Our understanding of monetary system is wrong?

Discussion in 'Economics' started by lemeeeplay, Feb 9, 2009.

  1. According to Steve Keen, neoclassical theory of money multiplier model is false. He says we live in a credit money system instead:

    (via debtdeflation.com.)

    " ...Thus rather than credit money being created with a lag after government money, the data shows that credit money is created first, up to a year before there are changes in base money. This contradicts the money multiplier model of how credit and debt are created: rather than fiat money being needed to "seed" the credit creation process, credit is created first and then after that, base money changes."


    In other words, banks create money via credit and the Feds role in all of this is insignificant.

    Look at his diagram of private debt vs M money supply. How do neoclassical theorist explain the massive rise in private debt in comparison to the money supply?
  2. yeah.
    Google fractional reserve lending.
    This is actually how most money enters.

    Banks lend out 10Xs the money deposited into them.
    They are required to keep reserves of about 2% or so around to meet withdrawal demands. The Fed and the FDIC set reserve requirements, capitalization ratios. (the amount that can be loaned vs the value of a bank's capitol (stock) and the interest rates that banks can charge each other for loans to make up any temporary shortfalls in these reserves.

    But also look up the economic multiplier effect andt the velocity of money. Your bills are other guys paychecks.

    In other words a guy buying groceries pays the grocer who then pays the supplier who then pays for his raw materials and packageing etc etc etc,
    so that one dollar spent at the bottem causes 7 dollars in economic activity before it either gets paid in taxes or saved.
  3. So, under this theory, how do you solve the current crisis. That's the issue I have with the article. They try to change the paradigm, but don't give any solutions.
  4. I did not read the artical, but people have spent generations trying to prove Say's law, which states that supply creates it's own demand. And it does in a very low supply universe, but in societies that are productive enough supply saturates demand and the economy becomes demand controled.
    That is basicly the regieme that we are working in, and the solution is to stimulate demand by creating jobs. As in all fiat currency schemes, the currency created is backed by the goods and services that are created with it.
    Adam Smith went back and forth but finally decided that labor was the creator of wealth. In Terry Pratchett's book Making Money he called it the Golem standard, which I thought was pretty good.

    What he is trying to say is that banks found new ways of making credit. They are called DERIVATIVES. This does not mean that the money multiplier is gone from the big picture.

  6. Good post, but I think this last paragraph may be misleading. In the case of the grocer getting a dollar and then passing it down the line, it is the same dollar that transacts 7 times (that doesn't count as $7 worth of activity).

    What (I believe) actually happens is that the grocer, the supplier, the packager, the farmer, etc., take a portion of their profit from the transaction (say 10% of their 15% profit, or 1.5% of the transaction value) and put it in the bank. the bank then lends out 7-10x the deposit, and THAT is what causes the money to multiply. Note that the original dollar doesnt make it very far through the chain, since every party takes a profit.

    In parallel, the 90% of the 15% profit that is not saved by the grocer is likely spent on other (non-primary) goods and services that each then spawn other streams of profit-taking saving and re-spending.

    It might be interesting to think about whether the type of good the $ is spent on makes a big difference in the length of the chain and the flow through of the original dollar. Spending it on a Supercomputer involves a huge string of suppliers, credit, salesforce & other overhead, whereas spending it on a ... I don't know, painted pebble at a trinket shop on the indian reservation has less of an effect. But then again, the profit margin is much larger on the latter transaction, so if the profit is then in turn spent on a tractor payment (or at the liquor store...) it starts it's own chain quickly...

    I posit that the last paragraph may be total BS; was just musing...
  7. moo


    That's an extremely important article. Too long and difficult for most, but I do wish everyone would understand it.
  8. You can't "solve" the problem. It is inherent to the nature of money/debt. Cyclical blowups like the one we're currently experience are part and parcel of the nature of things. It happens with fiat money and it happens with metal-based "hard" currencies.

    It's "solved" the same way forest fires are "solved" - by burning until the fuel is gone. The more successful the interference with the small intermediate fires, the bigger the final conflagration.

  9. Good analogy. I agree with your statement.
  10. Actually he does propose a solution: Printing of massive money to pay off debts (in the order of many trillions). Or debt cancellation / bankruptcy.
    #10     Feb 10, 2009