[OPE-L:1956] Re: [MIKE WILLIAMS] electronic money

Duncan K Foley (dkf2@columbia.edu)
Thu, 25 Apr 1996 09:45:31 -0700

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On Thu, 25 Apr 1996, riccardo bellofiore wrote:

> At 13:23 24-04-1996 -0700, Duncan K Foley wrote:
> >On Wed, 24 Apr 1996, riccardo bellofiore wrote:
> >
> >> You are quite right. However, this follows from the fact that, as you quite
> >> explicitely put forward, here you are looking at how national central banks
> >> behave in an open economy setting, i.e. within the international payment
> >> network. I think that when discussing how the monetary system works, we
> >> must start from a *closed* economy (or, if you prefer, a world economy)
> >> institutional framework. Here, the credit-money issued the banking system
> >> as a whole (and hence, also State's liabilities towards the banking system)
> >> is quite independent by definition on the holding of reserves.
> >
> >I'm not sure what you're thinking of here. Even in a closed economy, when
> >the central bank (or the state) issues currency, it functions as a
> >liability of the state (or the bank), and represents a loan from the
> >public to the central bank or the state. It is true that in this case the
> >issue of currency is not limited by an external drain of reserves (which
> >is what I suppose you have in mind). On the other hand, if the state
> >maintains convertibility into gold, issue of currency could lead to an
> >internal drain of gold reserve to the public. It seems to me the issue
> >have to do with the forces determining the valuation of the state debt in
> >terms of commodities.
> >
> >Duncan
> May be I jumped into a discussion which was explicitely framed to discuss
> State debt, and not State debt *and* the nature of money: so may be I am
> out of tune. What I wanted to say was the following. There is no inner
> necessity to have State debt to have money in the system: this money may be
> created by the banking system *without* a Central Bank; or by the banking
> system *with* the Central Bank in. That is, the analysis of the economy as
> a monetary circuit does not need to start presupposing the presence either
> of the Central Bank or of the State. We should (and must, in my opinion)
> start with only 'private' agents: commercial banks, firms, households. We
> can then put in the Central Bank without the State, and then the Central
> Bank and the State. Most of the outside money is money lent by the banking
> system to the State. I am taking the money issued directly by the State,
> independently from the Cntral Bank, to be a negligible phenomenon (am I
> wrong?). In this latter case, we would have seignorage.

I agree that the currency issued directly by Treasury Departments is of
neglible importance in most contemporary countries that I know about. I
also agree that in principle a monetary system could be an entirely
"inside" money system, in which the deposits and notes issued by banks
circulated as money. However, this would be possible only if the deposits
and notes of the banks were convertible into some standard of value,
historically either gold or the debt of the nation-state. While the
banking system can bootstrap the quantity of credit, given a value for
money, it cannot create a standard of value.

> >From here, some consequences. All money is created by the banking
> system.This money is totally issued ex nihilo (the banking *system* do not
> need, and cannot, go into debt with the public in order to make loans).

I think I disagree with you on this point. When the public holds deposits
or notes of the banking system it is essentially making a loan to it.
This point is clarified in Tobin's essay "Commercial Banks as Creators of
'Money'". It is true that there is considerable elasticity in the size of
the banking system, depending on the availability of reserves against
deposits, reserve requirements, the degree of monopoly in banking, and so
on. But even a competitive banking system could not issue more notes or
deposits than the public is willing to hold. (Since the notes or deposits
have to be convertible, if they overissue, the public will convert and
reduce the issue, and the banks will run out of reserves.)

The nation-state in contemporary institutional circumstances, faces no
such constraint on the issue of its liabilities (whether monetary or
interest bearing bonds), since the nation-state does not guarantee the
convertibility of its debt into anything else at a particular rate of
exchange. This raises the particulary acute question of locating within
monetary theory the determinants of the value of the state debt. As I
indicated in some posts, and in the paper you are about to publish from
the Bergamo conference, I believe the right road to a solution of this
problem lies in the theory of speculative valuation of assets.

> *If* there are, or there have been in the past, State deficits financed
> with money, and this money is still in the money holdings of the
> households, this (stock of) money surely represents a liabilility of the
> State and an asset for the household sector. But this is not a necessary
> condition to have money in the system. We can have, for example, a (stock
> of) (inside) money because debts have not repayed in its entirety their
> loans to the commercial banks, and we have also here a liability (for the
> firms), on one side, with assets for the households, on the other side. We
> may even have no stock of money held in the system, and the system still
> being a monetary economy (if all loans, by the firms or by the State, have
> always been repaid at the end of each circuit in the past, as in the
> current period).
> Hence, I return to my two conclusions. In the macro view (closed economy)
> the power of the banking *system* to create money is not limited by 'real'
> assets (credit-money supply is not linked to 'credit'), because the banking
> *system* can always make good its claims (this is not true, of course, for
> individual banks: but we must distinguish the two things, the second, the
> 'micro' analysis, qualifying the first, the 'macro' analysis).

Here again I could agree only with strong qualifications. The banking
system cannot always make good its claims unless it holds reserves of
whatever it undertakes to pay its deposits and notes in. The banking
system has never, to my understanding, been in the position of the nation
state, that is, with strong enough credit that its liabilities have a
value without an convertibility into anything else.

It is true
> that the convertibility may create the problem of the internal drain: this
> is however an institutional constraint superimposed to the working of the
> monetary system, though it may well 'peg' the valuation of money in terms
> of commodities - and, I agree, a constraint which must be taken seriously
> into account when turning to history or policy. What I contest is that it
> must be included from the beginning as a necessary feature of the working
> of the monetary economy 'as such', or 'in pure theory'.

I think convertibility is a necessity for the operation of a banking
system, though it has turned out to be dispensable for the functioning of
the state credit.

> I take this to be in the tradition of monetary theory of this century
> before the General Theory, from Wicksell to Keynes Treatise on Money, now
> being revived by some postkeynesian and (French and Italian) circuitist
> authors.

Yes, but this shows exactly how confused this tradition has become, due
to a sloppy use of the concept of "fiat" money.