United Liberty
Quick Thoughts on Chartalism
Sun, 03/07/2010 - 9:57am | posted by Matt Wittlief
Chances are that you’ve never heard of chartalism (unless you arrived here because you Googled the word). I’ve been reading an increasing number of articles which argue certain points which are central to the economic theory of chartalism. This theory is centrally focused on characteristics of a fiat currency regime. The basic assumptions and conclusions are sounds although I have not studied it enough to have a fully informed opinion. Further, I disagree on principle with some conclusions on the surface level.
So what is it all about? Basically, the chartalists suggest that the state issues fiat currency via government spending and recoups (destroys) the money via taxation. Thus, fiat issue is no more than printing money and, if the government did not do so, there would be no money for citizens. This extends to a conclusion that the private sector cannot save money unless the government runs a deficit. This is further shown by using simple algebra with the formula for GDP. This reinforces the argument of the adherents.
I see a few basic flaws in this theory. First, if there were no fiat money, that would not destroy economic activity. There would be, at a minimum, barter activity. Second, it seems to ignore debt (or at least under-appreciate its role like most all schools of economic thought). Since private banks issue credit, the state is not the only entity which can issue currency (depending on one’s definition).
Nonetheless, this is important. Governments can and do print money. The U.S. Dollar is essentially backed (primarily) by U.S. Treasuries. In other words, the value of the Dollar is derived by the use of it to pay government debt. The point remains that next time you find yourself in a debate about the nature of the state and deficit spending, one can not summarily dismiss the notion that deficits don’t matter or the suggestion that the U.S. will not default on its debt. There are shades of gray to this. Again, I don’t completely agree with all the assumptions or conclusions of this theory. But, well-informed (and sometimes even well-intentioned) adherents will make good points - specifically that this theory is sound due to its identity relationship from the GDP math.
One of the main goals of United Liberty is to educate and inform. Shouting matches between ideological opponents and semi-informed debate participants are a problem in the political environment. If libertarians or other marginalized political (or economic) groups fail to understand the perspective of our opponents, we will risk continued marginalization and be reduced to nothing more to uninformed noisemakers.
For more on chartalism and its post-Keynesian cousin circuitism, visit the forum on Steve Keen’s blog and read this thread. (Full disclosure: I have not yet read it.)
Hello Matt,
Just a few points:
The chatalist school can be understood as two processes:
The first, is that the institutional arrangements between various financial institutions, such as, the central bank, treasury and banking sector. This process, is a process of understanding the actual operational realities between these entities. This is done by applying financial accounting principles and stock and flow consistent models.
The second process is policy prescription. This concerns the value judgements on what policies should be enacted and what governments should do. It is completely seperate from the former process.
Chartalists view the economy through two processes of money creation. The first is the vertical transaction, between the government and the private sector. Government spending creates money (net financial assets) and government taxation destroys money (when not directed to Tax and Loan accounts), as a matter of accounting. Government spending provides the means for the private sector to net save, pay taxes and purchase government bonds.
THe second transaction process, is the horizontal process. It describes the money creation of banks within the private sector. Banks lend to customers they deem to be credit worthy. The act of loan creation creates a loan and matching deposit. Reserves are found after the fact. A point to remember here is that reserves are only needed for interbank settlement and to meet reserve requirements. The reserve position of the bank does not restrain a bank’s ability to lend. Within the private sector all finanicial assets must have a matching financial liability, as a matter of accounting. Therefore, no net savings is possible soley through private sector money creation.
In the situation you describe, of no fiat money. firstly, the private sector would have no means to pay its tax obligations; unless the government determined thta something else should fill the role. Secondly, the private sector would not be able to net save, as financial assets would have a much liability.
There would not be ‘barter exchange’ - except perhaps if there was a huge social breakdown. Barter has never been an important mode of exchange throughout history. It is ironic that economics places such emphasis on this mode of exchange, as historical evidence seems to indicate that it occurs in limited situations, such as, when other means of exchange, such as, credit exchange have broken down, or when would be enemies/strangers trade; a breakdown of trust.
As to your second point: that chartalism ignores debt, this is incorrect. The debt of the government is a different debt to that of bank debt. A government liability in its own currency, is that the same as a normal liability. It has no obligation with its liability, as its currency is not convertible into anything except itself (fiat money).
It’s not true that banks issue currency. Banks issue bank credit which is convertible into currency. Even though we have a tax liability denominated in currency and we can use our deposits or money in the bank to pay extinguish this liability. In reality what happens is that the banks reserves are also drawn down. I’ll clarify this point in an example: say we have to pay $100 to the government. We decide to pay this online through our online bank account. Our deposit account goes down $100 and the central bank debits your bank’s reserve account by $100. While it may seem that the bank credit is currency there is actually more to the story.
Re printing money. I personally do not like this word, as it bears no relation to what actually goes on. Governments never spend by running the printing press. They spend by crediting a private bank’s account or by issuing a cheque.
Chartalists claim that it is in fact the tax obligation that the government places upon us that makes government currency generally acceptable. It is not its ability to purchase U.S. Treasuries. This also brings us to an important point.
U.S treasuries and any government issued bonds do not finance government spending but instead are an interest rate maintenance operation. I’ll expand on this at a later point.
For more I would suggest:
Bill Mitchell’s blog:
http://bilbo.economicoutlook.net/blog/
Warren Mosler’s blog:
http://moslereconomics.com/
New Economic Perspectives from Kansas City:
http://neweconomicperspectives.blogspot.com/
I’d just like to add that I am only a student of economics and Chartalism. If any one of the Chartalists find something wrong please point it out.
Look forward to hearing from you Matt.
MDM
mdm - thanks for the thoughtful comment. I will provide a substantive reply when I have the opportunity to sit down and do so… stay tuned.
Thanks again, mdm, for the long comment. I appreciate having a real-life Chartalist comment on the post. Your detailed summary on the school is congruent with my understanding (not surprisingly), although I do have a few comments.
I very much understand the implications of the accounting equations both within the private sector and also when it comes to the balances between public, private, and the current account. These will always hold true nominally, although, I’d argue, they are not necessarily true in real terms. We do not have consistent mark-to-market accounting mechanisms and individuals do not account in such terms. Further, a net positive savings by the private sector is again nominal. Large current account deficits and/or public deficits can and do lead to inflation (not 100% of the time), which diminish the real value of nominal savings. One of my criticisms of Chartalism is the implicit suggestion of free lunch.
I do very much appreciate your understanding of the private banking process which creates money at will only to find reserves after the fact. I personally find this to be troubling as it too creates inflation diminishing the real value of the nominal effects. It also gives a select class (banks) a monopoly on the process while extracting value from the real economy.
Fiat money does provide a means for tax collection, but taxes existed before fiat money. Be it tributes of food, gold, or labor, these have all historically been a means of taxation. And, even government issued notes were previously backed by commodities (such as gold), which were collected for taxation, but were technically not fiat.
I could wax and wane on the subject of barter for quite some time, but do not take my appositive statement in the article to suggest that it is the most pragmatic and feasible solution. My only point here is that the nature of economics precedes the formal nature of currency. Further, commodity money is a natural extension of barter whereas fiat money is a natural extension of government force. The lack of existence of fiat money would not, on its own, destroy economic activity.
When I say the school “ignores debt”, I suppose I should have said it “under-appreciates the role of debt.” To say government debt has no obligation may be technically correct, but, then again, that depend on your definition of obligation. Government debt does have consequences - namely inflation. Now, I am not a U.S. Dollar hyperinflationist due to a broader understanding of all major global currencies and economic/financial situations. But, I do not believe it gives governments the license or obligation to run up huge deficits as many chartalists believe.
Yes, you are correct that banks do not issue “currency” - again, in a technical sense. I should have said that they create “money” because I do believe that credit is money. And, I am also aware and sensitive to the modern equivalent of “printing money” which is exactly what you describe. My target audience for writing does not have the same depth of knowledge on this subject and “printing money” is more widely understood.
My statement that the Dollar has its value from bonds is simply to draw the parallel between the accounting in a fiat regime as compared to commodity based currency. It’s simply a statement regarding the general composition of the assets on the central bank’s balance sheet. Yes, Treasuries are more functionally used to manage interest rates via the Fed’s open market operations. You’d probably not be surprised that I am opposed to this function of the central bank as well. I’d prefer rates to be set purely by the private markets. But, that too, is another conversation.
I too am merely a student. Although, I am only a student via my own studies. I have spent a little time on Bill Mitchell’s blog. I will have to check out the others. I’d like to suggest you visit Steve Keen at debtdeflation.com. I’d also ask that you check out the Austrian school (although I suspect your critiques would be similar to mine). However, the Austrian’s bring an important philosophical point to economics that is ignored by policy wonks and advocates of fiscal policy as a remedy to society’s ills. Perhaps a more prescient recommendation would be to read “The Law” by Bastiat.
Thanks.