Understanding the Monetary System

This post is to introduce a tutorial which is posted up top as Monetary_System. It describes the workings of the our modern fiat monetary system, which differs significantly from the gold standard upon which classical economics theory was based. Many economics textbooks have not caught up with this.  For instance,  the widely-taught money multiplier model of fractional reserve banking no longer applies.  This article points out some counter-intuitive aspects of today’s financial system: banks can make loans without having any prior deposits, ongoing government deficit spending is typically prudent and necessary, and an increase in net savings in the private sector cannot be produced by individuals trying to save.

The article starts off discussing money in general, and then describes the interactions of the U.S.  treasury and central bank. Although it gets into the operational details of bonds, loans, and investments, it does not presuppose a background in economics, and defines most specialized words as they appear.  The casual reader will probably find the first third of the article easy going. After that, it depends on how thirsty you are for knowledge. The article is probably too long to read at one sitting.

The contents are:

What is Money?

Measurements of Money Supply

Clashing Schools of Economics

Monetary Realism: Economics Without Politics

Basic Operations of Fiat Monetary Systems

Money Creation in the Private Sector

Sectoral Balances: Private, Government, and Foreign Surpluses and Deficits Must Net to Zero

Historical U.S. Sectoral Balances

Trade Deficit and Government Deficit

Financial Assets and Real Wealth

Accounting for Investment and Savings

Federal Government Borrowing Operations

Is Quantitative Easing “Printing Money”?

Can the Government Print Money?

Should the Government Print Money?

Is the National Debt Really a Problem?

Fiscal Policy Choices: Short versus Long Term Effects

About Scott Buchanan

Ph D chemical engineer, interested in intersection of science with my evangelical Christian faith. This intersection includes creation(ism) and miracles. I also write on random topics of interest, such as economics, theology, folding scooters, and composting toilets, at www.letterstocreationistists.wordpress.com . Background: B.A. in Near Eastern Studies, a year at seminary and a year working as a plumber and a lab technician. Then a B.S.E. and a Ph.D. in chemical engineering. Since then, conducted research in an industrial laboratory. Published a number of papers on heterogeneous catalysis, and an inventor on over 100 U.S. patents in diverse technical areas. Now retired and repurposed as a grandparent.
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2 Responses to Understanding the Monetary System

  1. humanengr says:

    Thank you for the very helpful exposition. Do you see any further nuances to address from Joe Firestone’s response to Marc Lavoie’s criticism of MMT (http://neweconomicperspectives.org/2013/06/lavoies-critical-look-at-modern-money-theory-a-reply.html) or in the comments there? (I’m not sure there are, but wanted to bring it to your attention.)

    • Interesting article, thanks for pointing it out. It covers a lot of ground. I’ll just make a couple of comments about a few points that drew my attention. First, I’d agree with most of Lavoi’s (friendly) cautions. Yes, it’s true that dollars collected by the feds are only there to be collected b/c they were deficit-spent into existence earlier. So it is fair to hammer on the point that deficit spending is a necessary, responsible thing. But it does seem like in some MMT writings or speeches it can SEEM like they are saying govt can just spend without taxes or debt issuance, which in turn can freak out their audience and lose credibility. Better to stick within normal vocabulary, but point out that, while in a given fiscal year Treasury can only spend what it collects through taxes and bond sales, those bond sales are nothing to be scared about, for reasons I discussed.
      Also, in the U.S. the Fed is not an arm of the govt, and cannot directly buy Treasury debt. So the private banking sector is always involved in debt sales. So to oversimplify by treating it all as “govt” does not seem helpful or accurate to me.
      Final point is that there is much touting of the power of the govt to coin coins, especially platinum. As I noted, that is a theoretical possibility, but not likely to happen. If the govt gets really hard up, the Fed can just keep QEing away, since the Fed does have the power to create money from thin air. I think that is easiest for people to understand.

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