WM set out a beautiful model of the real economy a few years ago which consisted simply of a family: that is parents and children, with money taking the form of business cards, issued by the parents. Unfortunately I can’t find WM’s original exposition of this analogy / model, but if you Google something like “Warren Mosler, business card, parent, children”, you’ll find several people explaining the basic ideas in the model.
I’ll set out this basic “family economy” first, and then extend the family / economy to incorporate commercial banks and money issued by those banks. Note: I’m setting out the WM business card economy from memory, so I may have some details wrong. That is, if you want the original exposition, you’ll have to find it yourself. Also, the latter “extension” is my own: I’m not suggesting WM would agree with it.
First, this “family model” is realistic in that every family is a mini economy: that is each parent produces various goods and services which are supplied to other members of the family (e.g. the wife does the cooking) and children over the age of about eight normally also have to perform tasks.
In the hypothetical WM family economy, the parents decide one day to issue a form of money, in the form of business cards. There is no good reason, as WM correctly explains, why those cards should have any value, until a day or two later, the parents decide to impose a tax on the children, which must be paid using the cards, else the children are punished.
That’s a very realistic model of the way in which money has been introduced to several civilizations over the last few thousand years. That is, the historical fact is that money has often arisen as a result of kings’ or rulers’ desire to collect tax more efficiently.
Collecting tax in the form of agricultural produce (a common way of collecting tax thru history) is clearly inefficient. Money is much more convenient. So numerous rulers decided to do exactly what the parents in WM’s model did: issue a form of money with the condition that taxes are paid using that form of money – or else. That immediately creates a demand for that money, and gives the money value.
Next, in the business card economy, the parents realise they cannot issue too many cards, else the cards will lose value (inflation). Nor can they issue too few: that would result in deficient demand for the goods and services available in the household. That is, it would result in unemployment.
Put another way, each child is bound to want to keep a limited stock of cards against a rainy day, but only a limited stock. I.e. the parents (aka the government / central bank / ruler) must issue enough cards to exactly meet the children’s desire to save, and to keep the economy working at full employment.
Next, borrowing and lending would arise in the business card economy, and absent any attempt to parents to influence the rate of interest, some sort of free market rate of interest would establish itself. The parents could artificially raise that rate of interest by offering a rate of interest above the going free market rate and could fund the interest out of taxation. But quite what the point of doing that would be is a bit of a mystery. In particular, it is widely agreed in economics that GDP is maximized where prices (including the price of borrowed money) is at its free market rate, thus any attempt by the parents to artificially raise the rate of interest would seem to be counterproductive.
Put another way, it is always tempting for governments to borrow, as pointed out by David Hume over two hundred years ago (see endnote below), but that borrowing artificially raises interest rates, and reduces GDP.
Indeed, that point ties in very neatly by WM’s claim that there should be a permanent zero rate of interest. I.e. while for example those who offer pay-day loans will always charge way above a zero rate, the rate offered by the state on its liabilities should be zero. (See 2nd last para of WM’s Huffington article “Proposals for the banking system.” and his paper “The Natural Rate of Interest is Zero”).
Having set out the basics of the WM family economy, and doubtless having left out some important points that WM made in his original version of that economy, let’s now move on to commercial banks.
As already explained, there’d be nothing to stop the children lending to each other, plus there’d be nothing to stop one or more of the children setting up as a commercial bank, i.e. specialising in safeguarding other childrens’ cards, and lending to other children.
However, that would enable the “banker children” to play a trick which commercial banks play big time in the real world, which is thus. Instead of lending out “parent issued business cards” (base money) at interest, there’d be nothing to stop the banker children issuing promises to pay genuine business cards. And as long as the non banker children trusted the banker children, that commercial bank issued money would serve as well as the real thing, i.e. parent issued cards.
If you have any grasp of banking, you’ll see what is going on here. But in case you don’t, I’ll explain.
The discovery by banker children that they can lend out promises to pay was exactly the discovery that the goldsmith bankers in England in the 1600s and 1700s made: that is, they discovered that when granting a loan, they didn’t need to lend out real gold, or even receipts for real gold. They could lend out receipts for gold that didn’t exist! They were into money printing, pure and simple.
In short, in the WM business card economy, banker children would be able to supplant the parents, and become the main issuers of money. And indeed that is exactly what has happened in the real world: prior to the 2007/8 crisis, a good 95% of the money in circulation was issued by private banks, not central banks. (That percentage has dropped to roughly 90% as a result of QE, far as I can see. But that’s not of much relevance to the argument here.)
So, does money issuance by banker children (aka “private banks”) make sense? Well the answer is that assuming that money is used purely and solely as money, and not as a long term loan, it makes no sense at all. Reason is that privately issued money is inherently expensive compared to state or “parent” issued money.
Where a commercial / private bank is going to supply a customer with money, the bank has to check up on the customer’s credit-worthiness, allow for bad debts and so on. That involves very real costs. In contrast, there is no need for a central bank (aka parents) to do that.
Incidentally, when I said “use money purely and solely as money, and not as a long term loan”, what I meant was as follows. Where a bank customer (aka child) has no money, and needs money for day to day transactions, the customer might agree with the bank to become overdraw to a maximum of $X, e.g. when short of money just before pay-day, while having a credit balance at the bank just after pay day of around $X in a typical month. In that scenario, there would be no overall loan by the bank to the customer (or vice versa) over the year as a whole. That is, the $X loan is being used purely as a float, i.e. purely as money.
As distinct from using money borrowed from a commercial bank purely as money, there are loans which are genuine long term loans, e.g. mortgages.
Now if a child banker (or a real world commercial bank) simply lends out parent issued cards (or central bank issued base money in the real world), there is little effect on demand. Reason is that in order to obtain the cards to lend out, the child banker has to persuade another child or children to ABSTAIN from spending cards, by offering the latter interest. So the reduced spending by the latter children will approximately equal the INCREASED spending by the former “borrower children”.
In contrast, if the banker children lend out “promises to pay cards”, that is entirely new money. The effect is a rise in demand, and assuming demand was already at the maximum permissible without sparking off inflation, the effect will be inflationary. Thus the parents will have to impose some sort of deflationary measure, like raising taxes and confiscating cards from other children.
In short, the effect of child bankers lending out promises to pay cards (and the effect of commercial banks in the real world lending out their home made money) is very much the same as the effect of traditional back-street counterfeiters who turn out fake $100 bills: the money printers clean up, while the rest of the community is robbed.
To summarise, where a commercial bank supplies home made money to a customer which is used purely as money, that exercise is pointless, and indeed will not take place if the central bank issues enough base money. Alternatively, where commercial banks lend out money which is used as a genuine long term loan, that activity is subsidised by the community at large.
Endnote – David Hume.
Hume explained why governments incur debt much more succinctly than any 21st century economist. As he put it:
“It is very tempting to a minister to employ such an expedient, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamours against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker's shop in London, than to impower a statesman to draw bills, in this manner, upon posterity.”