This article will be of little interest to most people, and I'm mainly putting it here so I don't have to repeatedly make the same arguments with Modern Monetary Theorists (MMT) who read, and have been misguided by Warren Mosler in his 'Seven Deadly Innocent Frauds', on the subject of money creation.
I'll stress, I agree with much of what Mosler has to say, but he makes a couple of glaring errors, or at best, exceptionally weak assurtions based on very poor evidence, which are contradicted by the Bank of England (BOE) and the Institute for Fiscal Studies (IFS), in the area of how money is created, and how it is destroyed.
Due to the fact that much of what Mosler has to say is exceptionally valid compared to some politicians comparisons of national economies with household budgets, some people have come to treat his work as if it's gospel, which is unfortunate, given some of his assurtions are highly dubious, his evidence is seriously lacking, and he is, as I have previously stated, contradicted by such institutions as the BOE and the IFS.
We can but look at the actual evidence.
What we have is two competing arguments about how money comes into being, and the suprising part for those not familiar with the subject, how it vanishes from the economy.
Mosler argues that money comes into being when governments spend, and vanishes when people pay that money back to the government through tax. Truth be told, It would probably be better if it did work this way.
However, The Bank of England state that "Most of the money in the economy is created, not by printing presses at the central bank, but by banks when they provide loans." https://edu.bankofengland.co.uk/kno.../how-is-money-created/
Regarding the destruction of money, the IFS state :
"Almost two-thirds of revenues come from the three workhorse taxes: income tax, National Insurance contributions (NICs) and VAT." -https://www.ifs.org.uk/publications/9178
So the IFS certainly don't believe that all tax revenue is being destroyed.
Mosler offers two pieces of evidence to support his theory, which I've addressed and debunked in parts 1 and 2 below. Part 3 is describing what actually happens, if we are to believe the Bank of England, and the Institute for Fiscal Studies.
1. Warren Mosler states regarding the payment of taxes :
And what happens if you were to go to your local IRS office to pay your taxes with actual cash? First, you would hand over your pile of currency to the person on duty as payment. Next, he’d count it, give you a receipt and, hopefully, a thank you for helping to pay for social security, interest on the national debt, and the Iraq war. Then, after you, the tax payer, left the room, he’d take that hard-earned cash you just forked over and throw it in a shredder.
Yes, it gets thrown it away. Destroyed! Why? There’s no further use for it. Just like a ticket to the Super Bowl. After you enter the stadium and hand the attendant a ticket that was worth maybe $1000, he tears it up and discards it. In fact, you can actually buy shredded money in Washington, D.C.
If you go and look on the US Treasury web site, and find out where they get the paper money they shred it says the notes in questions are ones which "are found to be imperfect during the printing process" and "The Federal Reserve System destroys worn currency notes"
There is no mention at all of shredding notes after tax is paid. Either the US treasury are lying, or Mosler is making some pretty unfounded assumptions.
2. The second part of Moslers justification for his theory is:
"Here is a quote from the good Federal Reserve Bank Chairman, Ben Bernanke, on 60 Minutes for support:
SCOTT PELLEY: Is that tax money that the Fed is spending?
CHAIRMAN BERNANKE: 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."
Fortunately it turns out the entire transcript of that interview is available online.
When put into context, it is evident that Bernanke is not talking about general federal spending, but very specifically about the money that was used to bail out the banking system in 2009 after the banking crisis.
Yes it's true that quantitative easing, and such bail outs were created by the Federal Reserve, and the Bank of England out of thin air. This does not mean that all government spending works this way.
3. So what actually happens?
Mosler goes on to state :
"Now let’s build a national currency from scratch. Imagine a new country with a newly announced currency. No one has any. Then the government proclaims, for example, that there will be a property tax. Well, how can it be paid? It can’t, until after the government starts spending. Only after the government spends its new currency does the population have the funds to pay the tax."
This is almost right. But in our case, what happens is not that the government spends the currency into existence, but the money is created when we borrow it from private banks when we take out loans and mortgages.
As I stated earlier, this is what the Bank of England tells us happens.
We borrow the money into existence, rather than the govt spending it into existence.
So when Mosler asks, "Where else could it possibly come from?" the answer is "Private Banks." Money is created when your bog standard high street banks make loans, specifically in this day and age, mortgages, and destroyed as those loans are paid off; Which is why house prices have increased so ludicrously over the last fifty years, as banks have made more and more debt available when creating money out of nothing.
It appears that governents are not quite so stupid (or corrupt) as to destroy perfectly good cash, and then build up a national debt by borrowing it, as Mosler asserts. On the other hand, it appears they are so stupid (or corrupt) as to allow private banks to create (and profit from) creating the vast majority of money in our economies, rather than doing that themselves, on our behalf.
The following graph (provide by Positive Money) shows the amount of money in existence since 1960. There is a clear correlation between the amount of money available, and the ludicrous increase in house prices, and hence mortgage debt. We can even see how the graph launches in the 80's, with the introduction of council house sales, and drops following the banking crisis in 2008 when banks stopped lending.
Basically, While Mosler has some interesting things to say, and his economic model would probably be a better way of doing things, it is clearly not what is currently happening.
Click on the image for the original larger version from the Positive Money web site.