those everyone?

    • beowulf November 1, 2012 at 2:50 pm

      I’m a fan of looking at MZM (Money Zero Maturity, that is, M2 less small-denomination time deposits plus institutional money funds).

      It usually tracks pretty closely with Net Financial Assets (NFAs = publicly held debt) in trend and size. Indeed, you know there’s a problem when they stop tracking, like during the 2000s when publicly held debt was undershooting trend. This led to the MZM trendline being filled in by some really weak private loans.
      http://tinyurl.com/7e4pecs

      • beowulf November 1, 2012 at 4:20 pm

        This–
        “This led to the MZM trendline being filled in by some really weak private loans.”

        Is related to this—
        “Update: The internet bubble was an MoA driven phenomenon, and the mid 2000′s refi-boom was a MoA phenomenon.In the internet bubble, many transactions were exchanges of equity with zero MoE involved. “

        • Fed Up November 1, 2012 at 4:44 pm

          “.In the internet bubble, many transactions were exchanges of equity with zero MoE involved.”

          The way the system is set up now, doesn’t MOA = MOE = currency plus demand deposits. That means the equity is still denominated in MOE?

      • Fed Up November 1, 2012 at 4:37 pm

        I try to follow MOE with borrowing from a bank or something bank-like increasing MOE while other borrowing does not add to MOE.

  • Fed Up November 1, 2012 at 2:30 pm

    What if the MOA & the MOE are the same (currency plus demand deposits)?

  • Cullen Roche November 1, 2012 at 2:44 pm

    Great post Mike.

    • Michael Sankowski November 1, 2012 at 2:50 pm

      thx CR. We’re still kicking it over here at MR.

      • Cullen Roche November 1, 2012 at 3:53 pm

        Thanks for keeping the momentum going. I’ve been swamped with other stuff. I’ll pull my weight over here soon enough. :-)

  • Greg November 7, 2012 at 5:01 am

    I may be at odds with my own opening statement above but after thinking more about this important topic I have a couple more comments;

    Medium of account as I understand it can be thought of as how things are priced. What numeraire is used. In the US we use the “dollar sign” to price things and “the dollar” to pay for things.

    People should intuitively understand the difference between a dollar bill and a price tag with a dollar on it and not confuse them but I think they do.

    On our balance sheets we do have a variety of things which determine our wealth level. Some are dollar balances in checking accounts, some are dollars owed to other people and others are prices, in dollars, of things we own. The most volatile are the prices in dollars of the things we own. They can change drastically in a minute if they are a stock or commodity.

    The problem, or A problem, as I see it is that our financial institutions do much of their transacting behaving as if the stock they hold that has a price tag of 100$ is the same as a 100$ bill. This is completely unreasonable, because this price is at the level it is within a certain range of sellers to buyers. If everyone at once wanted to get their 100$ a share for the stock, and tried to sell, the price would plummet and few would get their price. So at any given time only a percentage of people with the 100$ stock can convert it to a 100$ bill so to speak.
    The rest must hold or turn it into a 50$ bill.

    When panics happen everyone is trying to get their 100$ bills and only a few can be successful. Another fallacy of composition.

    So it is important to distinguish between a dollar price tag and dollar bill. You cant really buy much with just a dollar price tag unless there is a barter exchange. Most of the time we need to convert first to a dollar bill and then make the exchange. The strength of the relationship between price tag and “bill-ness” is liquidity.

    I think Monetarists like Sumner want our “million dollar stock portfolio” to be equivalent to a million dollar bill and that just cant be so except for a few of the portfolio owners at THIS moment.

    • Oilfield Trash November 7, 2012 at 9:01 am

      ‘I think Monetarists like Sumner want our “million dollar stock portfolio” to be equivalent to a million dollar bill and that just cant be so except for a few of the portfolio owners at THIS moment.”

      Greg

      I too think this is Sumner issue, the stock of money has been confused with the flow of economic activity that money can finance over time.

      • The Arthurian November 10, 2012 at 3:41 am

        Oh, this is the part I wanted to quote:

        “I too think this is Sumner issue, the stock of money has been confused with the flow of economic activity that money can finance over time.”

        Yes… but this is not just Sumner’s confusion. It is a confusion embedded into policy by the wealthholders we elect.

        Art

    • beowulf November 7, 2012 at 4:32 pm

      “as I see it is that our financial institutions do much of their transacting behaving as if the stock they hold that has a price tag of 100$ is the same as a 100$ bill. This is completely unreasonable, because this price is at the level it is within a certain range of sellers to buyers”

      Not just stocks, if mortgage-backed securities and US Treasury bonds were both give a AAA rating, it stands to reason they’re equivalent. :o)