Wednesday, 24 February 2016

How Randall Wray should have attacked debt based money.


The vast majority of money in circulation is issued or created by private banks rather than central banks. And it is often claimed that “loans create deposits”, i.e. that private banks when they grant a loan simply create the relevant money out of thin air and give it to the borrower. Thus, so the story goes, privately created money necessarily involves debt creation, or quote a popular phrase, “Without debt there’d be no money”.

That all gives rise to the phrase “debt based money”. And in view of the negative overtones of the word debt, that leads many to argue that there is something wrong with so called debt based money.

L.Randall Wray (professor of Economics at the University of Missouri-Kansas City)  has written a few articles recently criticising the “debt based money” concept and on the grounds that the alternative form of money, i.e. central bank issued money (base money), is also a debt of sorts.

Wray’s articles produced several responses e.g. from Eric Lonegran, Brian Romanchuk and from me. I argued among other things that central bank / government issued money, if it is a debt, is so different in nature to a normal debt that basically it is not a debt at all. For example the so called debtor (i.e. central bank / government) can simply wipe out any amount of the so called debt it wants whenever it wants via tax. That is, when the government machine says “We’re raising taxes by $X, and you households and corporations better pay up else you go to prison”, then government is essentially wiping out $X of the so called “debt” it owes the private sector. And that’s clearly very different to the debt you owe your bank in respect of your mortgage: there is absolutely no way you can wipe out that debt by simply announcing the debt no longer exists – and the bank manager goes to prison if he objects.

So to summarise, Wray’s argument that base money is also a debt isn't brilliant. Now for a better argument (hopefully).

The real flaw in “debt based money”.

One problem with the debt based money idea is that at the moment when a private bank grants a loan of $Y, no net debt is created. Reason is that the bank sets up two equal and opposite debts. First there is the $Y the bank owes the borrower and that’s called “money”, and the bank undertakes to become indebted to anyone the borrower chooses when the debtor says so (using his/her cheque book, debit card or whatever). Money is debt owed by a bank to a bank customer. Second, the equal and opposite debt is the obligation on the borrower to repay the first debt at some point.

Next, there is a crucial distinction between bank customers who simply want a supply of money, and bank customers who want loans. Suppose a private bank were to set up in an economy where money previously didn’t exist, and it offered some wondrous new stuff called “money” to anyone wanting to dispose of the inconvenience of barter. Also assume the bank announced that each unit of money was equal to the value of a gram of gold or some other rare metal.  That would not of itself create long term debts.

The bank would simply credit money to the accounts of those wanting money (maybe after collateral was deposited); then, any money paid out of one account would necessarily arrive in someone else’s account (assuming for the sake of simplicity that there was no physical cash).

In short, everyone’s account would bob up and down above and below the original amount credited to their account, thus there’d be no long term debts.

Would the bank charge interest to those whose balance was below the original amount credited? Well it could, but assuming everyone’s account is ABOVE the amount originally credited as often as it was BELOW, then account holders would be equally justified in charging the bank interest. All in all, the charging of interest would be a waste of time.

It would make sense for the bank to charge for ADMINISTRATION COSTS, but that’s not the same as genuine interest (indeed, that’s one of the weaknesses in debt based money: it’s inherently expensive to create compared to base money).

To summarise, where a private bank simply creates money as distinct from granting a long term loan, bank customers don't incur net debts over a full 12 month period. Plus the charging of interest wouldn’t make much sense.


In contrast there are long term loans, e.g. for mortgages which often last decades.

A long term loan necessarily involves the transfer of REAL RESOURCES for an extended period, and interest is what is charged for borrowing those real resources. For example where someone gets a mortgage for $100k, that enables them to acquired a big lump of valuable real resources or wealth, commonly known as a “house”.

Now there is absolutely no way a bank can produce real wealth / resources. That is, a bank is simply a collection of offices, full of computers, bank staff, etc. Banks don’t produce bricks, concrete, timber joists and the other stuff needed to build a house.

Banks simply issue bits of paper or book-keeping entries that enable one set of people and firms to purchase stuff off other people and firms in a more convenient way than occurs under barter. Thus when a bank grants a loan for an extended period, the real stuff that the borrower comes by is not produced by the bank: it’s produced (in the case of houses) by those who run and work in brick kilns, saw mills and so on.

Put another way, when a bank grants loans to a set of borrowers, and assuming the economy is at capacity, some other set of people must save, i.e. produce more than they consume, else the economy overheats: inflation becomes excessive. And those savers normally demand interest.

In short, when interest is charged by a bank, the bank is simply passing on the interest that the bank itself has had to pay to savers. Of course banks charge borrowers significantly more than banks have to pay to savers, but to repeat, that’s for administration costs of one sort or another: salaries paid to bank staff, something to cover bad debts, upkeep of bank buildings and so on.

In short, the idea that there is something wrong with privately issued money because a debt arises whenever such money is issued is nonsense. Also the popular claim that we, the people, have to pay interest on the money supplied to us by private banks is nonsense. Banks DO CHARGE for administration costs involved in creating money, but they do not charge what might be called “genuine interest” on that money. In fact banks don’t even charge genuine interest on loans: what they do is PASS ON the interest they have to pay to savers, and then add something to allow for administration type costs and of course something for profit (i.e. a reward for one particular type of saver, namely shareholders).

So is privately issued money without fault?

Having argued that the alleged debt element in privately issued money is non-existent or not a problem, that’s not to say that privately issued money is without fault. For example, private banks act in a pro-cyclical way: that is, they create and lend out money like there’s no tomorrow in a boom. Then come the bust, their money creating and lending activities grind to a halt. That’s the exact opposite of what we’d like them to do.

So should we prohibit privately issued money? Well that’s a big question: not one I’ll deal with here.


P.S.  (25th Feb).  There's a new article just out by Eric Lonergan which also criticises Wray.


  1. Interesting discussion...

    Ralph> Money is debt owed by a bank to a bank customer.

    Well, no, money isn't debt. Money can't be debt because money is an ---asset--- while debt is a ---liability---. Money and debt are two, opposite, sides of the same coin (pun intended).

    The best phrasing I could come up with, is that money is "a token of indebtedness" (token e.g. in the form of coins and notes) or "a transferable acknowledgment of indebtedness" (in the form of credit in a current account or similarly liquid and transferable account). Money is an asset in the hands of the bearer or account holder, corresponding to a numerically equal liability owed by the issuer of the token or account to the bearer or holder.

    Bank money (as credit in current accounts) is acknowledgment of indebtedness of the bank to the account holder.

    Base money (as coins and notes) are tokens of indebtedness of the issuing central bank or treasury. Base money (as reserves held by commercial banks at the central bank) are acknowledgments of indebtedness of the central bank to the commercial bank. This perspective of base money as token/acknowledgement of indebtedness (i.e. IOU's) corresponds to the idea that base money derives its value from its being accepted by the state as settlement of debts to the state (such as taxes). It's even printed explicitly on all dollar notes: "This note is legal tender for all debts, public and private".

    This is consistent with the view of Alfred Mitchell-Innes in his 1913/1914 papers
    In the first article, p. 14, he even writes explicitly: "Money, then, is credit and nothing but credit. A's money is B's debt to him, and when B pays his debt, A's money disappears. This is the whole theory of money."

    Ralph> How Randall Wray should have attacked debt based money.

    This must be a slip of the pen or a strawman, Randall Wray doesn't attack "debt-based money" at all. Actually he does the exact opposite, he mocks and adamantly rejects the idea of "debt-free money" because (in his view and consistent with comments above) money without the underlying notion of indebtedness doesn't make sense. See his series of posts on the subject.

    So, in summary:
    (1) Money is not debt (it's the opposite, i.e. credit)
    (2) There is no money without debt (not even base money, since it's logically equivalent to IOUs).

    1. Eric,

      Your first few paras (on the subject of commercial bank created money) seem to be saying much the same as me, namely that such money is a debt owed by a bank to someone with a credit balance in their account at that bank. The only difference is that you say the debt is “transferable”. OK: fair point.

      Re your point that base money is a “token of indebtedness” to commercial banks, I realise that base money often CLAIMS to be a debt. For example £20 notes say that the Bank of England promises to “pay the bearer” £20 – presumably in gold. But of course that’s a completely empty promise. The value of £20 notes lies in the fact that they are GENERALLY ACCEPTED as money. If instead, £20 notes had a picture of Donald Duck, and the notes said “Donald Duck promises to make a quacking noise for you on request” and Donald Duck notes were widely accepted as money, then Donald Duck notes would constitute money. The fact that the “promise to quack” is completely empty wouldn’t matter.

      Add to that the fact the state can simply wipe out chunks of it’s so called debt whenever it wants via tax (as mentioned above), and the whole idea that base money is any sort of real debt looks very questionable to me.

      Re Wray’s argument, his basic point if I’ve got it right is thus. Some people claim that privately issued money is a problem because debt is inherent to that form of money, whereas there is no debt inherent to base money. Wray tries to criticise that idea on the grounds that base money actually is a debt, and hence that the later distinction between the two forms of money doesn’t hold water. My answer to that is that base money is either not a debt, or if it is, it’s a very odd sort of debt. Moreover, those concerned about the alleged debt element in privately issued money have got it wrong as well.

  2. Ralph> Re Wray’s argument, his basic point if I’ve got it right etc.

    Okay, my understanding of Wray's position and line of argumentation corresponds to your description in this last paragraph.

    Ralph> ... such money is a debt owed by a bank to someone with a credit balance in their account

    Again, the whole confusion, with all people turning around in circles, saying and repeating the same things in opposite ways, and misconstruing each others arguments, arises from that misleading "money is debt" equation. No, money isn't debt, it's the reverse. From my perspective, my money in my bank account is my asset, it's "plus" for me. From the perspective of the bank, there's a corresponding debt in their books, a liability, in "minus" for them. Let's stop equating money to debt. And also, let's acknowledge that there can't be money (for me) unless there's a corresponding debt, with reverse sign (for the bank or some other entity). Evidently this applies to bank money, and I think everybody agrees on this.

    Now what about base money, issued by "the sovereign" (central bank or treasury). There are two lines of thought.
    (1) In the view of Mitchell-Innes, Randall Wray etc, base money can be understood and explained in logically the same way as bank money, with a liability on the sovereign. The sovereign acknowledges the liability by accepting the corresponding asset (the money) as settlement for debts of the bearer to the sovereign. Without such acknowledgment of liability, the money would lack its basis for value (that's the basic Randall Wray "redemption" argument).
    (2) Others (including you) claim that it's different, for all sorts of reasons. Often they ---want--- it to be different in the hope of having debt-free money of some sort.

    Well, both views have their merits. But let's be clear...

    Ralph> Add to that the fact the state can simply wipe out chunks of it’s so called debt whenever it wants via tax...

    Whenever it wants? In any quantity it wants? These are unrealistic claims often heard in MMT circles, even though MMT-man #1 Randall Wray would not make such claims. In the real world, sovereigns ---cannot--- arbitrarily raise taxes, at will and as much as they please, because (1) populations may object and protest (democratically or violently), and (2) the maximum amount of collectible taxes is limited by the effect of the Laffer curve: beyond some tax rate, the collected amount doesn't accrue but shrinks.

    Ralph> For example £20 notes say that the Bank of England promises to “pay the bearer” £20

    Pound notes are promissory notes, assets in the hand of the bearer, promises (i.e. liabilities, debts) for the issuer (BoE). Essentially same as any base money. The real value is the result of the pounds being accepted for settlement of taxes (it must be in the laws somewhere, though it's not printed as such on the notes).

    Re Donald's promissory money: its value would be determined by (1) the perceived economic value of his promise, (2) the perceived likelihood that he actually honours his promise. My compatriot Bernard Lietaer has interesting things to say about such parallel privately-issued community monies (WIR, Torekes, Dora etc):


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