Cencini rossi economic and financial crises; a new macroeconomic analysis (2015)

CAPITOLI DI TEORIA MONETARIAELEMENTI DI MACROECONOMIA MONETARIA MACROECONOMIC FOUNDATIONS OF MACROECONOMICS MONETARY MACROECONOMICS: A New Approach MONETARY THEORY, NATIONAL AND INTERNAT

CAPITOLI DI TEORIA MONETARIA

ELEMENTI DI MACROECONOMIA MONETARIA

MACROECONOMIC FOUNDATIONS OF MACROECONOMICS

MONETARY MACROECONOMICS: A New Approach

MONETARY THEORY, NATIONAL AND INTERNATIONAL

MONEY, INCOME AND TIME

TIME AND THE MACROECONOMIC ANALYSIS OF INCOME

EXTERNAL DEBT SERVICING: A Vicious Circle (with Bernard Schmitt)

LA PENSÉE DE KARL MARX: Critique et synthèse (with Bernard Schmitt)

PER UN CONTRIBUTO ALLO SVILUPPO DEL MICROCREDITO (with

Marco Borghi)

CONTRIBUTI DI ANALISI ECONOMICA (co-edited with Mauro Baranzini)

INFLATION AND UNEMPLOYMENT: Contributions to a New Macroeconomic

Approach (co-edited with Mauro Baranzini)

Also by Sergio Rossi

LA MONETA EUROPEA: UTOPIA O REALTÀ? L’emissione dell’ecu nel rispetto delle sovranità nazionali

MACROECONOMIE MONETAIRE: Théories et politiques

MODALITES D’INSTITUTION ET DE FONCTIONNEMENT D’UNE BANQUE CENTRALE SUPRANATIONALE: Le cas de la Banque Centrale Européenne MONEY AND INFLATION: A New Macroeconomic Analysis

MONEY AND PAYMENTS IN THEORY AND PRACTICE

MACRO E MICROECONOMIA: Teoria e applicazioni (with Mauro Baranzini and Giandemetrio Marangoni)

MODERN MONETARY MACROECONOMICS: A New Paradigm for Economic

Policy (co-edited with Claude Gnos)

MODERN THEORIES OF MONEY: The Nature and Role of Money in Capitalist

Economies (co-edited with Louis-Philippe Rochon)

MONETARY AND EXCHANGE RATE SYSTEMS: A Global View of Financial Crises

(co-edited with Louis-Philippe Rochon)

THE ENCYCLOPEDIA OF CENTRAL BANKING (co-edited with Louis-Philippe Rochon)

THE POLITICAL ECONOMY OF MONETARY CIRCUITS: Tradition and Change in

Post-Keynesian Economics (co-edited with Jean-François Ponsot)

Economic and Financial Crises

A New Macroeconomic Analysis

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3 Business Cycles versus Boom-and-Bust Cycles 59

4 From Monetarism to the New Classical Synthesis 83

5 From Keynes to Post-Keynesian Economics 106

6 Economic Crises and Their Relationship to Global Supply

and Global Demand 129

Part III The Monetary Macroeconomics

of Crises

7 Capital Accumulation and Economic Crises 151

8 Interest, Rate of Interest, and Crises 184

9 The International Dimension of Financial Crises 204

10 Reforming Domestic Payment Systems 226

11 Reforming the International Monetary System 241

v

Bibliography 260

Tables and Figures

Tables

1.1 The opening of a line of credit 201.2 The payment of wages 251.3 The purchase of produced output 361.4 The result of the final purchase of output 374.1 The use of money-marble as unit of payment 889.1 The equality between A’s real imports and its real exports 22410.1 The result of the payment of wages through the two

departments of a bank 22910.2 The result of a bank loan 23110.3 The result of a residential mortgage loan 23210.4 The entry of profit in the second department 23510.5 The transfer of profit to the third department 23510.6 The investment of profit 23610.7 The entry of redistributed and invested profit 237

Figures

1.1 The result of the payment of wages 265.1 The IS–LM diagram 110

5.2 The relationship between S and I 113

5.3 The identity between L and M 1157.1 The process of fixed capital formation 1737.2 The production of amortization goods 1767.3 The expenditure of the income formed in the

production of amortization goods 1777.4 The investment of profit 1787.5 The production of amortization goods and its

9.1 The double charge of the payment of in 213

vii

Bernard Schmitt and his quantum macroeconomics have been a stant, privileged source of inspiration for us in the preparation of thisvolume Remembering and honouring his groundbreaking work, hishumanity, and his tireless support, we pay grateful tribute to him, amentor and a friend, who passed away on 26 March 2014 We arealso grateful to our undergraduate, graduate, and postgraduate stu-dents for their thought-provoking questions and comments Helga Wildand Niklas Damiris have generously helped us by revising the Englishmanuscript and also by providing useful suggestions and comments.Andrea Carrera, research and teaching assistant at the University ofLugano, Switzerland, has skilfully plotted all figures and tables andcompleted the bibliography Our warmest thanks go to all of them

con-viii

main-As surprising as this might appear, inflation, involuntary ployment, sovereign debts, financial bubbles, and global economicrecessions are all negative effects of a single original cause: the erro-neous conception of bank money The import of this claim can only

unem-be evaluated once it is recognized that the emission of bank money

is what characterizes all our economies In the absence of banks, onlypre-capitalist economies would exist Without bank money, neithermonetary nor financial intermediations would be possible, and theterms ‘inflation’, ‘deflation’, ‘financial bubble’, and ‘sovereign debt’would be meaningless Yet, this is not to say that these pathologies arethe unavoidable consequences of the discovery of double-entry book-keeping and the creation of banks Banks make it possible to build aneconomic system based on the accumulation of capital Whether such asystem is an orderly or a disorderly one depends on whether it conforms

or not to the nature of money, income, and capital Bank money in itself

is not the cause of any pathology; rather, it is the way money is keptdistinct from or is mixed up with income and capital that determineswhether the result is pathological or not

1

The importance of bank money has been clearly perceived by manygreat economists of the past From Smith’s distinction between nominaland real money to Keynes’s emphasis on the principle of double-entrybookkeeping, one can trace a line that culminates with the work ofSchmitt and his unique definition of bank money What distinguishesquantum macroeconomic analysis from mainstream economics is thedefinition of money and the relevance attached to it According to quan-tum monetary analysis, money is a numerical form issued by banks as

an asset–liability and associated with physical output through the ment of wages Its great relevance derives from the fact that it enablesthe numerical expression of wages and makes it possible to express realgoods numerically, in terms of wage units Economics would not exist

pay-as a science if its object of enquiry could not be mepay-asured As the Clpay-as-sics knew well, the determination of a unique and invariable standard

Clas-of value plays a crucial role in the building Clas-of economics as a science.Yet, the search for such a standard is unavoidably hopeless so long aseconomic value is considered as a dimension It was Walras who firstrecognized that economic value is essentially a numerical relationshipand not a substance as the Classics believed Unfortunately, Walras didnot follow up on his intuition and was unable to find the numericalstandard of value implied by it It is with Keynes’s introduction of thewage units that a solution has appeared But it is only once money isidentified as an asset–liability that Keynes’s wage units acquire their fullsignificance in economic analysis

If it is the case (and who could deny it?) that our economic systemsare monetary, and that money is bank money, then it is also a fact that ifeconomic laws exist at all, they must be related to money and to the waythe latter is associated with production It is at this stage that anotherimportant distinction appears between quantum macroeconomics andmainstream economics According to the latter, economic laws arestrictly related to economic agents’ behaviour (the all too famous law

of supply and demand is the clearest example of such microeconomiclaws), whereas according to the former, economic laws are objectivelydefined by the identities deriving from the presence of bank money aswell as from its flow nature and its role as a means of payment Now,the choice between these two antithetical approaches is not a matter ofpreference Either macroeconomic identities exist in reality or they donot If they do, they define the strictest possible relationship betweentheir terms, a relationship that holds good whatever the behaviour ofeconomic agents and that is independent of any set of norms imposed

on monetary and financial institutions It is only a rigorous analysis of

our monetary economies of production that can establish whether nomic identities are a matter of fact or not And bank money is thenecessary starting point of such an analysis In this volume, we con-sider the various steps that, starting from the analysis of bank money,allow one to discover the logical laws of our monetary economies andexplain the nature of the pathologies as deriving from the lack of con-formity of the present systems of national and international paymentswith these laws.

eco-Since its origin, economic analysis has been conceived either as atool to understand a system fundamentally based on relative exchangeand on economic agents’ behaviour or as an instrument to discoverthe structural logical laws that economic agents have to comply with.The distinction between these two kinds of analyses has not alwaysbeen clear-cut, and in the last decades differences have become blurred

On the whole, apart from rare exceptions, it might be claimed thateconomists are now unanimous in believing that, conceptually, nothingfundamental has yet to be discovered in their domain The great major-ity of them are utterly convinced that their efforts must tend towardsthe construction of mathematical models that are able to reproduce eco-nomic reality more and more accurately, in an attempt to provide evermore reliable economic forecasts Substantially, they view economics as

an empirical ‘science’ akin to meteorology and consider economic crises

as unfortunate events caused by unexpected external shocks If this viewwere correct, the role of economists would be to make the best models

to anticipate the impact of such external shocks in order to mitigateagainst their possible negative effects

Now, this pragmatic approach to economics has proved unsatisfactory

in practice and can additionally be shown to be wrong conceptually.Its conceptual poverty is revealed immediately as soon as one raisesthe question concerning the nature of money and its ‘integration’ withphysical output To consider money as a net asset or, even worse, as

a commodity is a misleading conception and a dangerous ical claim The confusion between money and income is widespreadand would not be worth dwelling on if it had no serious consequences.Alas, this is not the case The correct understanding of the nature ofmoney and of the payment that transforms it into income is crucial,because it leads straightforwardly to the discovery of the first logical law

metaphys-of macroeconomics: the identity between any macroeconomic supplyand its demand

Neoclassical and Keynesian attempts to develop mathematical modelscapable of reproducing the real-world dynamics fail because economics

is not a branch of mathematics, and this is so because macroeconomiclaws are simply logical identities For too long, economics has beentrapped in an axiomatic theoretical framework characteristic of themethodology in the field of mathematics General equilibrium models

of a Walrasian or non-Walrasian type are clear examples of this kind

of approach, and Keynesian general disequilibrium models of varioustypes, although distinct from the former, are not substantially differentfor the simple reason that they too are founded on a series of condi-tional equalities whose terms balance only for the equilibrium value ofsome specific variables Essentially, economic models are far too ambi-tious Their aim to reproduce as complex a reality as that of capitalisteconomies is way beyond the capabilities of mathematical modelling.But even if they managed to account technically for all the conceiv-able decisions taken by economic agents, for their combinations, andfor all the possible external shocks, the mathematical and the statisticalapproaches would still have to be rejected The reason for this rejectionlies in the nature of the laws at the core of any economic system based

on the accumulation of capital

The difference between mainstream economics and the quantummacroeconomic analysis advocated in this volume could not beclearer: whereas mainstream economics, whether of a neoclassical or aKeynesian mould, is built around the notion of equilibrium betweensupply and demand, Schmitt’s macroeconomic analysis is founded onthe necessary equality between these two terms when referred to thesame production Whereas mainstream economists look for the ori-gin of economic and financial crises by investigating the relationshipbetween external shocks and economic agents’ behaviour, quantummacroeconomists look for it at the structural level, investigating theactual workings of the system of national and international payments.Whereas for mainstream economics inflation and unemployment are tosome extent unavoidable and the only thing that can be done, or at leastattempted, is to keep them under control, for the advocates of quan-tum monetary macroeconomics these are pathological conditions thatcan be eradicated through a reform of the present structure of nationalpayments

The differences between the analysis developed by Schmitt, as duced again in this volume, and the traditional approach based on themicroeconomic foundations of macroeconomics are not just confined

intro-to the study of national economies of production, but they also cern the enquiry into the causes of international disorders related tothe international economy of exchange As a matter of fact, mainstream

con-economics has little to say about the pathological state of the national economic system Since Keynes’s and Schumacher’s proposalsfor a reform of the system of international payments, mainstreameconomists have provided no further insight into this matter, and theirexplanation of international disorders, such as the sovereign debt crisis

inter-or the creation and exponential growth of a financial bubble, remainstherefore highly unsatisfactory They recognize that the present ‘system’

is in reality a ‘non-system’ of international payments, but they do notexplain why it is so, or what has to be done to transform it into a soundstructural arrangement Once again, what is missing in their analysis is

a correct understanding of the nature of money and of the way national payments have to be carried out What they do not know isthat money is essentially a flow (and not a stock in motion), and thatthis becomes more apparent at the international level, where real goodsproduced nationally are traded among countries

inter-The net-asset definition of money is a deleterious source of seriousmistakes and a barrier against the correct understanding of what isneeded to provide the world with a sound system of national payments.The most relevant improvements in this area have been accomplished

by practising bankers rather than by academic economists Nationalbanking systems owe their present structure to bankers, and it is only fair

to recognize that it is thanks to their initiative (and their advisors’ ommendations) that countries are homogeneous monetary areas, whichmeans that a unique currency exists within each sovereign countryeven though each single commercial bank issues its own spontaneousacknowledgement of debt (money) Monetary homogeneity is the result

rec-of a system rec-of real-time gross final settlements created by banks andmanaged by the central bank Surprisingly enough, neither economistsnor bankers have so far realized that, unless a structurally similar sys-tem is created internationally, national currencies are bound to remainheterogeneous and payments between countries pathological

Quantum monetary macroeconomics is based on a thorough gation of the nature of bank money and provides a new insight into thecharacter of international payments In particular, it shows that coun-tries’ sovereign debts are entirely pathological, as their very existence isdue to the absence of a proper system of international payments Thegravity of the sovereign debt crisis is all too real to insist on the rel-evance of Schmitt’s investigation What is immediately unclear in theanalysis of mainstream economists is their meaning or understanding ofthe term ‘sovereign debt’; so it is not surprising to observe that sovereigndebt is often wrongly identified as being the debt incurred by the State

investi-The public debt, however, is not co-extensive with the debt of a countrydefined as the set of its residents, which owes its existence as much toprivate as to public debts incurred abroad This lack of a correct defi-nition of sovereign debt is the unavoidable result of misunderstandingthe way countries are involved in the external payments carried out bytheir residents (State included) Schmitt’s analysis makes it clear thatsovereign debts are of a macroeconomic nature and therefore cannot beimputed on the (mis)behaviour of economic agents Once again, it isthe non-system of international payments that is identified as the cause

of this monetary pathology

The discovery of a pathological duplication affecting the payment of

a country’s net interest on debt as well as the formation of a country’sexternal debt, its sovereign debt, is Schmitt’s last legacy and a key result

of quantum macroeconomic analysis Its relevance for the ing of financial crises is great, and its outcome is particularly significantbecause of the reform it calls for To impute the sovereign debt cri-sis to the excess of borrowing that countries incur in order to financetheir surplus expenditures amounts to maintaining that the balance-of-payments principle, which establishes the necessary equality betweeneach country’s total purchases or imports (commercial and financial)and its total sales or exports (commercial and financial), is systematicallydisregarded by the present non-system of international payments As amatter of fact, the disregard for the balance-of-payments identity is whatcharacterizes the pathological state of the actual system This does notmean that, as any other logical identity, the necessary equality betweeneach country’s total sales and purchases can be put in jeopardy by thebehaviour of economic agents, in particular by their decision to increasetheir foreign expenditures Logical identities cannot be transformedinto conditions of equilibrium and cannot be submitted to the good-will of economic agents However, so long as these laws are not fullyunderstood and complied with, a discrepancy will always arise betweenthem and the way payments are carried out by banks When the iden-tity concerning payments among countries is not complied with, thenthe pathology that emerges from this lack of conformity generates acountry’s sovereign debt Plainly stated, this amounts to claiming thatsovereign debts should not exist, that their very formation is of apathological nature, and that they can and must be avoided through areform that allows for the implementation of a system of internationalpayments consistent with the balance-of-payments identity

understand-The aim of economic analysis is to explain the real world of nomics and to provide a solution to the economic and financial crises

eco-that are currently plaguing it Mainstream economics has failed on bothfronts, mainly because it has, erroneously, assumed that the logicalfoundations of macroeconomics are microeconomic On the contrary,quantum macroeconomic analysis shows that macroeconomics has itsown – that is, macroeconomic – foundations, which consist in a set oflogical laws that form the analytical framework for the orderly working

of the national and international systems of payments The reforms sented in this volume are those developed by Schmitt between 1984 and

pre-2014 and pertain to the structural changes necessary to avoid nationaland international economic and financial crises respectively, as well asmonetary and financial disorders originating from international transac-tions Their common feature is the aim to provide a system of paymentsrespectful of the numerical and flow nature of money

Indeed, the choice between mainstream and quantum economics

is about two radically different ways of coping with economic andfinancial crises The microeconomic approach chosen by mainstreameconomics considers crises the unavoidable result of a system in con-stant search of an ever-fleeting equilibrium In such a framework, theleast economists are expected to do is to reduce disruptive fluctuations

to a minimum, being aware that unexpected shocks are always lurkingand ready to prove them wrong at any time In short, we would justhave to learn to live with inflation, unemployment, and sovereign debt

in the hope to be able to limit their amplitude as much as we can On theother hand, quantum macroeconomics provides a novel way out of thispredicament by proposing a structural bookkeeping reform of both thenational and international systems of payments, able to eradicate thecauses of the pathology affecting our economies Let us be very clear inthis respect The reforms needed to make the national and internationalsystems of payments consistent with the macroeconomic laws derivingfrom the logical distinction between money, income, and capital arenot solutions to the problems concerning what and how to produce;how much to pay different categories of workers; how to redistributeincome; and what role to attribute to the State, to trade unions, to lob-bies, and so on What these reforms make possible is only the passagefrom a disorderly to an orderly system of payments, both nationally andinternationally In a reformed economic system, which we could name

a regime of post-capitalism if we call capitalism the actual cal system, inflation, involuntary unemployment, and sovereign debtwill no longer be possible However, this key shift still only involvesproviding a sound structure that guarantees the ‘neutrality’ of money.People will still have to decide on what economic policy to implement

pathologi-to support the ideal society of their choice The role of economists is thusprecise and circumscribed: to specify the structural reforms required toavoid the pathological working of our economic systems This is the aim

of the present volume, which unfolds as follows

Chapter 1 asks a number of fundamental questions that are still to beanswered properly by the economics profession at large What is moneyand how do banks issue it? Is money endowed with a positive valuesince its creation, or does it acquire its purchasing power, and how?

Is it necessary to distinguish between money and income? The chapterexplains that the nature of money remains a mystery and needs to beinvestigated starting from its bookkeeping origin A rigorous analysisbased on double-entry bookkeeping shows that money is intrinsicallyvalueless and can only derive its purchasing power from production.This new macroeconomic analysis of money leads to dismiss the old-fashioned idea that by issuing money banks originate credit, in terms of

a loan granted to the economy and financed by banks themselves.Chapter 2 elaborates on the positive analysis of monetarymacroeconomics and discusses the macroeconomic laws of monetaryproduction economies Following Walras’s contribution, and despiteKeynes’s suggestions, today it is generally accepted that economic lawsare mainly behavioural and founded on microeconomics This is instru-mental for the use and abuse of mathematics, and equations of variouskinds are considered as the best tools available to represent the realworld of economics The aim of this chapter is to re-establish the logicalpriority of identities and to show that identities are in fact the founda-tion of macroeconomic analysis For that purpose, the second chapterstarts from a reappraisal of Say’s law, goes on to give a reinterpretation

of Keynes’s identity between global demand and global supply, and endswith Schmitt’s law of necessary equality between each agent’s sales andpurchases

Chapter 3 analyses the search for a theory of crises where nomic disturbances are considered as endogenous events inherent inthe workings of our economic systems Such an approach is essentiallymacroeconomic and aims to determine the laws supposedly intrinsic

eco-to capitalism The chapter also addresses business cycle theories thataim to show that crises are periodical events due to economic fluc-tuations Whether in the form of business cycle theories emphasizingthe role played by trade, money, and credit, or in the form of realbusiness cycle theories, the models proposed in this framework have

in common their microeconomic structure They identify thereby thecauses of economic disorders in exogenous shocks imputable to agents’

(mis)behaviour This approach also underpins Minsky’s boom-and-bustcycle theories of financial crises.

Chapter 4 shows that both monetarism and the new classical sis fail to provide a satisfactory analysis of the working of our economicsystems and of the way disorders may arise in them It argues that the so-called equation of exchange on which monetarism rests is tautological,and that the concept of the ‘quantity of money’ is completely at oddswith the true nature of bank money New classical economics fares nobetter This approach provides new general equilibrium models explain-ing business cycles consistently with the microeconomic approachtypical of neoclassical analysis The rational expectations hypothesisplays a crucial role in these models, which attempt to identify the causes

synthe-of economic crises in irregular external shocks and imperfect tion Whether in the form of monetarist or new classical models, inthem money continues to have little or no impact and is still considered

informa-as a commodity or identified with a financial informa-asset

Chapter 5 investigates Keynesian, New Keynesian, and post-Keynesianeconomics to verify if they succeed in reaching a better understanding

of the origin of crises than their neoclassical counterpart It shows thatKeynesian economists of all schools fail to reach this goal, despite theiremphasis on the role played by monetary factors Keynesian and NewKeynesian economists indeed aim at finding adequate microeconomicfoundations for their models and thus have abandoned any attempt

to search for the macroeconomic foundations of macroeconomic ysis The emphasis that some post-Keynesian economists put on therole of money and banks in a monetary production economy maylead one to conclude that their approach is much closer to the mes-sage conveyed by Keynes’s own analysis than that of Keynesian andNew Keynesian economists However, post-Keynesian economists havecompletely lost sight of the conceptual distinction between money andcredit

anal-Chapter 6 investigates economic crises and their relationship to globalsupply and global demand Starting from Say’s law and Keynes’s logi-

cal identity between Y and C + I, the chapter addresses the problem of

whether or not the insurgence of an economic crisis entails the rejection

of them Indeed, the possibility of reconciling a situation of librium with the identity of global supply and global demand seemsinexistent However, quantum macroeconomics provides logical evi-dence that the identity between global supply and global demand is atthe heart of economics This can only mean that, eventually, economiccrises will have to be explained without denying this identity The

disequi-chapter argues that economic crises can be explained by simultaneouslyrespecting the identity between global supply and global demand and

by allowing for a numerical difference between them

Chapter 7 focuses on capital accumulation to detect if the latter canlead to economic crises Capital is indeed one of the central concepts ofeconomics However, there is still no consensus among economists onhow to define it Well-known economists such as Ricardo, Marx, Walras,Böhm-Bawerk, and Keynes have addressed this question and, with thenotable exception of Walras, have reached the conclusion that capitalcannot be considered as a direct source of economic value However,both Ricardo and Böhm-Bawerk emphasize the role played by time inenabling capital to be an indirect source of economic value Keynes’sanalysis of capital is another important contribution to a correct under-standing of this concept and encapsulates all the deepest insights ofhis predecessors concerning the role of saving and time By introduc-ing these elements into a theoretical framework where the presence ofboth money and banks is essential, Keynes opens the way to the modernmacroeconomic analysis of capital

Chapter 8 elaborates on the analysis presented in the precedingchapter, focusing on interest and interest rates Capital is indeed formedthrough the investment of profit and defines a macroeconomic sav-

ing: this derives from Keynes’s identities between global supply, Y, and global demand, C + I, and between S and I A correct analysis of interest

has to respect these identities and explain how it is possible to derive

a positive macroeconomic value from capital given that labour is thesole macroeconomic factor of production The chapter shows that capi-tal accumulation reduces the rate of profit within the economic systemtaken as a whole By narrowing the gap between the rate of profit andthe market rate of interest, this creates the conditions for an economiccrisis As the macroeconomic rate of profit gets closer to the market rate

of interest, investment must be reduced, and this has a negative effect

on employment The economic crisis is then worsened by the cial crises induced by a growing pathological capital and the speculativetransactions it feeds

finan-Chapter 9 focuses on the analysis of international transactions andtheir impact on financial crises It shows that what is wrong with thesystem of international payments is actually the way it works In par-ticular, it introduces two strictly related analyses that have led to thediscovery of a pathological duplication of countries’ debts The first con-cerns the problem of indebted countries’ external debt servicing andshows how the payment of net interest on a country’s external debt has

actually a total cost of twice the amount of the interest due to foreigncreditors The second analysis explains that the pathological duplicationinduced by transnational payments entails the very formation of coun-tries’ external debts and not merely the payment of net interest on thesedebts.

Based on the arguments in its preceding chapter, Chapter 10 presents

a structural monetary reform of domestic payment systems As theglobal financial crisis that erupted in 2008 has made it plain, banks aremoney as well as credit providers In fact, as Ricardo explained, the emis-sion of money and the provision of credit can be carried out by twoseparate bodies, without the slightest loss of advantage Indeed, thisseparation is a structural factor of financial stability, because it allowsavoiding that banks issue empty money in purely financial transactionsthat do not generate new income within the economic system as awhole The chapter elaborates on this and explains also the importance

of introducing a third department in banks’ accounting, which has toaccount for those profits that are invested in the purchase of capitalgoods and which therefore should not be available as bank deposits tofinance lending operations on any kind of market This will avert capitalover-accumulation and the resulting macroeconomic disorders

The last chapter of this volume, Chapter 11, deals with the necessaryreform of the international monetary system This chapter presents thereform elaborated by Schmitt on the basis of his analysis of the patho-logical formation of countries’ sovereign debt The advantage of thisreform is that it can be implemented by any single country irrespective

of what is done by the rest of the world and without causing any harm to

it Thanks to this reform, a country would be able to avoid the ical duplication of its external debt, and its government’s budget wouldearn the domestic income lost today because of the net expenditurescarried out by its residents Besides showing that any single country canprotect itself against the monetary and financial disorders caused by thepresent non-system of international payments, the chapter also showsthat the passage to an orderly system of international payments is possi-ble In particular, the euro area could implement easily enough a reformpreventing its member countries to suffer from the serious drawbackscaused by the actual lack of finality of their external payments and fromtheir sovereign debt crisis

patholog-On the whole, the positive and normative analysis presented in thisvolume shows that it is not only possible but also urgent to transformeconomic analysis into a socially useful and powerful tool for humandevelopment in a framework where systemic economic and financial

crises cannot occur This should be a welcome contribution to provide

a really scientific status to the ‘dismal science’ whereby economics andeconomists can provide a set of policy proposals aimed at the commongood within an orderly working economic system, nationally as well asinternationally

Part I

Modern Principles of Monetary Macroeconomics

The Monetary Macroeconomics

of Modern Economic Systems

What is money and how do banks issue it? How is it associated withphysical output? Is it endowed with a positive value since its verycreation, or does it acquire its purchasing power, and how? Is it nec-essary to distinguish between money proper and money income? Ifyes, what is their logical relationship? These are some of the questionsdealt with in this chapter, where we endeavour to show that the spe-cific nature of bank money remains, in part, a mystery and needs to

be investigated starting from its bookkeeping origin Too often tified with a commodity or an asset, money is mainly perceived as astock that can circulate more or less rapidly within the economy andwhose cost has a direct impact on production Is this definition con-sistent with the way money enters those payments that banks carryout? A rigorous analysis based on double-entry bookkeeping shows thatthis is not the case, because money is intrinsically valueless and canonly derive its value or purchasing power from production The clas-

iden-sical distinction between nominal and real money finds a new raison

d’être in the distinction between money and income, where the latter

is the result of a transaction through which money (a simple ical form) integrates produced output as its real content This newmacroeconomic analysis of money and income leads to a fundamen-tal dismissal of the old-fashioned idea that money creation is nothingless than a credit creation, or in other words that, by issuing money,banks originate credit, that is, a loan granted to the economy andfinanced by banks themselves In fact, banks act as monetary as well

numer-as financial intermediaries, and credit is never financed through moneycreation

Let us proceed step by step along a path that will lead us to discoverthe principles of modern monetary macroeconomics

15

About money

Economists almost invariably begin their monetary writings by giving

a wide and usually empirically based definition of money, which maycorrespond to the dictum that money is what money does, or may go asfar as to identify money with a commodity, an asset, or a veil Even the

author of A Treatise on Money is no exception, for he starts his famous

book by defining money through its functions

Money itself, namely that by delivery of which debt contracts and

price contracts are discharged, and in the shape of which a store of general purchasing power is held, derives its character from its rela-

tionship to the money of account, since the debts and prices mustfirst have been expressed in terms of the latter

(Keynes 1930/1971: 3)

The weakness of this approach is that it assumes that a conceptual inition may be made to coincide, a priori, with a nominal or with anaxiomatic definition Nominal definitions are arbitrary and say noth-ing about the nature of what is being thereby defined The choice of

def-a word to def-appose to def-an object is def-a cledef-ar exdef-ample of nomindef-al tion Whatever word we choose to name a given object or concept,our understanding of its nature does not progress at all To the extentthat it does not increase our knowledge, an axiomatic definition is nomore useful than a nominal one Moreover, these two kinds of defini-tion are quite different Axiomatic definitions, in fact, are not arbitrary

defini-As universally established principles, they are the result of a process

of understanding, which transforms them into self-evident statements

only a posteriori A true axiom is a principle arrived at through

analyt-ical discovery The fact that the Earth rotates around the Sun may betaken as an axiom today, but was certainly not considered as such beforeCopernicus Finally, correct conceptual definitions are bound to becomeaxioms When this happens, they can be taken for granted and intro-duced as axiomatic definitions from the outset What cannot be done

is to assume the axiomatic character of a definition before having ously established it A conceptual definition is indeed the arrival point

rigor-of a process rigor-of understanding, and not its point rigor-of departure logically

As far as monetary analysis is concerned, we cannot start by cally defining money, because the definition of money must be the endresult of our conceptual enquiry

axiomati-The different forms that money is supposed to take on, and the ent ways in which it is made to operate, are symptomatic of the lack of

differ-a clediffer-ar understdiffer-anding of whdiffer-at money rediffer-ally is As cldiffer-aimed by Mishkin

(2004: 44), ‘[e]conomists define money (also referred to as the money

supply) as anything that is generally accepted in payment for goods or

services or in the repayment of debts’ On top of being aprioristic, thisdefinition is far too vague to be meaningful As a matter of fact, any-thing can be accepted in repayment of debts, from banknotes and coins

to checks, deposit certificates, securities, or even goods and services.The only apposite conclusion in this regard is therefore that ‘there is

no single, precise definition of money or the money supply, even foreconomists’ (ibid.: 44)

In 1930, Keynes entitled Book I of his Treatise ‘The Nature of Money’

and Book II, ‘The Value of Money’ This is the logical succession that has

to be followed if we are to avoid taking for granted any aprioristic

con-ception of money Claiming, as done by Mankiw (2007: 77), that ‘money

is the stock of assets that can be readily used to make transactions’ istwice misleading, since it is at the same time too broad and too specific

a definition It is too broad because it encompasses every kind of assets,and too specific because it assumes that money is an asset In reality,one cannot take for granted that money is an asset, even though his-torical observation seems to corroborate it While it is undisputable thatgold, silver, and other materials have been used in the past to representmoney, it is no less certain that money cannot be identified with any

of these materials To describe the physical aspect of a coin, a banknote,

or any other object is no contribution to understanding what money’snature is

In their explanation of money, economists almost invariably startfrom a brief analysis of the different forms taken up by what has his-torically been chosen to play the role of a standard The passage fromcommodity money to bank money has marked a process of increas-ing dematerialization, which clearly shows how erroneous it would be

to keep identifying money with its physical supports Money is notgold, nor silver, nor an electric impulse; convertibility has long beenabandoned; and central banks have given up the official link betweenmoney and their gold reserves The recent evolution of payment systemstowards the electronic use of book-entry money has clarified the terms

of the problem, thus making it easier for researchers to avoid confusion.However, the main difficulty remains, namely that of explaining thenature of an entity that, although dematerialized, pertains to the realm

of economics Money is essentially a conceptual entity, which is notidentifiable with any material or any object whatsoever, but is neverthe-less strictly associated with or integrated to produced goods and services.Abstraction is not an easy way to follow However, it is a necessary step,

which has to be taken without falling into the trap of abandoning anyreference to the real world Money exists in the real world, but it cannot

be physically defined or identified; this is why it has so imperfectly beenunderstood so far This explains also why it has generally been confusedwith a series of physical objects to which it was erroneously identified.Our problem is thus clearly stated: to determine the specificity of moneyirrespective of the device used to play its role

The nature of nominal money

Let us start from the first function usually attributed to money, namelythat of a unit of account Economists are not unanimous when defin-ing this function of money For many of them, money acts as unit ofaccount in that it is a measure or a standard of value The ‘role of money

is to provide a unit of account; that is, it is used to measure value in the

economy’ (Mishkin 2004: 46) For others, money is a numerical unitused to express economic magnitudes such as prices, debt, income, cap-

ital, and so on ‘As a unit of account, money provides the terms in which

prices are quoted and debts are recorded’ (Mankiw 2007: 77) Now, todefine money as a standard of value from the outset is logically unac-ceptable, since it would amount to suppose that money has a positivevalue, and that its value is of the same kind as (and therefore comparablewith) that of the goods and services it is meant to measure Such a proce-dure must be rejected, for the simple reason that, as intuited by Keynes(1930/1971), the nature of money must be explained first, before askingwhether money has a value of its own or not The numerical conception

of money avoids this criticism and is far more promising to understandthe working of our economic systems

A unit of account is, first of all, a numerical standard used to count

or to enumerate Strictly speaking, it consists of numbers alone, and istherefore deprived of any intrinsic value Numbers can be used to count

a collection of homogeneous goods in order to ascertain their cal sum This is not, however, what a unit of account is supposed to

arithmeti-do in economics, where produced goods and services are far from beinghomogeneous In this framework, numbers are given the task of repre-senting the means through which physically heterogeneous objects may

be given a common numerical form To introduce money as a unit ofaccount has no other meaning than introducing numbers in the realm

of economics

The earlier statement may sound strange Numbers are just here for

us to use; why should we need money to introduce them into nomics? The answer relates to our previous remark: goods and services

eco-are physically heterogeneous and cannot be summed up unless they eco-aremade commensurable The existence of numbers is not enough to solvethis problem What is still needed is a way to integrate numbers andgoods, which requires numbers to be made available through a specificeconomic operation.

Numbers have been part of economics since the introduction ofmoney However, it is only with the appearance of an exhaustivemonetary system and through the generalized use of money that theintegration of numbers has been achieved The easiest way to under-stand the numerical nature of money is therefore that of analysing whatallows banks to provide the economy with a unit of account

The idea that banks create money is not new Keynes (1930/1971)devotes the first section of his chapter on bank money to the ‘creation’

of bank money, and claims that ‘the bank may create a claim againstitself in favour of a borrower, in return for his promise of subsequentreimbursement’ (Keynes 1930/1971: 21) It is by spontaneously issuingtheir own acknowledgement of debt that banks create money, and it

is worth observing here that, correctly, Keynes does not confine thecreation of money to the central bank Any bank can issue money bycreating a claim against itself The question that has to be clarified atthis stage is how it is possible for a bank to get spontaneously indebted,and how it is that, through its spontaneous acknowledgment of debt,numbers are introduced into economics

The discovery of double-entry bookkeeping, which took place in teenth century’s Italy, is the event that marks the origin of banks.Double-entry bookkeeping was itself made possible by the previous(seventh century) discovery, attributed to the Indian mathematicianBrahmagupta, of negative numbers, which, in its turn, is closely related

thir-to a new conception of the number zero For a long time, zero was notconsidered a number in its own right: it was merely conceived as a sym-bol for an empty space in the system of numeration; it represented theabsence of anything, the void, or the ‘nothing’ Since Brahmagupta, zero

is known to have a definite numerical value of its own More precisely,zero is the first number of the series of positive integers, the numberthat precedes one and that separates positive from negative numbers.Double-entry bookkeeping is an application of this distinction, whichallows arriving at zero by adding negative to positive numbers

The first meaning of bank money creation is the possibility given tobanks by double-entry bookkeeping to issue simultaneously+x and −x

units of money Indeed, this is the only acceptable way of envisaging ation without recurring to metaphysics Banks are human institutions,

cre-Table 1.1 The opening of a line of credit

Bank B Assets Liabilities

Credit on client A x m.u. Debit to client A x m.u.

and as such they cannot create anything positive The risk of runninginto metaphysics is avoided if what is created is at the same time posi-tive and negative This is what happens when banks get spontaneouslyindebted to a client who accepts to get indebted to them, that is, when abank agrees to open a credit line to the benefit of one of its client, A Thedouble-entry representation of this contract is shown in Table 1.1

By entering A on the liabilities side of its ledger, bank B edges its willingness to get indebted to its client A insofar as the latter iswilling to become its debtor Overdraft facilities pertain to this kind oftransactions They simply mean that the bank is prepared to carry out apayment on behalf of its client, and that its client will have to reimburse

acknowl-it No payment has yet occurred, and the amount of money actually ated is zero However, the operation is not void and meaningless Thesimultaneous creation of a positive and a negative amount of money tothe benefit of A has no direct consequence for B and for A, but sets theconceptual and the practical framework for a payment system to exist.The signal given by banks to the economy is that they can provide thenumerical vehicle required to convey a payment

cre-At this point a new question arises If money is but a numerical vehiclewith no value, and if banks by themselves can only issue zero units

of money, how can any payment be carried out? The answer to thisquestion leads us straightforward to consider the problem of money’svalue

The value of money

Apparently, the easiest way to attribute a positive value to money would

be to define it as an asset However, as we know, this is not a able solution, because bank money is almost completely dematerialized,and, even more important, because this definition cannot be introduced

suit-as an axiomatic suit-assumption An alternative solution is offered by thechartalist view that money in general may be accepted as a means ofpayment, as one of its components is State money As a matter of fact,economists unanimously agree that the passage to inconvertibility has

generalized the use of fiat money, that is, ‘paper currency decreed bygovernments as legal tender (meaning that legally it must be accepted

as payment for debts)’ (Mishkin 2004: 48) A government decree wouldthus be at the origin of money’s general acceptance in payments This

is so much so as the government may impose different tax liabilities tothe population and declare that it accepts State money as a means fordischarging these liabilities According to Smith (1776: 328), ‘[a] prince,who should enact that a certain proportion of his taxes should be paid

in a paper money of a certain kind, might thereby give a certain value

to this paper money’ (see also Mitchell Innes 1913: 398–9) Hence, theState can induce all taxpayers to accept these pieces of paper as money,because any non-bank agents know for sure that everyone who has topay taxes will accept them in turn (Tobin and Golub 1998: 27)

Attractive as the chartalist view might seem at first, it takes us nonearer to a solution of the problem, for it rests on the arbitrary assump-tion that the government has the supernatural power to create a cur-rency with a positive redeeming power ‘[Fiat money] is manufactured

by the government from thin air’ (Tobin 1965: 676) As already sized by von Mises (1912/1981), the chartalist theory of money doesnot provide any explanation of either prices or money’s value, and must

empha-be rejected as entirely useless ‘The state theory is not a bad monetary

theory; it is not a monetary theory at all’ (von Mises 1912/1981: 510)

A way out of this conundrum seems to be that of referring to social,general acceptance, that is, of maintaining that money’s redeemingpower derives from ‘its general acceptability in the discharge of publicand private transactions’ (Tobin 1965: 676) So, we are told that moneyhas a positive value because we all accept it as a means of paymentdischarging debts Money’s value would derive from social convention,

in a similar way as in language the meaning of words is determineduniversally because everybody agrees about it

As long as everyone continues to accept the paper bills in exchange,they will have value and serve as money Thus, the system of com-modity money evolves into a system of fiat money Notice that in theend the use of money in exchange is a social convention: everyonevalues fiat money because they expect everyone else to value it

(Mankiw 2007: 80)Social, general agreement emerges as the cause of money’s value on top

of government’s enforcement of paper currency as unique means of taxpayments Yet, a question arises almost spontaneously: for what reason

should individuals agree on accepting a mere acknowledgment of debt

in exchange for their goods and services? Bank money being deprived ofany intrinsic value, its general acceptance should derive from the gener-alized belief that everybody is prepared to accept it as if it had a positivevalue To put it bluntly, this amounts to saying that if we all accept to

be dupe, no one of us will eventually be fooled Needless to say, this is

an odd way of making ends meet Indeed, the whole argument is cious, and winds up in a vicious circle, money’s general acceptance beingfounded on the belief that everybody will accept it Reality is much morestraight and pragmatic: it is because money has a positive value (whoseorigin we still have to explain) that it is generally accepted, and not theother way around

falla-In most general terms, money’s value is identified with money’s chasing power What makes an individual to accept money in exchangefor her/his goods and services is the certainty that the sum receivedwill allow her/him to purchase other items of an equal value The perti-nent question to ask, therefore, is where does money’s purchasing powercome from To explain how money acquires a positive purchasing power

pur-is to explain how we can pass from nominal to real money, to put it

in the language of classical economists, or, using today’s terminology,from money to income ‘We mean by the purchasing power of moneythe power of money to buy the goods and services on the purchase ofwhich for purposes of consumption a given community of individualsexpend their money income’ (Keynes 1930/1971: 48) Let us address thisissue in the next section

The logical and factual distinction between

money and income

As we noted in the previous section, double-entry bookkeeping ers banks to spontaneously incur a debt to the economy Since this debt

empow-is balanced at once by an equivalent credit with respect to the sameagent, the opening of a credit line has no direct consequences either

on the creation of money, or on income In this first phase, banks ply show that they are able and willing to provide a numerical unit ofaccount to their clients, and to convey payments on their behalf Whathas to be clearly understood is that, up to this point, no money hasbeen issued, and no income has been formed Hence, banks can, usingdouble-entry bookkeeping, ‘vehiculate’ payments, but they are by nomeans capable to finance them so far No shortcut is permitted here

sim-Logically, we must start from tabula rasa, and we cannot suppose the

pre-existence of positive bank deposits of any sort The formation ofincome has to be explained starting from a situation in which bankshave no deposit, hence no income to lend.

The problem we are faced with is how to determine the payment thatbanks can carry out starting from a zero income At first sight, it wouldseem that logic leaves no room for a positive answer If payments per-tained all to the same category and implied the final purchase of goodsand services, this would be it Indeed, any final purchase implies theexpenditure of a positive income, of which there is no trace at the begin-ning of our thought experiment The absence of any pre-existing income

is not the only requirement imposed to the analysis, which forbids alsothe pre-existence of produced goods and services It follows that bankscannot finance any final purchase both because no income is available

in the system so far, and because there are no goods to be purchased atthis stage Our task is thereby drastically simplified: to find a paymentthat does not require the expenditure of a positive income and does notdefine the purchase of any produced good or service

As argued by Keynes (1930/1971: 111), income is directly related toproduction ‘We propose to mean identically the same thing by the

three expressions: (1) the community’s money income; (2) the earnings of

the factors of production; and (3) the cost of production’ The payment we

are looking for is therefore a payment that banks can carry out on behalf

of firms, and which does not amount to the purchase of raw materials,energy, machinery, or any other item of this kind Now, only one candi-date is eligible for this: the payment of wages This clearly means that,unlike what Marx (1867/1976) wrongly assumed, the payment of wagesdoes not define the purchase of a particular commodity called labour-power It also means that the payment of wages does not define the finalpurchase of produced output by firms or banks When paying wages totheir workers, firms would be purchasing the result of their labour activ-ity only if wages were paid out of a positive income If this were indeedthe case, income would be deemed to remain totally unexplained If apositive income exists – and no one doubts it – it is because, as a result ofthe payment of wages, firms do not become the final owners of producedoutput

Most authors advocating a macroeconomic approach to economicshave emphasized the peculiarity of human work Among them wefind the exponents of classical theory, as well as Keynes and some

of his followers According to these authors, labour is not a modity, but rather the source of all of them In particular, classicaleconomists identify labour with the source of economic value, and

com-Keynes (1936/1946: 213–4) considers labour as the sole macroeconomicfactor of production ‘It is preferable to regard labour, including, ofcourse, the personal services of the entrepreneur and his assistants, asthe sole factor of production, operating in a given environment of tech-nique, natural resources, capital equipment and effective demand’ As amatter of fact, it is not only preferable but also logically compulsory toconsider labour as essentially different from all other (microeconomic)factors of production This is so because labour does not result from anyprocess of production Land and capital are themselves the result of pro-duction, whereas labour is not In terms of inputs and outputs this may

be expressed by saying that labour is nothing but an input, while landand capital are outputs before becoming (microeconomic) inputs: theymust first be produced if they are to be used in the production of someother outputs

The final proof that labour is the sole (macroeconomic) factor of duction has been provided by quantum economic analysis, and rests onthe fact that workers alone can be credited with the result of a paymentthat does not require the expenditure of a pre-existing income

pro-Indeed, let us recall that money as such is the spontaneous edgment of debt issued by banks, and that the object of this debt is apayment What the beneficiary of the bank’s acknowledgement of debtobtains is the promise that, when required, a payment will be carriedout on her/his behalf Now, banks carry out their payments by usingdouble-entry bookkeeping, that is, by debiting the payer and creditingthe payee into their ledgers The payment we are concerned with hereregards production, and is meant to have the double task of account-ing for the positive creation of money, and the formation of income

acknowl-In this regard, Schmitt (1998–99a: 52, our translation) holds the view

that the only apposite payment is the payment of wages, as

‘individu-als only are credited and debited Neither land, nor capital can be the

subject of credits and debits [ ] Once again, it is inconceivable that

a capital be credited or debited or “credited-debited” Only the “humanfactor” is suitable for that’

By opening a credit line to firms, F, banks declare their availability tocarry out any payments up to an agreed amount If a positive incomewere already deposited with banks, their initial payment on behalf of

F could be made to the benefit of agents selling any kind of goods, forexample raw materials or machinery As no production has yet occurred,

no pre-existing deposits are available, and income amounts to zero.Under these circumstances, the initial payment of banks cannot con-sist in the purchase of any positive asset, either real or financial What

Table 1.2 The payment of wages

Bank B Assets Liabilities

Credit on firm F x m.u. Wage earners’ deposit x m.u.

is, then, the nature of the payment of wages? How is it that banks canpay F’s workers even though they have no positive income at their dis-posal? To answer these questions we have to analyse in some detail thepayment of wages as entered in a bank’s ledger

Let us start from the double-entry bookkeeping representation of thethree-pole transaction defining the payment of wages (Table 1.2).The three poles concerned by the payment of wages are the bank,

B, which acts as a simple intermediary, firm F, on behalf of which thepayment is carried out, and workers, W, who are credited in the bank’sledger What can be immediately observed is that the payment repre-sented in Table 1.2 defines a complete and self-consistent transaction.From a double-entry point of view, the payment does not require anycomplement, since what is entered on the assets side of B’s balance sheet

is perfectly matched by what is entered on its liabilities side It is alsoimmediately clear that W’s credit to the bank is not compensated by anydebit incurred by W Workers are net creditors, which means that, sincethey have been paid out of zero income, their payment is at the origin

of a positive income To be sure, the source of money’s value is labour,and the payment of wages gives it its numerical form The meaning ofwhat is entered on the liabilities side of B’s ledger is univocal: workersare the owners of the new income deposited with B The bank owes Wthe amount W lend to it by depositing their newly formed income.The formation of income is closely related to production Double-entry bookkeeping alone could not account for it The passage frommoney to income takes place at the very moment production is mon-etized, that is, when physical goods and services are given a commonnumerical form through their association with money The nature ofmoney is thus double: it is both a flow and an immaterial form Thesejoint aspects of the same entity have a very short existence, which coin-cides with the instant wages are paid As a flow, money comes alive inevery payment, and disappears as soon as the payment has occurred

As a numerical form, money carries out its task at the moment physicalgoods and services are given their numerical expression In the payment

Figure 1.1 The result of the payment of wages

of wages, money is created and is given a real content By the sametoken, it is transformed into income and deposited with the bank Theformation of income marks the passage from a flow (money) to a stock.Money disappears, and gives way to monetized output Indeed, this isprecisely what income is, namely the result of a transaction by whichphysical goods and services are injected into a numerical form, andare thus momentarily replaced by a sum of money income Figure 1.1illustrates what happens in this regard

The debt incurred by F to B is represented as a negative bank deposit,whereas the positive bank deposit represents the credit of W (B’s debt toW) Since the object of F’s debt is nothing but produced output, we havelodged it in F’s negative bank deposit When wages are paid, the posi-tive and negative bank deposits are no longer defined with respect tothe same agent F becomes a debtor and W a creditor to the bank Beforethe payment, debit and credit have no real content, and the object of B’sacknowledgement of debt is the acknowledgement of debt itself Afterthe payment, the object of both W’s net credit and F’s debit is producedoutput Physically stored in the firm’s warehouse, produced output iseconomically lodged into F’s negative deposit with the bank, where itmomentarily disappears From an economic point of view, physical out-put is replaced by income This is so because income – the object of W’snet credit to the bank – is the very definition of produced output

In his book on inflation, unemployment, and capital malformation,

Schmitt (1984a) introduced the concept of absolute exchange, that is, of a

transaction in which a given object is exchanged against itself, albeit in

a different form The payment of wages is actually an absolute exchange,where output is transformed into a sum of money income

The payment of wages is an emission: this is to say that [ ] workers

get their own product, in money This is not just an equivalence, but

an identity: each worker obtains a money that, given its emission

in the payment of wages, is made identical to the real product of thisvery worker In the same transaction, the firm gives and gets the sameobject; which is the mark of an absolute exchange

(Schmitt 1984a: 347, our translation)

In the absolute exchange defined by the payment of wages, physical put becomes the object of W’s income, but it is also, at the same time,the object of F’s debt to the bank Even though output is physicallystored in F’s warehouse, it is not owned by F, precisely because F hasincurred a debt to B, whose object is physical output On its turn, B can-not be the economic owner of physical output, because B is indebted

out-to W Indeed, workers are the true owners of newly produced output,since they own a net credit over a positive amount of income depositedwith B By transforming output into a sum of income, the absoluteexchange that takes place when wages are paid out gives workers theeconomic ownership of the product resulting from their own activity.This conclusion should not come as a surprise, because it is the directconsequence of labour’s particular status It is because labour is the only(macroeconomic) factor of production that its remuneration is at theorigin of income, and it is because wages are the outcome of produc-tion that they define produced output Through the payment of labour,physical goods and services are made identical to money wages, so thatincome holders are the economic owners of produced output

Money’s value, to wit, its purchasing power, is defined by those goodsand services with which money is identified The idea that money’svalue is what allows money to be exchanged against real goods andservices is misconceived, if this is considered as a relative exchange inwhich money’s value is the counterpart of produced output In no cir-cumstances it is possible to separate income from output as if they weretwo distinct assets Income and output are the two faces of the samereality They define each other, neither of them having an autonomousexistence with respect to the other Indeed, without a numerical form,output would be only a heap of physically heterogeneous objects, andwithout a physical content money would amount to an empty numer-ical form of no positive value It is through their strict association thatthey acquire a meaningful standing, namely that physically heteroge-neous objects are transformed into commodities, and money is given

a real content In the absence of an absolute exchange transformingphysical output into money income, money’s value could never beexplained The very idea of a positive purchasing power implies the

existence of a strict relationship between money and output The ment of wages allows for money and output to become the two terms of

pay-an identity, which is the strictest possible relationship Money’s ing power results from such a relationship: it is the direct consequence

purchas-of money income being the very (economic) definition purchas-of producedoutput

Nothing of what we argued so far about the nature of bank moneyand the formation of income has been assumed as dogmatically given,

or derived from a set of axioms The double-entry bookkeeping ple has been the only instrument used in our analysis of the way moneyenters the realm of economics, and its creation is made to overlap withproduction Whatever theory economists adhere to, they cannot con-fute the principle of double-entry bookkeeping Hence, if economists arestill far from an agreed understanding of what money is, it is because thisprinciple has not yet been assimilated within their theoretical frame-work In particular, negative numbers are still alien to their monetarywritings However, negative numbers are essential for the very existence

princi-of double-entry bookkeeping, which is based on the constant matching

of negative and positive numbers The necessary equality between its and credits, as a matter of fact, is an identity between negative andpositive numbers Once this is clearly understood, it appears that eachtransaction has to be entered both on the assets and on the liabilitiessides of a bank’s ledger, so that the result for the bank (considered here

deb-as a simple intermediary, and not deb-as a firm) can always be equal to zero

As odd as this might first appear, this implies that each agent ing in a transaction is simultaneously credited and debited (or debitedand credited) for the same amount of money units

interven-Let us refer to the double-entry representation of the payment of

wages (Table 1.2) When B pays x to W on behalf of F, it credits and its both F and W with x units of money In the same instant, B creates and destroys x units of money on F as well as on W Indeed, F cannot be the beneficiary of a positive creation of x money units, as they are imme-

deb-diately used in the payment of W On the other hand, workers deposit

at once the money they are credited with by the bank As a result ofthe payment of wages, workers are net creditors not because they hold apositive amount of money units, but because they deposit their moneywages with B (thus lending their income to it) If we consider moneyalone, we notice that, according to its nature of a numerical ‘vehicle’,

it instantaneously flows from B to F, from F to W, and from W back to

B The accounting representation of money’s circular flow requires F and

W to be simultaneously credited and debited with x money units, which

implies that the money created in the payment of wages is immediatelydestroyed once the payment has been carried out.

The flow nature of money has for a long time remained hidden, andhas yet to be perceived as a central feature of monetary analysis bymost economists Substantially, money and income have erroneouslybeen confused for one another, and money as such has not been given

a proper definition However, it is only fair to recognize that Smith(1776/1991) had already distinguished money (nominal money) frommoney’s worth (real money) – a distinction that was to be taken on

by Ricardo (1817/1951) and by Marx (1867/1976) According to Smith(1776/1991), nominal money corresponds to what we would call today

‘the numerical form’, a unit of account of no intrinsic value, whilereal money – money income or simply income in today’s language –

is defined by the amount of real output money comes to be fied with once associated to real production In his famous book onthe nature and causes of the wealth of nations, Smith (1776/1991: 254)defines money as ‘the great wheel of circulation’, and clearly states that,

identi-as such, it must be distinguished from a country’s revenue ‘[S]o money,

by means of which the whole revenue of the society is regularly tributed among all its different members, makes itself no part of thatrevenue The great wheel of circulation is altogether different from thegoods which are circulated by means of it’ (ibid.: 254) Smith then clar-ifies that (nominal or vehicular) money shall not be identified withmoney’s worth (real money or income) ‘[T]he wealth or revenue [ ]

dis-is equal only to one of the two values which are thus intimated what ambiguously by the same word, and to the latter more properlythan to the former, to the money’s worth more properly than to themoney’ (ibid.: 255) The Scottish author concludes by pointing out that

some-‘[t]hough we frequently, therefore, express a person’s revenue by themetal pieces which are annually paid to him [ ] [w]e still consider his

revenue as consisting in this power of purchasing or consuming, and not

in the pieces which convey it’ (ibid.: 255) Even if it is true that Smith’s(1776/1991) analysis of money is still influenced by an old-fashioned,metallist representation of money, it is difficult to deny that by distin-guishing money from money’s worth, and by conceiving of money as acircular flow (‘great wheel of circulation’) he provided the elements for

an entirely new conception of money Unfortunately, with the partialexception of Ricardo and Marx, his message went unheeded, and thereason for which money must be conceptually separated from incomeseems to be alien to today’s analyses To be sure, a distinction is made,but it is confined to the obvious consideration that money is used to

express and represent income What is missing is the awareness thatmoney is a mere flow or a numerical form of no value at all.

As intuited by Smith (1776/1991), money’s purchasing power does notderive from any hypothetical, intrinsic value of money, but rather fromits identification with produced output, which results from the payment

of wages ‘[T]hough the wages of the workman are commonly paid tohim in money, his real revenue, like that of all other men, consists,not in the money, but in the money’s worth; not in the metal pieces,

but in what can be got for them’ (ibid.: 260) The author of The Wealth

of Nations was himself the victim of the generally accepted view that

money had a value of its own (since it was made of precious metals);however, he was not fooled into identifying it with money’s purchas-ing power Today’s analysis of book-entry money shows that Smith wasright Whatever material is used to represent it (from gold to electricimpulse), money is not a revenue or an income It becomes (is trans-formed into) an income once it is made identical to produced output

It is at the very moment wages are paid that money is created, and it

is in this same instant that it acquires its purchasing power To be cise, money as a flow exists only within a payment Once wages havebeen paid, money is destroyed and is immediately replaced by a sum ofincome What has to be clearly understood is that banks cannot create

pre-a positive pre-amount of income, whose origin hpre-as to be looked for in theprocess of production Things being what they are, our next step is toanalyse the relationship existing between money and credit

Money and credit

One of the most enduring and serious mistakes in economics literature

is to identify bank money with credit and to maintain that banks cancreate a positive purchasing power As claimed by Bernstein (1965: 47),

‘[n]ew money is created in response to credit expansion by commercial

banks’, because ‘[w]ith the punch of a bookkeeping machine, the totalamount of purchasing power in the economy [is] obviously increased’(ibid.: 44) Let us take Parguez and Seccareccia (2000) as a more recentexample of this view In their analysis of the nature of money in themonetary circuit, they maintain that

[b]anks are deemed to be so creditworthy that no holder of their debtswould ever ask for reimbursement either in kind or in the debt ofanother agent Banking institutions enjoy, therefore, the capacity offreely issuing debt without it being subject to an exogenous resource

constraint This means that banks can create these debts ex nihilo

when they grant credit to non-bank agents who must spend them

to acquire real resources

(Parguez and Seccareccia 2000: 103)This quotation ascribes to banks the faculty of creating a money alreadyendowed with a positive purchasing power, which the beneficiaries ofthe creation can (indeed must, according to the authors) spend for thepurchase of real resources Is it really necessary to dispute such a fanci-ful claim? Most probably not, since it is immediately clear that banks’alleged faculty to create a positive purchasing power pertains to theworld of imagination In the real world, a creation is possible only if it isimmediately matched by an equivalent destruction, a result that can beachieved once negative numbers are associated with positive numbers.This is what happens when bank money is issued in compliance withthe rules of double-entry bookkeeping To endorse the idea that bankscan create credit is to evoke a supernatural power that goes far beyondour terrestrial competence

Nevertheless, it seems difficult to give up the widespread idea thatmoney creation is closely related to credit Indeed, what cannot beaccepted is the axiomatic assumption that banks can create credit, andnot the existence of a necessary link between money creation and credit

In order to understand the origin and nature of this link, we need to takeinto account the role of intermediation played by banks In particular,

we have to investigate the financial intermediation carried out by banks

in the payment of wages, which is – as we already know – the transactionleading to the formation of income

Wages would be paid out of a positive income only if banks wereable to create it, in which case we would be entitled to identify moneycreation with a credit operation Banks would lend the newly createdincome to firms, which would use it in the purchase of produced outputfrom workers This not being the case, if a credit is nevertheless involved

in the payment of wages, it must originate in the income earned byworkers As a matter of fact, as soon as wages are paid out an income isformed, which immediately takes the form of a bank deposit As shown

in Table 1.2, the sum paid to workers is entered on the liabilities side

of B’s ledger, which means that B has just incurred a debt to W Thereason for B’s indebtedness is that it benefits from a loan: W’s income,formed as a bank deposit, is lent to B at the very moment of its forma-tion Workers end up with a claim on a bank deposit, which states thatthey are the owners of the income deposited with (and thereby lent to)