–Mr. Felix Salmon quotes popular myths

The debt hawks are to economics as the creationists are to biology.

On August 19, 2010, Felix Salmon posted:

There aren’t many things that the government can do to try to boost the number of jobs in the U.S., but at the top of the list has to be attempts to boost lending to small and medium-sized businesses. . . This morning, a Treasury announcement showed one way that this can and should be done. Treasury’s CDFI Fund has awarded just over $100 million to 180 local financial institutions, including $750,000 to my own credit union. That kind of money, leveraged and lent out to small businesses, can do more for creating jobs than just about any other government program. The CDFI initiative is small beer, however, compared to the Small Business Jobs and Credit Act, which would create a $30 billion fund to be used to encourage small banks to lend to small businesses. Combined with standard bank leverage, that could mean $300 billion in new, job-creating loans.

Isn’t it odd that people who want the federal government (which cannot go bankrupt) to borrow less, also want the private sector (which is subject to bankruptcy) to borrow more? Mr. Salmon quotes the myth of fractional-reserve banking. It doesn’t exist. A bank’s lending is not limited by its reserves. A bank could have $0 reserves and still lend billions. The federal government lends all banks sufficient money to cover any amount of reserves. Bank lending is limited by capital, not reserves.

Popular wisdom holds that banks are at fault for not lending enough. Nonsense. Rather than trying first to indebt business, the government first should provide business with profits. It does this by buying goods and services, in short, by deficit spending.

Business borrowing is not the first stimulus for business growth. Profits come first; then borrowing. To borrow today in hopes of profits tomorrow, is a dangerous game. It’s exactly what homeowners did and this kind of thinking was the single most important reason for our recession. Small businesses go bankrupt so often, because they borrow without profits to support their borrowing. A loan should leverage profits, not hopes.

Rodger Malcolm Mitchell

No nation can tax itself into prosperity

19 thoughts on “–Mr. Felix Salmon quotes popular myths

  1. Now you see, I got confused again.

    I hear Mosler and Auerback saying that the government spends which creates and equal amount on the private side of the books as in double entry accounting. ( http://watch.bnn.ca/after-hours/august-2010/after-hours-august-19-2010/#clip338580 )

    So, if that is true then that implies a zero sum game. The debits equal the credits, blah, blah, blah. Yet we hear over and over that our economy and free market is not zero sum. Rising tide lifts all boats, etc., etc.

    As the government spends and likewise creates debt that the banks purchase and then the Fed buys from the banks, this is supposed to then turn around and add reserves to the banks for which they can then lend.

    But as you say, lending is capital bound not reserve bound. So just how do bond purchases which started out as government spending actually create more money in the system that can be used for debt?

    I understand government spending creating a demand for a product and thus the purchase may stimulate the economy. But, we’re talking about the debt that gets created from the spending. Just how does that help again?


  2. Debits always = credits. Government creates money and sends it into the economy (credit) by deficit spending. Simultaneously, it debits its own balance sheets.

    Your bank receives the money and credits your account, while debiting one of its reserve accounts.

    Bond purchases have nothing to do with government spending. No relationship whatsoever. They do not create money.

    Rodger Malcolm Mitchell


      1. Federal spending is the original source of money.

        Visualize a brand new country with no money. How do the people obtain money? The federal government creates money and sends it into the economy by deficit spending.

        Rodger Malcolm Mitchell


    1. Is this an issue of semantics where people like myself simply do not understand the difference between reserve requirements and capital requirements but we all mean the same thing but use improper terms?

      Is this point similar to when people use the phrase, “the government is printing too much money”, where despite the fact that everyone understands that the word “printing” is used as a kind of metaphor, we still go down the tiresome path of pretending we need to explain it?

      Don’t take me as an antagonist, I’m currently a firm believer in MMT and quote you profusely.


    2. After a stint over at the wiki site, this is how I think I understand it.

      When people talk about “fractional-reserve banking” they are referring to fractional-capital banking” or the idea that a certain fraction of capital needs to back up the risk they take. So even though both sides are talking about exactly the same underlying principal, my side, the MMT guys, appears to be playing such a semantic game that even I, a rabid supporter of MMT, am having a hard time understanding the points other MMT people are trying to make.

      If a supporter of MMT can’t understand the points other MMT people are trying to make how hard is it for others?

      Of course maybe I simple have a lot more to learn and my interpretation is way off base…


  3. DAB,
    It’s not semantics. As I said earlier, capital is money owned by the bank. Reserves is money held by the bank, but owned by depositors.

    A bank is a business. It’s capital is the net assets it, as a business, owns. The bank does not own the money you have on deposit with them. You still own your checking and savings account deposits. The bank just holds them for you.

    For a bank, “reserves” are deposits + cash in the vault. Theoretically, there is a reserve requirement, but in actuality, if a bank runs short of reserves, it can get money from the federal reserve discount window. So the fractional-reserve requirement is a farce.

    The real limitation is the capital requirement, which is based on the banks own money, not on depositors’ money.

    Rodger Malcolm Mitchell


    1. Fair enough but when others, not me, talk about the fractional reserve system they are actually talking about the fractional capital system we have. In the end they would be happy to change the words they use to reflect that (rolls eyes) but, their arguments against it would not change in the slightest. If the words change but the arguments being made don’t than that tells me we are talking past each other a little bit and I may point out the technical difference in what we are talking about but just as the “print money” conversation, I don’t think there is anything of substance to be gotten from winning those battles.

      As always, just learning and ready to change my mind on these things at the first opportunity…


      1. There actually are two limits: Reserves and capital. However, reserves is not a true limit, because the government will lend a bank all the reserves it wants.

        When people talk about “fractional-reserve,” they really do believe they are talking about reserves. They think the bank is lending the money people put into their savings accounts.

        Rodger Malcolm Mitchell


  4. “Federal spending is the original source of money.”

    Is it? Perhaps in printed form, but not all forms of money.

    As you say lending is capital constrained. If tomorrow a cure for cancer is found by the use of bank lobby chairs and only bank lobby chairs, then the value of those bank lobby chairs just went sky high. And thus, so did the capital of the bank. The bank can then increase it’s lending by just depositing money into bank accounts. Did any of this money come from government spending? Did any of this come from government printing money? No.

    That’s the confusion I have with this double entry accounting. If I decide to produce something more than I produce today, I can earn more money with more products. And like you say in the post above you imply profits are necessary. If I save my profits I don’t need to borrow money yet I have money to spend. Did my new spending ability come from government spending? No, it came from my production. The bigger thing I kill tomorrow the more I eat the next day.

    If the government stopped spending any money tomorrow would the bank not have capital to make a loan?

    Perhaps if I needed physical money all the time to buy and sell goods then this would make sense that the government has to put money into the economy (spend) for there to be physical money to pay for things. But when products and services are bought and sold with numbers in bank accounts, I think the reliance on government spending is greatly reduced.

    Maybe this is the next evolution of chartalism. Money does not have intrinsic value like we’ve said before. Neither does it have a source of government debt and government debt only like your tag line implies. Maybe money has value only by its use in an economy.

    So perhaps here is the next step: . Since the gold standard doesn’t mean anything for our monetary policy so perhaps our dependency on government creation of money is likewise a relic.


  5. I said, “Federal spending is the original source of money.”

    Visualize forming a brand new government, perhaps on an island somewhere. People there use the barter system, but there is no money. How would you institute the use of money and get it into the hands of the people?

    “Fractional-reserve” lending does exist in that a bank must have sufficient reserves in order to lend. The reason I call it a myth is because the government will give the bank all the money reserves it wants, so fractional-reserve is not a true limitation. But the source of these reserves is government money, not cancer-curing chairs.

    Bank lending creates money, but loans must be repaid, which destroys the money. The only money that does not need repayment is federal deficit spending.

    Rodger Malcolm Mitchell


  6. “Visualize forming a brand new government, perhaps on an island somewhere. People there use the barter system, but there is no money. How would you institute the use of money and get it into the hands of the people?”

    Does the money actually have to be physically in the hands of people? Can the money just simply be numbers in an account somewhere? Can the amount be carved on a piece of wood like a tally stick? http://en.wikipedia.org/wiki/Tally_stick

    In this comic by the Federal Reserve they discuss the barter system and then how money comes into existence. They don’t however say just how money gets into people’s hands. http://www.newyorkfed.org/education/addpub/Comic_Dime.pdf (pdf)

    You can read Peter Schiff’s book that describes how a barter system essentially creates money or a system based on money that is bank created and not government created. http://books.google.com/books?id=dIGizhIvCfcC&lpg=PP1&ots=MU2byogRod&dq=How%20an%20Economy%20Grows%20and%20Why%20It%20Crashes&pg=PP1#v=onepage&q&f=false

    I understand what you’re saying about physical money being issued by the government. But, banks used to create physical money too. Today they create money by creating a loan based on capital without the need to print money.

    I just don’t buy into the fact that government spending equals the one side of the economy where private sector spending has to likewise match this amount. The velocity of money in the private sector can create more money than is needed to repay government debt, interest, etc. Just like there is never any money created to repay interest, there is velocity that creates nominal money in the system to repay this interest.


  7. The Interest,

    I get the feeling you like to argue just for the sake of arguing.

    I wasn’t talking about physical money and never mentioned physical money. The federal government creates money by deficit spending. That’s how it gets into people’s hands.

    If the federal government does not put money into the economy, the banks cannot lend, therefore cannot create money. In another economy, with different laws, money can be anything – wheat, corn or gold. But in our economy, with our laws, money is what the federal government says it is. If the federal government does not run deficits, there would be no money. You can believe it or not. Whatever. I’m not going to argue about it any further.

    Your Peter Schiff is mentioned in one of my posts. Look it up. He said, “Almost every dictionary defines inflation as an expansion of the money supply, not rising prices.” Of course, he is completely wrong. I have no respect for Peter Schiff as an economist.

    You said, “I just don’t buy into the fact that government spending equals the one side of the economy where private sector spending has to likewise match this amount.” I have no idea where you got that notion. It’s the strangest idea I’ve ever read.

    You also said, “The velocity of money in the private sector can create more money than is needed to repay government debt, interest, etc.” That makes no sense whatsoever. It’s total gobbledegook.

    Finally, you said, “Just like there is never any money created to repay interest, there is velocity that creates nominal money in the system to repay this interest.” That makes no sense, either. More gobbledegook.

    Rodger Malcolm Mitchell


  8. Rodger–I’m sorry if you feel I’m pestering you. My purpose is to learn and test my knowledge, not to upset anyone.

    In my opinion you have not proven that banks must have the government deficit spend to produce loanable funds. And I’m sorry if I may not be asking the right questions to help me understand your point. I must be the only one in the world that doesn’t understand these concepts.


  9. If Peter Shiff was right and inflation=money supply expansion, then this “inflation” would be nothing to worry about, because it would have negligible impact on people’s lives. Rising prices do impact the economy, but money supply rarely translates into prices, so why care?


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