Monetary Theory: Where Is the Flywheel and other Intellectual Ponderings and Squabbles

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Published : March 17th, 2013
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Category : Crisis Watch

Money is power. And so like those other loci of power, politics, tribalism, and religion, the discussion can sometimes obscure rather than illuminate the facts and issues, such being the emotional state of people.

The discussion can sometimes become very heated, and very particular over the finer points, in a vacuum.   A system becomes rigorous and hardened by usage, and effete and elaborate the longer it is parked on the bench.

I am thinking of course of the recent case of Krugman v. Sachs. It tends to strike someone outside their sacred profession as a nerdish slap fight. There are no quarrels so petty and yet so vicious as those in the faculty departments, precisely because there is so much and yet so little at stake.  It is where people who are essentially without the power to implement their ideas in the real world must leverage the power of their reputations.

I will not get into the specifics of this particular squabble, except to say that out of frustration Sachs was needlessly provocative in penning an op-ed in collaboration with a deficit hawk.  And Krugman has been similarly provocative, out of frustration, in answering objections to deficits by ardent austerians by saying things like 'deficits don't matter' in public forums. Yes, yes he modifies this in the footnotes. But he lowers himself to the level of economic luddites and that is a mistake.

This lowering of the discussion is an understandable outcome given the staged performances, little more than wrestling matches pitting talking head against sound bite adversary, that passes for information on the Sunday morning talking shows and the mainstream news.  It is the age of not of reason, but spectacle.

I suggest that the real reason that Krugman and Sachs are 'at each other' is because the standard bearer of the progressives is at best playing rope-a-dope, and at worst is little more than a cynical deal maker. I speak of course of Barack Obama, whose position is always hard to discern from the standpoint of principles if one watches what he does rather than what he says.  And I suggest that this is because he has few principles, rather than perhaps sentiments, that get in the way of his pursuit of the deal, and his own power. 

Now I turn to the curious situation of the Modern Monetary Theorists.

Let me state, unequivocally, that there is nothing new to be seen here. There are no new discoveries, there are no new wonderful theories that make things possible that were not possible before, in the manner of an invention like the transistor, atomic fission, or flight.

What is presented as 'new' is the notion that the state can simply print and distribute its own funds as needed, determined by it.  And in doing so there will be no serious consequences.

I am willing to suspend all other discussion and objections, and bring this down to the absolutely critical point in any monetary system. And that is, 'where is the flywheel?' Or for the less mechanically inclined, where is the constraint, the restraint, the governing factor, on expanding the money supply?

In the case of an external physical standard, like gold and silver, or a hard peg to another currency, that constraint is easily seen. The 'flywheel' that governs how fast the printing presses may go is the amount of gold and silver one can obtain, or the level of value of some other currency, that is hopefully stable but may not be.

One can expand the money supply beyond the metal supply, but only with a conscious and obvious devaluation of the units which each ounce of gold and silver represents.  Or one can cheat and lie, but that is another matter, and a facet of all human systems which lack transparency.

In the case of a debt based market system, the flywheel is the willingness of the market to take the government debt at some value which 'works' for the monetary authority's purposes.

It is undeniably true that Bernanke is gaming this mechanism in what is purported to be the short term by buying that debt, the government bonds, at non-market, artificial prices. And it shows up in the Fed's balance sheet, for all to see.

As I have pointed out at some length before, as long as the Fed has at least one Primary Dealer in on the scheme, the money machine can keep turning until the market is revulsed by the stated valuations, and the machine breaks down.

And this is by design.  It is the principle of 'lender of last resort.'  And it is supposedly what provides the Federal Reserve System more flexibility to address currency shocks than a hard external system.  That the Fed has caused those currency shocks by its own policy errors at times is another matter.

But at least I understand why the Fed and the board of governors are doing what they are doing now, and it is obvious what they are doing despite the enormous lengths to which some may go to say otherwise.  And since it requires the agreement of a number of different, somewhat independent parties, it may very well stop before it goes too far. 

So I would ask, where is the flywheel in Modern Monetary Theory, in which the government spends at much as it wishes, and simply issues the currency to 'cover' its expenditures?

And if the answer is the checks and balances of the Congressional appropriations process and the policy of the Treasury Department, you will understand if the general public runs screaming towards the exits, given our recent experience with the budgeting and spending levels.  Or if the answer is that it is 'in the cloud' and that a restraint is an old-fashioned concept that is no longer applicable, then we will know that as it stands it is another new era idea like efficient market theory.

So, with regard to Modern Monetary Theory, what acts as the restraining factor on the expansion of the money supply? Where is the flywheel?

Answer that honestly and straightforwardly in less than two paragraphs,  and it might be said that MMT at least has a system.  And if not, it is something that needs to be done to take it from sophistry, which dodges and changes as required by the turn of the debate, into the realm of a real system that can be examined and critiqued.


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"Or for the less mechanically inclined, where is the constraint, the restraint, the governing factor, on expanding the money supply?"

There is none. It defies human nature to stop after eating just one potato chip. Nature will always out itself.
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"It is not what is used as money so much as how it is managed....
Gold presents problems that paper does not.
If new gold does not keep up with growth, you run into one type of imbalance. "

It is always management that screws the pooch. Let us see, we hire the least qualified ( no successful business experience) to manage the community purse. What could go wrong?
No it doesn't. But I have an open mind, so name just one.
No it doesn't. The valuation of merchandise the gold is exchanged for just shifts. Or did someone repeal the "Law of Supply and Demand?"

The problem is, was and will always be "individuals will eschew personal responsibility and demand that the PTB insures them." All forms of this "insuring" demand an ever expanding monetary base.
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It is good that you have an open mind....i named more than 1 thing. You understood my points and dismissed them with your comment that the valuation of merchandise the gold is exchanged for just shifts, as the law of supply and demand still holds true. Perhaps you missed the implications of what that would mean. In the first case of not enough new gold, while good for savers, it would make it that much more difficult for borrowers to pay off their loans. In the second case, as history has shown, while good for borrowers, it has disasterous consequences for savers.... If money is supposed to be a store of value (one of its prime functions) we see that gold can and has failed miserably. No sensible monetary system can be based on the haphazard discovery of new money. As well, money should have no other other function. Gold is used in electronics, dentistry, photography, medicine and other industries; making it a poor choice to represent money....If gold really is the ideal representation for money, why then is it not used by even a single nation anymore? Is it more sensible to believe that no nation wants to have a monetary system that actually works or that the gold standard was abandoned by all because it does not work very well?
To answer the question: the constraint placed on the issuance of paper money would be the rate at which the economy is growing. Simple. Stick to it and it works. Gold, just like paper, has been abused countless times by the monetary authorities. It is not what is used as money so much as how it is managed....Gold presents problems that paper does not. If new gold does not keep up with growth, you run into one type of imbalance. Or if natural disaster strikes or war is declared, gold does not offer the flexibility of paper to cope with the changing landscape. Far worse for savers is when an abundant new source is discovered. Silver had to be demonetized in 19th century America and Phillip II of Spain had to default 4 times on Spain's debt in 39 years because of all the new gold flowing in from the new world.....Now think of all the new companies being set up to mine asteroids. Just guess what they will be coming back to Earth filled with and imagine what that will do the price. And that says nothing about the roughly 17,500 times more gold that is in the oceans than has been mined throughout history....The facts are what the facts are. We ignore them at our own peril.
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"Or for the less mechanically inclined, where is the constraint, the restraint, the governing factor, on expanding the money supply?" There is none. It defies human nature to stop after eating just one potato chip. Nature will always out itself. -------  Read more
overtheedge - 3/17/2013 at 5:45 PM GMT
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