No, Really, MMT Is Wrong About Banking

Or the wilder shores of those claiming to be MMT are perhaps

Modern Monetary Theory is interesting. For there are some truths in there. Sure, government can just go print money and spend it - there’s never an actual shortage of cash that is. We’ve known that for a long time, it’s called monetisation of fiscal policy.

That’s also what leads to such joyous times as the hundreds of thousands of percent inflation rates that afflicted Weimar Germany, the tens of thousands of percent that have recently afflicted Venezuela, the hundreds of percents that have recently been afflicting Argentina - well, you get the point. Print money, government spends it, the money supply rises, inflation results.

MMT at least claims to realise this and insists that the solution is easy. Just tax back that newly created money so as to kill the inflation. OK. Which then comes up against two little difficulties.

The first is simply political economy. Politicians love spending because they get to buy presents for voters who will then vote for the politicians. Luvvly Jubbly. Politicians hate taxing because that makes the voters taxed irate and unlikely to vote for the taxing politician. Nottso Jubbly. Therefore the political impetus will always be to crank up the spending and not the taxation - substantial inflation will be inevitable in an MMT economy. Not because the initial economic observation is incorrect, but because of the gross ignorance of how politics works.

The second is that even if MMT is done economically correctly it doesn’t, in fact, change anything at all. The old rules had us with the unfortunate fact that if we wanted lots of lovely government then we had to have lots of tax to pay for it. The new, MMT, dispensation just says that if we want to have lots of lovely government then we’re going to have to have lots of tax. That the tax is to prevent the inflation rather than pay for the spending changes nothing. For we still end up in the same place. A high government spend economy will be a high tax economy.

So, at this stage MMT is true but not useful. It doesn’t change the basic econo-political calculus. Do we want more of life run by Richard Burgon or less of life run by Richard Burgon?

However, there are those who take from the MMT basics things which simply are not true. As ever, one of the people not grasping reality is Professor Richard J Murphy, who tells us the following:

Ah, no.

Now, the initial point made, that banks create money when they lend, yes, that’s at very worst a useful analogy. It can also be taken as being true if we want to mash our words a little.

Start with MV=PQ, the money equation. Money times velocity of circulation equals prices times quantities.

Or, to make this blindingly obvious, the amount of money times the number of times we use money equals the number and amounts of times we use money - the price times the quantity of times we use money. This isn’t arguable, it’s a definition.

It’s also possible to use another analogy. I’d not want to say that this is absolutely true, but it is useful. M there is that base money, the government created stuff. V is the number of times it floats around the economy and the two together give us wide money. Banks lending is a huge influence on the size of V, therefore on the wide money supply even as the base or narrow supply is defined by government itself.

And, yes, banks create that wide money by lending. We’re fine up to there.

I like to make this clearer, this wide and narrow money definition, by saying that the base/narrow money is money and the wide money is base money plus credit. Which is again not wholly and exactly true but is useful.

Or, government creates money, banks create credit.

In the usual technical descriptions of the money supply that’s pretty much how it works. M0 is that base money, M1 is that plus a bit of credit creation, all the way to M4 which is base money plus all the credit creation done by banks. We also tend to think that narrow or base money is supercharged in its effect upon inflation. Because it’s that wide money, M4, that determines the inflation rate and as we’ve just shown that’s a multiple - multiplied by V - of the narrow money supply.

At which point, yes, the banks create, out of nothing, new money when they make a loan. Or, as I’m calling it, credit or wide money. So, Murphy’s right then, right?

Until 4.30 pm.

Here’s a little test for those who want to think through this. Go look up the results of a bank. Doesn’t matter which one, Lloyds, HSBC, whatever. Doesn’t matter whether it’s quarterlies, annuals, whatever. You’ll note that capital plus deposits always equals loans. To the penny. That’s just the way banking results work - capital plus deposits equals loans. If they don’t the bank is bust. Bankrupt in fact.

But this doesn’t just happen at those special balance sheet dates for the results. This happens at 4.30 pm every day. Every day a bank balances its books. To the penny. Capital plus deposits equals loans. Or, to make this even more glaringly simple, money into the bank - capital plus deposits - equals money out - loans.

Every damn day at 4.30pm.

You can even test this again. Deposit a cheque, a payment, at 4 pm. It’ll likely show up as arriving the next day. Because, in order to do the work to check the books balance by 4.30 the bank decides that 3.30 is a good time to start counting.

This is also what all that interbank market was about back before 2008. When Lloyds took in more in deposits than it paid out in loans that day it would have a surplus of deposits (and capital) over loans out. Also, likely enough, HSBC (or other) on the same day would have lent out more than it took in in deposits. Both banks would have unbalanced books - the cure is for Lloyds to lend HSBC some money until the next business day. That’s what the overnight market was. This now tends to get mediated through the central bank accounts of each bank but the same process is happening. Bank books are balanced at 4.30 each day.

Now this is important. Because this is how banks go bust. If, at that witching hour of 4.30, they cannot make those books balance then they are bust.

This is what happened to Northern Rock. They would lend out the mortgages and then go and borrow the money from other banks on that interbank market. When they’d a big pile of such mortgages then they’d bundle them up into a bond (the programme was called “Granite”) and then sell them to investors. That then gave them a balanced (in a different sense) book. The bonds were issued for about the likely life of the bundle of mortgages. So, they were lending medium to long term (yes, a mortgage might be for 25 years, but some to many will refinance early, so 14 years for the book perhaps) and also borrowing medium to long term to finance that.

The hole in the plan was that if the interbank markets refused to lend to them then they’d be bust. Because they’d not have a big enough pile of those mortgages to make a bond and yet they’d already lent the money. They could get to 4.30 pm and not have a balanced book - no other bank was willing to lend to them - and so they’re bust. Which is exactly what did happen.

This is just the detailed example of a bank run. Depositors think the bank is going to go bust, they take their money out of the bank. At 4.30 that means the books don’t balance and so the bank is bust. For deposits plus capital no longer equal loans.

Don’t forget, we can - usually - take our deposits out when we wish. Loans take a little longer to call back in.

Every bank faces, every day, at 4.30 that basic test. Do deposits plus capital equal loans out? If not it’s bust. And we have seen examples, in living memory, of this not being true and of banks being bust as a result.

This is what makes “lending by a bank is unrelated to the deposits it takes from savers” the purest and most unmitigated tosh.

Sure, banks lend then go finance that loan. But they do, absolutely, have to finance that loan. By attracting deposits sufficient to cover that loan that has been made. And they’ve got to do that in an Action This Day sense. Which is why banks have a Treasury Department which manages this process.

Murphy has simply got the entirety of banking wrong here. He’s claiming that banks don’t even need deposits. Their loans, their balance sheets, deposits simply do not matter. When they do - because if you’ve not the deposits plus capital to finance your loans then you’re bust.

Which does make that insistence that those in economic academia (why, Hello Professor Murphy!) need to prove their understanding of how money works in banking is so much fun. Even that pass a test of basic economic competence. But then we all know that Richard J isn’t going to pass one of those.

It is possible to make this point much more simply. The claim is that deposits into banks have nothing to do with their loans. They’re just not important, it’s a vile misunderstanding of how banking works to even relate the two.

Hmm, OK. But if that is true then why in buggery do banks pay us interest on the deposits we make with them? If they don’t need deposits then why shell out real cash just to gain access to them?

The answer is that the entire concept is unmitigated tosh. Banks require deposits to finance their loan books, that’s why they pay interest on deposits. QED.

Shouldn’t universities be employing people who teach that truth?