[OPE-L:1997] Re: [MIKE WILLIAMS] electronic money

Duncan K Foley (dkf2@columbia.edu)
Sat, 27 Apr 1996 09:05:16 -0700

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On Sat, 27 Apr 1996, riccardo bellofiore wrote:

> Duncan,
> I think your post very clearly put on the table the issues, and
> clarify many differences. I cannot now pursue all the threads, so I limit
> myself to few considerations.
> >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.
> I agreed from the beginning that *historically* and for the problem of the
> *standard of value* it may be useful to consider some kind of
> convertibility - I would distinguish the conversion into basic money (say,
> fiat legal tender) and the conversion in actually circulating gold. Where
> we depart is in the fact that you say that an inside money system "wouuld
> be possible only if" etc. If this is not put forward in an historical
> sense, or as a policy proposition, it is plainly wrong. A pure credit
> system is quite possible, in 'pure theory', even without convertibility.

I think the formulation "a pure credit system is quite possible, in 'pure
theory', even without convertibility" is doubtful. What is possible in
pure theory is a credit system that operates with a zero or vanishing
reserve, due to the possibility of clearing. But there is a difference
between a system that runs because of a guarantee of convertibility but
without ever having actually to convert, and one that makes no guarantee
of convertibility at all. I question whether in 'pure theory' one can
adequately answer the question of why the liabilities of a purely
private, competitive banking system, would have any value at all, and
what would determine that value (that is, the price level).

> >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.)
> Here's the crux of the matter. It is of course true that deposits of the
> public means a loan to the banking system - which is the counterpart of the
> loan of the banking system either to firms or the State! Does that mean
> that the banking system "could not issue more deposits than the *public* is
> willing to hold? Not at all. It is right that there must be some demand for
> the loans by the State or the firms for bank to expand loans. But it is not
> true that it is relevant here household's portfolio choice, that is deposit
> demand. An individual agent may of course reduce or enlarge the total of
> the deposits she holsd; but that is not true for the whole of the household
> sector. It can reduce the amount of deposits only if there is somewhere in
> the system a reduction in loan demand, or in bank money supply: for
> example, if there is a 'shift' of part of the deposits to indebted agents,
> who cancel their debt with debts (but this means that the latter are
> cancelling a loan!); and/or if, in a system with reserve requirements, with
> the reserve ratio going up, commercial banks are compelled to reduce their
> loans because there has been a squeeze in the credit potential.

This is a somewhat old-fashioned argument, so perhaps there is not much
point in pursuing it a lot further. If banks over-issue deposits or
notes, the public has ways of disposing of the excess: repayment of
loans, purchase of state or foreign assets, etc. The confusion over this
point seems to me to arise from the practice of operating national
banking systems as cartels organized by the central bank and disciplined
by reserve requirements. Under these circumstances an increase in
reserves always creates an increase in deposits because the public is
effectively rationed in its holding of deposits, but I would argue that
it is a mistake to project this behavior onto a completely unconstrained,
competitive banking system.

> Note that there is no need for reserves for the banking system as a whole
> in a closed economy: so this reserve requirements must be introduced in the
> analysis later, as a sort of policy constraint, not as something which is
> proper to the working of the monetary system as such. Your argument
> according to which "banks run out of reserves" etc. depends on the internal
> drain, that is on a convertibility for which the banks may lose liquidity
> in favour of the public. That may happen, of course, *if* it is allowed in
> the system this kind of convertibility.
> As Schumpeter said, one may be a theoretical cartalist (= support the idea
> that the working of the money system can go on without any convertibility
> in a money-commodity) and a practical metallist (= support the idea that
> for the stability of the standard of value a convertibility in a
> money-commodity is essential). With slight changes, this could be used to
> describe my position towards yours.

I do question the sustainability of the cartelist position.

> Let me be clear. We agree on all the description of what happens, but not
> on the language and on the theoretical foundations. I dare to say that it
> is possible to show that there is a confusion in Tobin's approach when he
> still tries to defend in some way the idea that banks depend on household's
> portfolio choice, a confusion which reveals how still today it is difficult
> to abandon the multiplier view of the money supply, which is there in all
> the textbooks and even in Nobel laureates. A view which is in deep contrast
> with the idea that loans make deposits - hence it is wrong, unless you show
> me that the banking sector is able to collect deposits before making a loan
> (here Steve K. post is relevant).

In fact U.S. banks for the last 15 years have been financing marginal
loans by the sale of Certificates of Deposit and commercial paper at
market rates, not by the expansion of deposits.

> >
> >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.
> As we are discussing of the nation-state, we are in fact not at the macro
> level. For the rest, I agree that what you pose is a relevant issue: I
> simply would include it in the more general monetary framework.
> >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.
> I think that historical and policy questions, like the ones to which you
> are always returning, *must* be addressed, but within a (macro-founded)
> analysis which captures the logic of capital as such - and hence, also the
> logic of the money circuit as such.
> >
> >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.
> It is no new position, and I respect it a lot. By the way, it was the
> position of Mises - it is interesting because he stresses the point
> *together* with the idea that the banking system as a whole can create
> money at will, hence producing hyperinflation (the problem of the standard
> of value). I may even partly agree with this position: if what is said is
> relative to the problem of the stability of the standard of value and not
> to the working of the monetary system as such. But one can also reason in
> the following way: the pure credit model shows that private banks can
> expand in step, hence producing an unbearable instability. Hence, a central
> bank (with reserve requirements) is needed to peg the standard of value.
> >
> >>
> >> 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.
> I had to look in the dictionary for 'sloppy' (unsystematic? careless?). I
> agree that tihs tradition, being a minority one, is far less developed and
> refined (also because very few people work in it) than, say, neoclassical
> monetary theory, which is a scholarly rigorous, precise, wrong theory,
> especially on the fundamentals of money.

By "sloppy" I meant analytically imprecise. The problem goes to the
underlying (incorrect) idea that the state can create claims to the
social product directly by printing money. It can only create claims to
the social product insofar as it has the effective power to tax; the
function of currency in commanding social resources rests ultimately on
this power, mediated by speculation in cases of inconvertibility. The
experience of the U.S. Government with greenbacks during the Civil War is
a good laboratory for this point.


> As for the Paul C. post: I agree with Steve K. Reply. Let me add that I did
> not want to exclude the State, the Central Bank etc. from the picture.
> Simply (as Marx in the first volume of Capital?) they are not there from
> the start.
> riccardo
> ==================================================================
> Riccardo Bellofiore e-mail: bellofio@cisi.unito.it
> Department of Economics Tel: (39) -35- 277505 (direct)
> University of Bergamo (39) -35- 277501 (dept.)
> Piazza Rosate, 2 (39) -11- 5819619 (home)
> I-24129 Bergamo Fax: (39) -35- 249975
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