All the money in the world must equal all the net money that has ever been created. This is a fact. Money cannot enter circulation unless someone creates it. While I will not make any attempt to define “money” (e.g., banknotes, bonds, securities, currency, credit, fiat, etc.), I will assume that money serves a primary function as the agency for mediating transactions in the exchange of goods and services, including those of labour and taxes. For instance, the reward for labour services will be provided for and exchanged for a certain amount of the accepted money–reward in the institutionally accepted currency, which is broadly recognised by the population of the local community as a trustworthy medium of transaction (“TMT”). If this TMT is goats, chocolate beans, seashells, gold nuggets, cryptocurrency tokens, or gold coins, is not important for this definition. What is important is how this medium of transaction came to be TMT.
The Bank of England (BoE) explains that shopkeepers do not need to accept a payment in any form if they wish not to do so, even when using the national local currency’s banknotes. Legal tender, says the BoE, can be anything the shopkeeper is willing to accept; “If you want to pay for a pack of gum with a £50 note, it’s perfectly legal to turn you down. Likewise for all other banknotes, it’s a matter of discretion. If your local corner shop decided to only accept payments in Pokémon cards that would be within their right too”. To help understand how ‘something’ can become a TMT I will use the explanation of Modern Monetary Theory (“MMT”), which explains that the key element that turns something into TMT is tax. That is, the chosen natural or human formed artefact of any government in which it collects the taxes, that becomes the TMT of that community; the medium of transaction in which taxes are being paid, will inevitably become the dominant de-facto accepted TMT among the people of the community.
“If your local corner shop decided to only accept payments in Pokémon cards that would be within their right too”
Bank of England
Schumpeter uses in his 1919 essay ‘The Sociology of Imperialism’ an example two tribes who come into conflict over the control of hunting grounds or over some other essential resource to explain the rise of aggressive attitudes between states and imperialism expansion. I will use here a similar narrative. It is worth mentioning that some economic philosophers support that money did not emerge as a medium of transaction by indicating that in medieval Europe the largest share of transactions did not use physical money, but the promise to pay, that is, credit. Others point to ancient Babylonian clay tablets recording debt, assuming they could have been used in the same fashion we use credit today. However, for all these transactions to take place using credit the two parties would need a fully comprehensible language of communication. Hence, as we journey back in time the support for this line of argument becomes thinner. Without a common language for clear communication and comprehension there is little chance that two ancient people would agree on the exchange of goods for a promise of a future pay. Symbolic language cannot express the promise to pay later. Even evidence from the Neolithic period, about 12,000 years ago, shows organised societies with farming and arts. In fact, the linguist Derek Bickerton argues that it was language which gave humans abstract thought and helped the brain to develop. So, we need to go even further back.
“the moment when our ancestors first broke away from the kind of communication system that had served all other species well for at least half a billion years”
To illustrate this let us imagine this fictional scenario: Assume that by some arcane means at some point in time (t) a person manifests on an empty finite land. There is nothing on that land, but a typical natural environment of plants and animals, of mountains, and sea and rivers. For the sake of argument, let us assume that this person is equipped with basic knowledge for surviving in the wild. This person will build some shelter for protection from the natural elements, and will forage, hunt, and fish for food. There is no transaction at this point, hence no need for money or TMT. Let us assume even more that at a later time (t+1) another person manifests at a distant location from the first person and goes on to engage in a similar fashion as our first person in the construction of a shelter for protection from the natural elements, and the foraging, the hunting and fishing for food. If we keep repeating this process of populating this finite land while moving time towards infinity, there will be a point at t+n when two people will inevitably meet. Understanding human nature there will also be a point in time when one person will wish to have something the other person has, be it a colourful seashell, or some bone carving or a shiny gold nugget. There are two ways by which humans have been known to engage in the acquisition of goods, that is, either trade or aggression. Let us further assume that we are not at the point where violence takes place and the good nature of human beings prevails, and the acquisition of, let’s say a bone-carving, is exchanged for a shiny gold nugget. The trade makes both parties feel better off and they go about doing their business. Still, there is no need for a TMT and future trade can take place via arbitrary chosen barter transactions that we can accept are based on the needs and/or even on capricious temporal preferences of the people doing the bartering.
Nevertheless, if we go forward in time and more people keep appearing as the time moves further towards infinity, then more people will interact with each other, more transactions, then common interest groups will form, and inevitably as the history of mankind shows, a leader will emerge. Be it by cunning, charms, bravery or brains, there will be a person who will emerge as the leader of a group, and many groups will be formed with at least as many leaders. Inevitably, as the violent history of the world suggest, someone will at some point reject the exchange offering of bone-carvings for gold nuggets and the bone-carving will be violently acquired. Group violence will occur, then conquest and plunder. The leader becomes a Ruler, a Queen or King, and her or his close comrades in arms become Lords. The lands of the conquered groups become theirs and of the members of the original group. The people from other conquered groups that survived the violence will either move to further away lands seeking peacefully or violently shelter in the occupying lands of other groups or will submit to living as group-outsiders in the conqueror’s territory.
The King and Lords will at some point be unable to fight to protect their expanded territory themselves, due to old age, battle wounds, or just because they became too tired to keep on fighting. Therefore, to preserve their status and protect their territory from other groups which have been similarly enlarging their territorial gains, they will raise armies, and the armies will need some form of reward. Some will prefer skillful bone-carvings, others may prefer shiny gold nuggets, and some might appreciate having a collection of colourful seashells. To provide for this variety of goods, the King and Lords will need to redistribute some of their accumulated artefacts from previously plundering other groups. Alternatively, they might decide to use the stigmatised conquered people of other groups now living among them to produce the required bone-carvings, gold nuggets and seashells. Their reward is the life allowances the King and Lords are willing to provide them with. If this story sounds plausible so far, then this is the point when the first form of government taxation is introduced. Going back to ancient Sumerians or Greeks, taxes were imposed by the conqueror to the conquered.
By taxing the disempowered peasants, the King and Lords had all the labour they needed. By taxing everyone, the King and Lords had the motivation required to keep the army, the bone-carvers, the gold miners, and the fishermen at work. Historically speaking it is known that a share of the farming produce and livestock, such as goats, sheep, or cattle, was given to the Lords as a form of tax payment for peasants living and breathing in the land of ancient city kingdoms. At some point, one medium of transaction became the de-facto form in which the tax would be collected. One can only assume that taxes collected in goats and sheep would have quickly diminish in value in the eyes of King and Lords. What is more, it would not be so functional for the Kings and Lords to allow the collection of too many taxes in goats, since that would incentivise the livestock farmer to keep multiplying the sheep flock, and could end up making the livestock farmer a wealthy person and an antagonist of their power. In fact, anthropologists and archaeologists have long held that that money had emerged in service of politics rather than economics. Several coin hoards have been discovered in areas of military conflict, and Graeber (2012) argued that money emerged as a means to pay the army and fund military campaigns. A recent discovery of a spade-shaped coins minting site in Guanzhuang, in the Henan province of China indicates that the oldest well-organised minting had taken place in Guanzhuang around 640–550 BC (Zhao et al., 2021). These artifacts were made mostly of copper and lead, hence their value would have little to do with the metal elements and more with their function as means to pay taxes and the trade of goods. It might not be a coincidence that the same area was the power centre of the Zhou dynasty (later of Eastern Zhou) and the Zhou Kingdom, which played a major role in the prolonged conflict during the Spring and Autumn period in Chinese ancient history (771 to 476 BC).
Croesus the King of Lydia is attributed with the coinage of the first standardised quality gold coins. His father, King Alyattes is credited with the invention of coin minting. However, King Alyattes failed to make his gold coins widely accepted in the community of the Kingdom of Lydia. Nevertheless, where the father failed, the son succeeded, and Croesus became a mythical figure of wealth accumulation. Croesus owned a mine and made the gold coins he minted the de-facto accepted tax-payment artefact. One needs to realise that Croesus gold coins were not valuable because they were made from gold, but contrary gold was valuable because Croesus used the mineral we call ‘gold’ to make his coins. Gold has valuable characteristic such high resistance to corrosion, malleability (e.g., easy to shape), highly conductive (though unlikely known to Croesus), and last but not least, its metallic yellow colour is shinny like the sun (in Latin gold [Au] is Aurus which means “glow” and “become light”). Nevertheless, if anything the imprint of his face on it was what gave value to the gold coins. After that, unimaginable riches were just a matter of time. “Rich as Croesus” they still say. For years this was thought as the first instance a TMT, until the recent discovery on the Guanzhuang minting foundry.
Even much earlier than the time of Croesus, the Babylonians used clay tablets to record trade debts which could be used for claims against others; an ancient form, one could argue, of “I owe you” (“IOU”). However, while today debt can be exchanged in the form of bonds, treasury bills, and other forms of securities, it is impossible to know if the Babylonians traded those debt clay tables in the same way. If anything it reveals the existence of a detailed documentation of occurred debt which had to be repaid in one way or another. David Graeber describes in his ‘Debt the first 5000 years’ that the medieval Irish law used to record in detail the personal wealth and possessions of their people in order to put a price on the cost of injury or insult and accommodate a compensation for it. Graeber explains that the Irish and the Welsh typically used precious metals and cattle as the means to compensate the injured party. The Irish also used women slaves or bondmaids as a means of measuring wealth and hence to repay debts (i.e., cumal in Irish).
“Creative both in what could be used as a means of payment and on the precise breakdown of injuries and insults that required compensation: Compensation in the Welsh laws is reckoned primarily in cattle and in the Irish ones in cattle or bondmaids (cumal) with considerable use of precious metals in both”
Moving on to the world of today, one of the most intriguing theories that has come out of economics in recent times is arguably the Modern Monetary Theory or MMT for short. MMT started as an examination of monetary operations that was later consolidated into an economic theory. Among the major scholars that have influenced and shaped MMT are the American economists Warren Mosler, Stephany Kelton, and Pavlina Tcherneva, as well as, the British economist Wyene Godley, and the Australian economist Bill Mitchell. One could even go back in time to identify key elements of MMT in the writings of Georg Friedrich Knapp, John Maynard Keyes, Hyman Minsky, and Abba P. Lerner. While not without limitations, MMT is a mind-bending theory.
“We need the federal government’s spending to get the funds we need to pay our taxes”
MMT is as close to revolutionary in its core aspects as Keynes own economic theory almost a century ago. Kelton herself writes in ‘The Deficit Myth’ about her scepticism when first started to get around the ideas in MMT. She writes “I was sceptical when I first encountered these ideas. In fact, I resisted them. During my early training as a professional economist, I sought to refute MMT’s claims”. I will admit here that she captures my own thoughts exactly. Not that I have sought to refute as she did the idea of MMT, but that my homo economicus mind resisted the ideas put forward in MMT. The Deficit Myth answers many questions, but also raises about the same number of questions. While reading it, I wrote a dozen pages of notes about some claims that are far from bulletproof. As any economic theory, it is a more streamlined account of economic realities. Nevertheless, the core idea of MMT about how monetary policy and tax work in a country with its own sovereign currency regime is hard to deny. It is a –there is no spoon– event for the mind of the reader, and reading Mosler and Kelton puts the reader through a mind-altering process.
For those not familiar with MMT’s core idea about the nature of monetary policy, one needs only to think this: residents of a country who live and work there need to pay a portion of their earnings to the administrative government of the state in the form of taxes. Typically, the taxes are proportional to earnings. To pay those taxes, you need to earn some income in the form of wages or rent (i.e., non-labour income). For instance, if the dollar is the sovereign currency of a country (or whichever currency one wishes, the keyword is -sovereign-), then the tax on the earned income has to be paid in dollars. But why does the State need taxes? I mean, they are the ones issuing the dollars in the first place right? If you think it is needed to fund government expenditure, then you are in for a ride.
“Federal government spending is in no case operationally constrained by revenues, meaning that there is no “solvency risk”. In other words, the federal government can always make any and all payments in its own currency, no matter how large the deficit is, or how few taxes it collects”
Take a moment to collect yourselves and try to keep an open mind when you ponder on this core theme in MMT: If the State has monopolistic control on the produce of the sovereign currency it means that in order for people to pay their taxes in, say dollars, then they need first to receive dollars. Since the State has the monopoly in the supply of dollars it needs to first supply these dollars. If the State does not produce and distribute first the dollars to people, then there are no dollars to be found or earned. Essentially the State does not need taxes to have dollars in its pockets. It can produce it with a snap of its fingers. The State creates money, then puts it in circulation, then collects some of it back via taxation. Therefore, the money left in everyone else pockets are the money the State did not collect back, that is, the government deficit. It becomes clear then that the deficit of the government reflects the surplus of the non-government, which includes employees and businesses in non-governmental sectors. Nowadays it does not even need to print money (e.g., banknotes); most of the money are added in circulation by typing a number on a computer terminal with a keyboard and hitting ENTER [Exhibit A]. So, why does the State even demand its citizens to pay taxes if it does not need it? Well, the MMT argues that partly it is because had there been no taxes people would not have an incentive to work. I know this sounds weird to say the least. However, it is not untrue. Think back on the earlier example of tribes, Kings and Queens, and their payments for services rendered to the bone-carvers, the gold miners, the fishermen, and the upkeep of the army.
“A government borrowing in its own currency need never default on its debts; paying them is simply a matter of adding the interest to the bank accounts of the bond holders”
James K. Galbraith
As before, try to keep an open mind, and like Cypher told Neo in the now classic movie The Matrix, “buckle your seat-belt Dorothy cause Kansas is going bye-bye”. People work to earn income to pay for the expenses of life, be it food, water, electricity, housing, transport etc. They must offset their expenses with their income. However, the State does not need to do so; the dollars are useless to the State, since it can produce it at will (see e.g., Exhibit A). Yet, had the State provided dollars without collecting some of it back via taxes, everyone would inevitably reach a point where they would have as much as they needed to exchange for all the goods and services they wished. Under certain conditions, something like this would end up devaluing the currency (e.g., inflation).
Now, apart from providing financial jobs to those who operate the State money machine, why would anyone wish to collect the garbage, clean the streets, build bridges, police the cities and towns, fight forest fires, and so on and so forth. Millions of people do so, because at the end of the day they have taxes to pay to the State, and the State demands the payment in… dollars. Simply put, the State creates a tax on your house, and just like that you need to go to work to pay that tax, even if you did not need to work for any other reason. Essentially taxes remove money from circulation so that there are fewer to go around, and people must compete and labour for it [Exhibit B]. Effectively, unemployment is the result of taxation, which is designed by the State in its effort to supply itself with resources (e.g., labour).
How different would it be, had the State not have a monopoly on the produce of money? Can you imagine if there was some technology that allowed people who needed to pay for their taxes, to simply turn on their computer, type in the needed number and hit ENTER to get it? Why would anyone ever work? Maybe everyone would be some sort of an artist or a birdwatcher for all I know.
“It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed”
There is another element of MMT, which applies strictly to sovereign monetary currency regimes with a specific financial structure such as that of the United States of America. That is, the way the modern financial system operates within such a financial structure manages deficits entirely at a political level rather than an economical one. Therefore, the reader needs to be reminded that this theoretical element of MMT does not apply to currency regime areas where a state does not have sovereignty over the monopoly produce of their national currency, or the institutional power of a sovereign currency regime. For instance, this part of MMT would not apply to Eurozone countries, and countries/territories that have pegged their national currency to another country’s currency (e.g., Panama, Saudi Arabia, or Hong Kong). Even countries with monopoly produce of their national currency that do not have the necessary financial structure in place would not be able to apply this next magic trick as explained by MMT. It must be emphasised at this point that the U.S. dollar is the dominant currency in international trade and a global reserve currency. Also, several countries take on debt denominated in U.S. dollars.
Once again, try to keep an open mind. When the government runs a deficit in some year it means that its expenditure was greater than its revenue. Typically, a government will announce an auction of government bonds to raise the funds necessary to cover that deficit. MMT rejects as inconsistent with the realities of a modern financial system the mainstream economic theory argument that this leads available resources away from funding private investments (i.e., a crowding out effect). Instead MMT explains that in a modern financial system, such as the one in the United States of America, things work a bit differently. This is how it works: When the government pays somebody, it credits the reserve balance of a private banking institution (“bank”) for that amount, say $1,000. Then the bank will credit the bank account of somebody with that same amount. Think of it as A->B->C. When somebody pays their taxes the transaction flows towards the opposite direction, hence C->B->A. Notice that B, that is the private bank reserve balance, acts as the mediator in both scenarios. When the government runs a deficit, it essentially means that the private bank reserves are left with a larger quantity of money, and when the government runs a surplus, they are left with a lower quantity of money [Exhibit C]. Therefore, “fiscal deficits increase the aggregate supply of reserve balances” (Kelton, 2021:117).
“Congress appropriates the money and then the Treasury instructs the FED to credit the appropriate accounts, and that is how it’s paid for”
One might rightly ask at this point, why then does a government issue bonds? One thing should be certain by now; certainly not to balance the deficit. MMT argues that the reason a government of a sovereign currency regime goes into all the trouble of issuing bonds is to return the bank balance to its pre-deficit level, which prevents the increased bank reserve balance to raise the overnight interest rate. That, and a convenient act in the political theatre. “Selling bonds is entirely voluntary in the sense that Congress could always decide to do things differently” (Kelton, 2021:117).
“The overnight bank funding rate is a measure of wholesale, unsecured, overnight bank funding costs. The federal funds market consists of domestic unsecured borrowings in U.S. dollars by depository institutions from other depository institutions and certain other entities, primarily government-sponsored enterprises”
Federal Reserve Bank of New York
Kelton argues that it is not deficits nor inflation we as society and the state government should worry about. She argues that we are asking the wrong questions when thinking about how to pay for infrastructure development, healthcare, pensions and/or education and other as such which improve human development, quality of life, and the economy. “We should be asking”, she claims, “Are these things worth doing and do we have the real resources —the people, the equipment, the raw materials, and the technology— to do them? Will they make society better off?”. The limitation is that the above applies increasingly more to states which have monopolistic power to issue a sovereign currency within a mature, flexible, and internationally integrated financial system, and increasingly less to those states that do not.
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