As Reuters reports, German manufacturing and jobs are shrinking now.

So far, Germany had been able to keep growth and job creation relatively higher than the rest of Europe through its successful exporting industry. This has been done through wage containment (thus keeping domestic demand low) and thus taking advantage of demand created elsewhere (ultimately by fiscal deficits in their trading partners).

Now that fiscal restriction (in an important market for German exports) is kicking in, the infection spreads to the core.

European governments need a wake-up call now.

Does shredding dollar bills destroy wealth?

This question offers an opportunity to ascertain to what extent money (in the form of dollar bills) does, or does not, embody wealth.

Ok, so does the picture above illustrate an act of destruction of wealth?

Well, it certainly does not portray an act of destruction of our capacity to produce real wealth.

Why not? Isn’t this guy, depending on the scale of the operation, harming the wealth of the nation?

Surely not! This guy’s action does not affect his (or our) ability to work, plan, produce, project, or innovate. It does not make our human (physical, or social) capital any poorer.

Does this mean that destroying dollar bills like this guy does is of no consequence?

It all boils down to who this guy is.

What difference does it make?

Suppose the unknown guy pictured above is a wealthy, lunatic chap who decided to kill time with some funny game that costs him 20 dollars every, say, 5 seconds (the time needed for each note to get shredded). Irrespectively whether he does it for fun or otherwise (as a political gesture to show distrust in the U.S. government, or God knows what), he is surely destroying his own financial wealth, wiping out some of his power to pay outstanding liabilities as well as to pay for some real good or service he might enjoy consuming. When cash is shredded, he has less purchasing power. So, he had better stopped before he loses all his cash and is forced to sell a property to meet his April deadline to pay his income taxes!

Who else could this guy be?

Suppose the guy works for the Federal Reserve Bank System, and the dollar bills are owned by the Fed. Then there is no destruction of any wealth, real or financial, at all.

What does this mean? Does the Fed overtly destroy our money?

No, of course not. The money being inserted into the shredder by a guy working for the Fed is not “ours”. It is dollar bills that have been withdrawn from circulation and the Fed destroys them because they are no longer usable. They usually package the shredded pieces to make nice souvenirs for visitors of the Fed.

And isn’t the Fed destroying wealth in the process? And don’t they need to offset this somehow?

When the Fed shreds dollar bills, it does not destroy wealth in any form. And the Fed may or may not replace the dollar notes withdrawn from circulation with newly printed ones, depending on our needs, and on crime.

How does crime fit into this?

If there were less crime, people would likely use less cash, and the Fed would withdraw dollar notes from circulation more than it prints and issues as new.

Then, why there is no destruction of financial wealth if the guy works for the U.S. Fed?

Just think of a dollar note as an IOU, issued by the central bank, acting on behalf of the national state. Any IOU that I know of only has value as long as it is held by a party different from its issuer. This is because the party holding it can claim its value with the issuer. The last time I issued an IOU to one of my sons, he knew he could claim cash from me. When I paid my debt, he swapped my IOU with an IOU of the Fed. And when I received my signed IOU back, I tore that piece of paper into pieces, just like the Fed does here.

If dollar bills are IOUs, what is it that we can claim by presenting dollar bills?

Tax credit. If we have a tax liability we can zero it by delivering an equivalent amount of cash to the U.S. Treasury. Once cash (assuming one pays taxes in cash) has returned to its issuer, it could be stored for future use, or (most likely) tore or shredded, just like this picture shows, to be replaced with freshly printed dollar bills, if needed.

But isn’t the Fed the issuer, and isn’t the Treasury a different body?

Yes. This is a very good point. Indeed, the Treasury will not destroy cash before it keeps score of the fact that a certain amount of taxes has been paid. It will thus change the numbers in the account that the Treasury holds at the Fed. Once the Treasury and the Fed have kept due record of tax liabilities paid, and assuming they wish to keep the dollar bills in circulation in good shape, they’ll go ahead and destroy worn banknotes. Paying taxes is a spreadsheet operation.

Is the printing of dollar bills a cost to society?

This is another good point. First, consider that the expenses incurred for printing dollars create incomes for capital and labor used in the process. There is a real cost to society only if, should the printing of banknotes stop, capital and labor were immediately employed to produce something else. In any event, the private sector maintains a desire for holding cash, and it seems that society attaches value to the quality of banknotes in circulation. So, printing banknotes and replacing those worn seems to be a socially valued activity.

One last point: Isn’t the printing of banknotes a terrific deal for governments? Isn’t this a source of what is called “seigniorage”?

“Seigniorage” is a medieval word indicating the difference between the face value of a coin and the cost of producing it born by the coin issuer. This was the rent that the government could extract from issuing coins by being the monopolist of coins. With paper money the notion is the same, but it is inapplicable to the contemporary world.

Why?

Today, “seigniorage” earned by the U.S. Fed originates from the difference between the yields it obtains from holding assets (including loans to banks) and operating costs. Printing banknotes is more of a nuisance than a boon. When the Fed ships dollar bills to a bank, it simply swaps an electronic IOU with a paper-based IOU. And the Fed can “print” money more cheaply by simply crediting the account that the banks have at the Fed (as opposed to printing dollar bills). Printing banknotes is more expensive than changing numbers on a computer.

Is a cashless society possible?

It is possible, yet unlikely. People demand the possibility of making payments anonymously, and this is only guaranteed by cash in its current form.

Europe should hold another summit where all 17 euro nations agree on a general tax cut. This could be a VAT cut across the board, or an income tax cut, but it is imperative it is a progressive tax cut, i.e., boosting disposable income of low and middle income recipients.

At the same summit, Euroland governments will further announce that

• The “lost revenue” will be collected through Eurobonds
• Eurobonds will be guaranteed by the EFSF, backed by the ECB
• The same summit should announce that more issues of Eurobonds will follow to “fund” an ambitious plan for upgrading the European communication, transportation and digital infrastructure.

The Civilized Money View (aka MMT, or Modern Monetary Theory) has historical precedents:

First, the notion—developed by Adam Smith—that the wealth of a nation is measured not by monetary values, but by its capacity to produce goods and services.

Second, the notion of money—developed by John Maynard Keynes—that any modern state claims the right to declare what money is.

While Smith’s concept hints to full employment as the primary policy objective, Keynes’s concept hints to the management of money as instrumental to reach such objective. Furthermore, MMT explicitly recognizes that the currency itself is a public monopoly.

This leads to an appreciation of the monetary system fundamentally different from the traditional Monetarist-Keynesian paradigm.

What follows is a summary of eight key differences between these two models: the Monetarist-Keynesian paradigm (MK) and the Civilized Money View (or MMT)

1.
MK – The central bank controls the money supply indirectly through its power to control the monetary base.

MMT – The private sector uses bank deposits as money, and bank deposits are not directly controlled by the central bank: they get created by government spending and bank loans.

2.
MK – Because the central bank controls the money supply, it also controls the nominal interest rate in the money market.

MMT – Because it is the monopolist of money, the central bank controls the interest rate.

3.
MK – The long-term nominal interest rate is determined by private preferences about real saving and investment, as well as by inflation expectations.

MMT – The central bank has the power to control the interest rate at any maturity: the interest rate is a purely monetary phenomenon.

4.
MK – A monetary expansion can expand output and employment temporarily and yet, at some point, it generates inflation.

MMT – Any operation by which the central bank buys or sells financial assets does not make the private sector any richer and has little or no consequence on private spending decisions.

5.
MK – Government decisions are largely driven by short-term personal goals of politicians, and thus the management of money should be the responsibility of an independent institution with a long-run horizon.

MMT – While monetary policy can only set interest rates, fiscal policy is much more powerful, since any deficit of the public sector generates an equivalent financial surplus of the private sector, and thus affects spending decisions.

6.
MK – Taxes serve the purpose of financing government spending.

MMT – Because government spending takes resources off the private sector and simultaneously generates income and wealth in the private sector, it will cause inflation from excess demand unless a sufficient amount of taxes is levied on the private sector.

7.
MK – If the government spends more than its tax revenue, it must borrow funds from the private sector, and this reduces funding to the private sector.

MMT – Unless it loses its power to define what money is, the government is the currency issuer: It faces no funding constraint, and it must spend or lend first, before the economy has the funds needed to pay taxes and buy government debt.

8.
MK – Price stability is a precondition for economic growth and job creation.

MMT – A government deficit of a size that matches the private sector’s desire to accumulate financial savings is a precondition for full employment.

If negative, net income is a use of funds, which are provided by selling capital goods, selling financial assets, or increasing liabilities (borrowing). As opposed to the income statement, the flow-of-funds account fully tracks all uses and sources of funds for a given economic unit engaged in monetary transactions. Because it includes all entries in the ledger, all recorded debits match all recorded credits.

Consider, for example, an economic unit selling a service: On the ledger, both a debit entry (the payment received) and a credit entry (the service provided) will show. Yet, the income statement shows a positive net income, because the value of the transaction is only recorded as being delivered as part of the current operations of this unit. The flow- of-funds account, however, includes both the value relinquished as well as the value received (e.g., an increase in the balance of a bank account when payment is credited).

The net financial position

In any given accounting period, the net financial position of a single economic unit is the difference between its net income generated and its capital expenditure (i.e., its net acquisition of capital goods). It is also defined as the difference between revenue and total (i.e., current as well as capital) expenditure. In contrast to the definition of profit and saving, the net financial position of a given unit is independent of the classification of output between “output for consumption” and “output for investment.”

Figure 5 illustrates the structure of a flow-of-funds statement that is applicable to a household as well as to a business unit.

The upper section explains the net financial position as the balance between all sources and uses of funds that are related to economic (value-creating) transactions. It thus includes the income statement plus the capital account.
The lower section shows all funding transactions and thus provides information on how the unit has externally funded its operations and how it has used internally generated funds. This includes issuing and repaying debt (IOUs), selling and buying other units’ debt (financial assets), and decreasing or increasing money balances.

Figure 5. The flow-of-funds statement

Every source (or use) of funds in the upper section is matched by a use (or source) of funds in the lower section. It is a logical requirement that the funds a sector receives must necessarily be disposed of in some way. For example, a salary earned by a household and credited on a bank account is counted both as revenue (source) and an increase in money balances (use). This entails that the overall balance is zero, and thus the balance of net financial transactions in the lower section must be equal (with opposite sign) to the net financial position.

Because the revenue of any unit must match the expenditure of some other unit, the sum of the revenue of all units engaged in transactions must equal the sum of their expenditures. Thus, the net financial position of all units is zero.

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The Economist (Dec 31, 2011) gives a good fair account of neo-chartalism, and a momentous recognition of Warren Mosler’s long fight to have it accepted!
Like all new (and meaningful) views of the world, neo-chartalism develops from a number of forerunners, whose ideas are revamped under a new format.

Built on a clever use of accounting relationships, it explores the consequence of national states holding the power of using their own IOUs as means to acquire output from the private sector.

It is not a theory based on a set of assumptions. Rather, it can be effectively taught by removing assumptions from traditional monetary theory. It far more resembles the discovery that those round pieces sitting in the corner can be used as wheels!

Neo-chartalism is core to understanding how monetary economies operate—thus providing a powerful account of the cause and consequence of government deficits and surpluses, trade imbalances, private savings, changing prices, job losses or creation.

It does not provide an answer to the question of big vs. small government (this is not a monetary issue). Rather, it provides a compelling argument of how to achieve full employment and price stability—and this is precisely what the global economy needs today.

Read the article on The Economist

One claimed objective of the single currency area in Europe is (or should I say was?) to create a large single market for producers. But now the ECB is pressing national governments to gear their policies to enhance competitiveness so that they can “count on external demand” and increase their net exports! Mario Draghi, President of the ECB, and a key figure in the team now managing the European crisis, made this statement while responding to an Italian journalist, in the Q&A session of the ECB press conference of 8 December 2011.

Earlier, Draghi had described the ECB’s view of the 3-pillar recipe to end the euro crisis as follows:

First, European nations need budget policies geared to stability, growth, and competition (Note: he first said “stability, growth, and jobs”, but he immediately changed it into “stability, growth, and competition. And thus, jobs”).

Second, countries need common fiscal rules (the so-called “fiscal compact” of the euro zone approved this past week). The first two pillars are aimed at ending what Draghi calls a “confidence problem” with euro nations’ debt. So, again, for the ECB, it is all about “fiscal discipline”.

Third, the euro needs a “stabilization mechanism” led by the EFSF, with the ECB acting as its agent (and no involvement of the ECB’s balance sheet). In this respect, Draghi stressed that the ECB does not discuss its mandate: it simply complies with it.

Then, Alessandro Merli (from Il Sole24ore) asked Draghi if he wasn’t worried that budgets cuts in Europe would further intensify the recession.

Draghi’s answer was quite indicative of the conceptual framework of the ECB and of the economic scenario that the ECB expects will unfold as Europe continues with fiscal adjustments.

The ECB President admitted that budgets cuts and tax increases are contractionary—“in the short term” he added—but there are two ways to lessen their negative impact on growth:

One is the confidence-enhancing effect that will follow the new “fiscal compact”.

Now, does Draghi really believe that deficit and debt ratios will look any “better” after implementing the deficit cuts (which will, as he admits, deepen the recession in Europe)? And even assuming modest “improvements” of debt ratios, will this be enough to see markets suddenly rush for Italian and Spanish debt? Does he have a good explanation of why markets love debt issued by a non-euro country like the UK, whose deficit-gdp ratio is higher than Italy and Spain?

The other way of easing the impact of fiscal restrictions is, for Draghi, that “if you enhance the competitiveness, you can actually count on your external demand, on your net exports” (ECB press conference from 35′40” to 36′20”).

Does he really intend to make European growth depending on (or should I say at the mercy of) high levels of aggregate demand abroad? Does he not see that this means that Europeans will net export their standard of living by giving away goods and services in exchange for credits abroad? It is of course a matter of accounting logic that nations that net export will find it easier to keep their fiscal deficit lower, so perhaps Draghi is telling us that the myth of a balanced budget should rule all European policies, and Europe will do anything it takes to achieve “fiscal discipline”? Even if this means stagnation?

Or perhaps Draghi is a true genius, and he is subliminally trying to show us how absurd are the consequences of the current mandate of the ECB and of fiscal rules?

German central bankers (current and former) continue to voice their hostility to what the financial community now calls a Euro-style Quantitative Easing (aka big bazooka). This is the possibility that the ECB (directly, or through the EFSF) make an unlimited commitment to purchase euro bonds and remove the spreads.  Axel Weber, Juergen Stark, and Jens Weidmann have already voiced sharp criticism of the ongoing ECB’s sovereign bond purchase program (SMP, Securities Market Programme), saying it threatens the independence of the ECB.

Amid market rumors that the ECB will soon upgrade the SMP, Jens Weidmann (head of Germany’s Bundesbank) revisited the issue in a speech delivered last week in Berlin. This talk (by one of the boldest opponents of an ECB solution to the sovereign debt crisis) reveals how weak is the position of those who prefer to explore other paths: No real alternative is offered.

Weidmann first advocates what he calls a ‘macroprudential supervision column’. This would allegedly strengthen financial stability by giving the ECB the power to calibrate an additional buffer of bank capital and thus dampen credit expansion as needed. He then goes on to dispute the notion that monetary policy can be used to end the sovereign European debt crisis, and voiced the “staunch opposition of the Bundesbank” to any upgrade of the SMP.

What does Weidmann alternatively propose to save the euro? He calls for countries to “return to a sustainable path of public finance and to undertake the necessary structural reforms” coupled with “sufficient incentives for the member states” when austerity entails “painful and initially contentious adjustments”.
This result he says can be obtained in either of two ways:

One is a “fundamental change in the federal structure of the EU” and “a transfer of national responsibilities, particularly for borrowing and incurring debt, to the EU”.  The Unites States of Europe is a sure solution with a little problem: It demands political agreement of 27 sovereign countries. Is Weidmann aware of the cliff the euro is nearing each day?

The other is a “return to the founding principles of the system, but with an enhanced framework that really ensures sufficient incentives for sound public finances.”  Now, it is clear that (lacking political union) an enhanced set of incentives is needed, but Weidmann offers no explanation of how devising now a new form of discipline could turn things around to save the euro from the precipice.

So why does he oppose the big bazooka?

Here is my summary of Weidmann’s arguments in four bullets (with my comments):

Weidmann rightly acknowledges that in the euro area “the ultimate decision-making power has remained on the national level and the conditionality that was intended to rein in national policymakers has been increasingly relaxed”. This speaks for a mounting political problem, inevitable when a currency is without a state (see Goodhart 1998). It speaks not against the SMP. Rather, it says that the remaining question is how to dress the big bazooka up to make it politically suitable. And it says that more challenges, once the solvency issue is resolved, await the euro economy.

1. A full FICA suspension to end that highly regressive, punishing tax and restore sales, output, and jobs.

2.$150 billion in federal revenue sharing for the state goverments on a per capita basis to sustain essential services.

3. An $8/hr federally funded transition job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment.

4. See my universal health care proposals.

5. See my proposals for narrow banking, the Fed, the Treasury and the FDIC.

6. See my proposal’s to take away the financial sector’s ‘food supply’ by banning pension funds from buying equities, banning the Tsy from issuing anything longer than 3 month bills, and many others.

7. Universal Social Security at age 62 at a minimum level of support that makes us proud to be Americans.

8. Fill the Medicare ‘donut hole’ and other inequities.

9. Enact my housing proposals.

10. Don’t vote for anyone who wants to balance the federal budget!!!!