What’s the difference between $100 in cash and $100 in a checking account? Nothing — and everything. The two are the same in the sense that they’re equally spendable and freely convertible from one form to the other. But the paper bill in your hand is an obligation of the federal government, while the electronic entry is an I.O.U. from your bank. Their interchangeability at a rate of one to one is not a fact of nature but a social construct. So, not the same.
Now think about how money is created. Banks don’t need to wait for more deposits to arrive to make fresh loans. You go to your bank for a loan. The bank says OK. It goes into its computer and marks up your checking account by whatever amount you borrowed. Presto — new money. You owe it to the bank, and the bank owes it to you.
Bankers aren’t the only creators of money. Congress creates money from thin air by deficit spending and the Federal Reserve creates it by buying bonds.
The more you think about money, the weirder it starts to feel. The government’s money used to be backed by real stuff like gold and silver. Now, as we know, paper money is backed by nothing more than fiat — a declaration by the government that it is (in the case of the United States) “legal tender for all debts public and private.” Surprisingly enough, everybody kind of goes along with that.
Moneyness is a measure of transactability, not value. In prisons and prisoner-of-war camps, mere scrip can serve as currency. Conversely, real estate is valuable, but it isn’t money. Cryptocurrencies want to be money, but mostly aren’t.
Money is “a surprisingly slippery concept,” the economist Paul Sheard wrote in a new book. “There is no easy way to define and measure it, and it means different things to different people.”
Shaking up our casual assumptions about how money works is one of Sheard’s objectives in the book, titled “The Power of Money: How Governments and Banks Create Money and Help Us All Prosper.”
Here’s one truism he challenges: Politicians warn us that the debt we incur today will impose a debt on our grandchildren. But Sheard points out that our grandchildren won’t be just taxpayers. They’ll also be bondholders. So they’ll both pay interest on the national debt and receive interest on it. For the generation as a whole, that will be a wash. (To be sure, he acknowledges, there will be differences within our grandchildren’s generation; some people, in some countries, will owe, and others will be owed.)
Sheard is worth listening to on this topic. I have followed his work since before 2013, when he wrote an entertaining correction of conventional wisdom titled “Repeat After Me: Banks Cannot and Do Not ‘Lend Out’ Reserves.” An Australian American, Sheard is a former vice chairman of S&P Global and a former senior fellow and research fellow at Harvard’s Kennedy School. Among other jobs, he also served as chief global economist of Lehman Brothers and as the Tokyo-based head of Japanese investments for Baring Asset Management.
Nick Estes, a subscriber to this newsletter who is a retired lawyer in Albuquerque, has made a hobby of collecting quotes from experts who have at least partially shared Sheard’s take on things. The citations go back more than a century and include more recent pieces from the Bank for International Settlements, International Monetary Fund, Deutsche Bundesbank, Bank of England and the Federal Reserve.
Sheard’s ideas also overlap with Modern Monetary Theory, which holds that governments don’t need to worry about deficit spending unless it causes inflation. His disagreements are more political than economic. Most M.M.T.ers lean left. Sheard does not. He told me he isn’t enthusiastic about the M.M.T. concept of a job guarantee. And his book argues that inequality of income and wealth “is more a feature than a bug of a prosperity-generating system, and has more going for it than much of the usual hand-wringing would suggest.”
For another perspective on how money works, I emailed Anat Admati, a professor of finance and economics at Stanford’s Graduate School of Business. She and Martin Hellwig, a German economist, wrote “The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It,” which argues that banks rely too much on borrowed money.
In a 2019 document, Admati and Hellwig say deposits aren’t “literally the same” as cash because they are I.O.U.s from a bank. That’s true, as I wrote in my first paragraph. But deposits in banks don’t have to be literally the same as cash to function as money.
Admati and Hellwig also point out that a borrower can withdraw all the proceeds of the loan that are on deposit, leaving the bank with a hole in its balance sheet. When one bank sends money to another at a customer’s request, it pays by using up some of its reserves at the Fed, essentially a checking account.
I asked Sheard about that. He told me that a bank that’s short on reserves can borrow them from another bank that has extra. And if banks on the whole are short on reserves, the Fed will supply more to the system to keep the federal funds rate at its target level.
That said, Sheard told me he agrees with Admati and Hellwig that banks should rely more on money from shareholders for financing and less on borrowings and deposits. The money that banks create belongs to their depositors; all the banks own is the loans they make, which can go bad. As the Yale economist James Tobin wrote in 1963, “Unlike governments, bankers cannot create means of payment to finance their own purchases of goods and services.”
Early in the pandemic, many M.M.T. adherents called for aggressive fiscal stimulus. That helped economic growth but contributed to high inflation. Sheard told me the mistake both he and the M.M.T.ers made was to underestimate how badly the pandemic damaged the supply side of the economy, such as by causing people to drop out of the work force. The constricted supply wasn’t able to keep up with surging demand, so prices rose.
Conventional forecasters, including those at the Federal Reserve, made the same mistake, Sheard said. “It was a big forecasting error,” not a failure of the theory, he said.
Sheard argues that governments should coordinate fiscal policy (taxing and spending) with monetary policy (the raising and lowering of interest rates). One idea would be to give the Treasury secretary a seat on the Federal Reserve’s rate-setting Federal Open Market Committee. But he said he’s not set on that: “We need to go back to the whiteboard and have a discussion about what is the best macroeconomic policy framework.”
That’s a good idea. And his book would be one good primer for that brainstorming session.
Elsewhere: Helping Poor Children Learn
About 70 percent of 10-year-olds in low- and middle-income countries were unable to read and understand a simple, age-appropriate story as of last year, up from 57 percent before Covid-related interruptions of education, the World Bank and others estimated in a report last year on what they called “learning poverty.” On Wednesday, they followed up with recommendations for how to solve the problem. “Societies often did not internalize the magnitude of the crisis,” the new report says. It studies 60 countries, seven of them in depth: Cambodia, Colombia, India, Ivory Coast, Mongolia, Romania and Zambia. Among other strategies, it favors “structured pedagogy,” in which teachers stick closely to a lesson plan, and targeting instruction to students’ learning level, not their grade. Those strategies were identified as “great buys” in a May report by the Global Education Evidence Advisory Panel.
Quote of the Day
“But most ordinary households made their own tallow candles, an arduous process that could go on for days: heating up containers of animal fat, and dipping wicks into them. In a diary entry from 1743, the president of Harvard noted that he had produced seventy-eight pounds of tallow candles in two days of work, a quantity that he managed to burn through two months later.”
— Steven Johnson, “How We Got to Now: Six Innovations That Made the Modern World” (2014)