Mish & Steve Debate: Steve Says (I)

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I've just taken time-out from the pre-conference social event at the Central Bank of Turkey annual conference, and (as enjoyable as that function was) it's lucky that I did: Mish Shedlock has followed up on some criticisms of my "Mod­ern Debt Jubilee” pro­posal with a post on real solu­tions for the debt cri­sis. I will try to reply to Mish’s follow-up before I turn in for the night here in Cap­pado­cia.

Firstly, some praise: Mish and I come from very dif­fer­ent perspectives—Austrian ver­sus Post Keynesian—but through­out this cri­sis, we’ve learnt from each other a great deal, and exchanged respect­fully. When we dif­fer, we try to ascer­tain why—which is in stark con­trast to how Paul Krug­man reacted to crit­i­cism. We became friends before we had any rea­son to dis­agree in pub­lic, and I’m sure we’ll be friends on the other side of this debate.

Sec­ondly, there’s a has­sle with the Inter­net con­nec­tion from this semi-rural loca­tion in Turkey; it stopped some of the images being posted prop­erly. They’re OK in this PDF though–(which I’m mak­ing gen­er­ally avail­able rather than restrict­ing to Debt­watch and CfESI sub­scribers as I usu­ally do).

The key excerpts from Mish’s alter­na­tive to my pro­posal are as follows:

Struc­tural Issues

Giv­ing money away will not cure any struc­tural issues such as the high cost of edu­ca­tion, pen­sion under­fund­ing, med­ical costs, pre­vail­ing wages, stu­dent loans, etc., etc.

Indeed, I think it would com­pound those problems.

Like­wise, I think the sec­ond part of Keen’s idea about con­trol­ling debt in the future tied to GDP growth (or any­thing else for that mat­ter) would fail miserably.

A free mar­ket, not gov­ern­ment man­dated fiat money is the solu­tion. We cer­tainly do not have a free mar­ket now. Instead, we have fiat man­date, com­pounded by fraud­u­lent frac­tional reserve banking.

It is the frac­tional reserve bank­ing sys­tem that is the very root of the credit expan­sion problem.

Frac­tional Reserve Lend­ing Is Fraud

By lend­ing out more money or gold than exists, asset prices reach unsus­tain­ably high lev­els before they crash. Sound familiar?…

For more on the case against Frac­tional Reserve Lend­ing please see
Frac­tional Reserve Bank­ing by Mur­ray Roth­bard.

Case Against The Fed by Mur­ray Roth­bard

On page 46 of the book Case Against The Fed Roth­bard says “By the very nature of frac­tional Reserve Lend­ing, banks can­not honor all its contracts”.

Since that is known upfront, in advance, how is that not fraud?


Before we can address solu­tions to the debt prob­lem, we have to under­stand what caused the debt prob­lem in the first place. In this case, FRL is at the heart of it.

Since FRL is at the heart of it, any per­ma­nent solu­tion must address that prob­lem.

I pro­pose we start by address­ing the root cause of the debt prob­lem which I state is frac­tional reserve lending.

Not a Tran­si­tion Plan

My first obser­va­tion here is that, even if I believed that Mish were cor­rect, his is not a tran­si­tion plan: this is a plan for an alter­na­tive sys­tem. But how do we make the move from where we are now, to an alternative?

Let’s imag­ine that we do, one day, make the tran­si­tion from the sys­tem Mish describes as “Frac­tional Reserve Bank­ing” to one that is fully backed by gold. The day before that tran­si­tion, one individual—say, some­one called Jamie perhaps—may have a net claim to $10 bil­lion worth of fiat-backed money. Some­one else—say, Ma Ket­tle—might be effec­tively bank­rupt with $10,000 more mort­gage debt than assets. It may be too that Jamie’s immense wealth arose from per­suad­ing mil­lions of peo­ple like Ma and her rel­a­tives to take out a reverse mort­gage, or some other form of inno­v­a­tive lend­ing that was pop­u­lar in the pre-gold days.

How do we make the tran­si­tion? Do we give Jamie $10 bil­lion worth of gold-backed money, and sad­dle Ma with $10,000 of gold-based debt? Or what?

This is what my “Mod­ern Debt Jubilee” pro­posal is about. We cur­rently have a dys­func­tional finan­cial sys­tem that has imposed uncon­scionable debt bur­dens upon some, and cre­ated enor­mous Ponzi-based wealth for oth­ers. Do we sim­ply accept that, and move to a new sys­tem which allegedly won’t have the flaws of the pre­vi­ous sys­tem, but sus­tain the dis­tri­b­u­tion of wealth that resulted from that flawed sys­tem? Or do we reduce that unfair­ness under the cur­rent sys­tem before we move to a new one?

That is what my “Mod­ern Debt Jubilee”—or “Quan­ti­ta­tive Eas­ing for the Public”—proposal is about. By inject­ing money under the cur­rent sys­tem into the bank accounts of bank cus­tomers (rather than into their reserves as under actual QE), and requir­ing that the injec­tion be first used to pay down debts, it would dra­mat­i­cally reduce the income and wealth of the finance-sector, while being even-handed in its treat­ment of bor­row­ers and savers. That would minimize—but far from eliminate—the dam­age done by the cur­rent sys­tem, before any tran­si­tion occurred.

To make a tran­si­tion to a new mon­e­tary sys­tem, with­out min­i­miz­ing the prob­lems caused by the pre­vi­ous sys­tem, would poten­tially doom that new sys­tem to fail­ure, regard­less of its merits.

Not a Frac­tional Reserve System

My sec­ond obser­va­tion is that we don’t live under a Frac­tional Reserve Sys­tem at all; we live under a pri­vate bank­ing sys­tem in which there is a Cen­tral Bank that once sort-of attempted, unsuc­cess­fully, to reg­u­late pri­vate lend­ing by impos­ing a ratio require­ment between pri­vate bank money cre­ation and government-created reserves.

I say “once sort-of attempted” because the Fed long ago amended its reserve require­ments (see Table 12 in O’Brien, Y.-Y. J. C., 2007. Reserve Require­ment Sys­tems in OECD Coun­tries.) so that they apply only to house­hold deposits, and because there is a lag between deposits and reserves of 30 days: reserve require­ments are based on loans and deposits exist­ing 30 days ear­lier. This means that, as the Euro­pean Cen­tral Bank recently politely put it in rela­tion to its system:

In fact, the ECB’s reserve require­ments are backward-looking, i.e. they depend on the stock of deposits (and other lia­bil­i­ties of credit insti­tu­tions) sub­ject to reserve require­ments as it stood in the pre­vi­ous period, and thus after banks have extended the credit demanded by their cus­tomers. (ECB 2012, p. 21, empha­sis added)

I say “unsuc­cess­fully” because, as a sen­si­ble New York Fed Vice-President admit­ted decades ago, the actual prac­tice of bank­ing, com­bined with the lagged nature of the reserve require­ment, means that loans deter­mine deposits and reserves fol­low rel­a­tively pas­sively afterwards—the reverse of the argu­ment that peo­ple who believe we live in a frac­tional reserve bank­ing sys­tem actu­ally put (rang­ing from Mil­ton Fried­man in the 1960s to crit­ics like Mish today):

The idea of a reg­u­lar injec­tion of reserves … also suf­fers from a naive assump­tion that the bank­ing sys­tem only expands loans after the Sys­tem (or mar­ket fac­tors) have put reserves in the bank­ing sys­tem. In the real world, banks extend credit, cre­at­ing deposits in the process, and look for the reserves later… the reserves required to be main­tained by the bank­ing sys­tem are pre­de­ter­mined by the level of deposits exist­ing two weeks ear­lier. (Holmes 1969, p. 73)

(Note that in the 1960s, there was a 2 week lag. Now, with a mod­ern bank­ing sys­tem using sophis­ti­cated com­puter tech­nol­ogy, we have … a 30 day lag. Guess why!)

Mish has thus embraced the “loans cre­ate deposits” and “loans and deposits pre­cede lags” aspects of the empirically-based Post Key­ne­sian analy­sis of money, with­out quite real­iz­ing that this means the model of Frac­tional Reserve Bank­ing (FRB) is a false model of what cur­rently hap­pens. Instead of FRB explain­ing how banks are “lend­ing out more money or gold than exists”, some­thing else has to explain that phenomenon.

That some­thing else is the capac­ity of pri­vate banks to cre­ate money, and this capac­ity exists even under a sys­tem of “A free mar­ket, not gov­ern­ment man­dated fiat money”. So abol­ish­ing “Frac­tional Reserve Bank­ing” won’t elim­i­nate the capac­ity of banks to “lend out more money or gold than exists”, or more strictly speak­ing, to cre­ate money “out of nothing”.

Money cre­ation by pri­vate banking

There’s a fairly sim­ple way to show from double-entry account­ing that banks can’t lend from reserves, and that a sys­tem of pure pri­vate bank­ing can result in banks cre­at­ing money. I’ll start from the stan­dard Post Key­ne­sian analy­sis of money, which was devel­oped to try to explain the empir­i­cal data on debt and money cre­ation. It states in its sim­plest form that “loans cre­ate deposits”. The next table states this basic argu­ment in an absolutely par­si­mo­nious way, fol­low­ing the account­ing con­ven­tion that an increase in assets is shown as a plus and an increase in lia­bil­i­ties is shown as a minus:

Fig­ure 1

Pri­vate Bank Tan­gi­ble Asset Lia­bil­ity Equity
Account Loans Firms Equity
Type Ledger Money Ledger
Value 0 0 0
Sym­bol LF DF EB
Make Loan Loan –Loan
Repay –Repay Repay

This implies that banks can cre­ate money indef­i­nitely, so long as the rate of cre­ation of new loans exceeds the rate of repay­ment of old ones:

Fig­ure 2

The more conventional–but not empir­i­cally derived–“Fractional Reserve Bank­ing” model argues that banks need reserves from which to lend. But even if we start from a model in which banks lend from reserves, we can’t get the out­come that reserves play any part in lend­ing and remain con­sis­tent with double-entry book­keep­ing. The dilemma is that to make a trans­fer from Assets to Lia­bil­i­ties, the sum in account­ing terms must be zero: the change in assets (where an increase is shown as a plus) must be bal­anced by the change in lia­bil­i­ties (where an increase is shown as a minus).


So a direct loan from Reserves to a Depositor’s account is sim­ply impos­si­ble: that would involve a minus on the assets side and a plus on the lia­bil­i­ties side, which means that the deposit has fallen, not risen!


A way around that is to record that is a two step (but simul­ta­ne­ous) process in which (a) the bank ear­marks the money for a loan by increas­ing its loan ledger and decreas­ing its reserves and (b) lends from reserves to the borrower’s deposit account. That two-step process, together with repay­ment in the same way, is shown in the fol­low­ing table.

Fig­ure 3

That results in the fol­low­ing sys­tem, in which reserves play no part: all the action is between loans and deposits. We’re back to a sys­tem which, apart from an extra account, is oth­er­wise exactly the same model as the par­si­mo­nious Post Key­ne­sian one.

Fig­ure 4

Another way to involve reserves and try to make them part of the sys­tem is to argue that banks lend from lia­bil­i­ties rather than assets, and that one of its lia­bil­i­ties is a work­ing cap­i­tal reserve–the bank­ing sector’s own lia­bil­i­ties to itself. Then you can derive a sys­tem which appears to show that banks lend from reserves:

Fig­ure 5

Now we have a model in which reserves do play a part in lending:

Fig­ure 6

How­ever there’s a prob­lem with this rep­re­sen­ta­tion: the sec­ond row implies that the amount of money in the sys­tem (the lia­bil­i­ties of the bank­ing sec­tor) fall becase of the loan. But they don’t: instead the first row shows that the lia­bil­i­ties are sim­ply trans­ferred from the bank­ing sector’s work­ing cap­i­tal to the Firm sector’s deposit accounts. So the sec­ond row actu­ally makes a false claim (there may well be a fall in one bank’s reserves and an increase in another’s if a loan is made by one bank and deposited in another; this trans­fer of funds within the bank­ing sec­tor is one of the main rea­sons for reserves, and also why they nor­mally run at “fric­tional” lev­els).


This is why Neil Wil­son sug­gested that we had to add an intan­gi­ble asset–the value of the licence to be a bank–to the accounts. Then a loan could be shown as an exer­cise of the banks’ intan­gi­ble asset.

Fig­ure 7

So this is closer to the mark–and once again reserves play no role in lending:

Fig­ure 8

But now we have a bank­ing sec­tor that is hap­pily mark­ing the value of its good­will down to zero as its loans increase. What if instead–bearing in mind that this is a model of a pri­vate bank­ing system–the bank­ing sec­tor kept the recorded value of its good­will con­stant? How could it do that? It could add a pos­i­tive sum to its Good­will to off­set the Loan, and a neg­a­tive to its work­ing capital–so that it cre­ates new money by cre­at­ing a loan.

Fig­ure 9

We now have a sys­tem which is much more com­pli­cated, but which dynam­i­cally reduces back to the same par­si­mo­nious Post Key­ne­sian one we started with.

Fig­ure 10

So the bot­tom line here is that elim­i­nat­ing “Frac­tional Reserve Bank­ing” does noth­ing to elim­i­nate the capac­ity for banks to cre­ate money: that will exist in a purely free mar­ket sys­tem just as much as it does today.

There are also very good argu­ments, from a very good Austrian—Joseph Schumpeter—that this capac­ity to cre­ate money is a nec­es­sary part of the entre­pre­neur­ial process that makes cap­i­tal­ism a dynamic sys­tem. My other pro­pos­als, Jubilee Shares and “The PILL”, are intended to min­i­mize the dan­ger­ous use to which bank money cre­ation is put—financing Ponzi Scheme bub­bles in asset prices—and max­i­mize this cre­ative use of that power.

OK; it’s now the morn­ing, and after another jet­lagged sleep I have to present a con­fer­ence paper in 4 hours. I’ll leave my con­tri­bu­tion at this point and await Mish’s reply.

About Steve Keen

I am a professional economist and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous debts accumulated in Australia, and our very low rate of inflation.
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157 Responses to Mish & Steve Debate: Steve Says (I)

  1. Martin Brooks says:

    Whilst Steve’s idea is inter­est­ing I sus­pect that even if it were imple­mented it might sim­ply end up ‘kick­ing the can down the road’ for another 3–4 years.

    Global rebal­anc­ing’ (the appar­ent suc­ces­sor to ‘Glob­al­i­sa­tion’) means a con­tin­u­ing and inex­orable trans­fer of jobs and wealth from West to East. It is this reduc­tion in home-grown man­u­fac­tur­ing capac­ity in the US espe­cially that caused the shift over the last 30 years from man­u­fac­tur­ing to mas­sive finan­cial sec­tor Ponzi schemes that have now collapsed.

    US household’s real incomes remained sta­tic since the mid 1970’s but the pop­u­lace were kept happy by one bub­ble after another that raised house­hold wealth lev­els. With the col­lapse of the real estate mar­ket and stock/superannuation losses US house­hold wealth has col­lapsed today to a median value of $78,000, the same as it was around 20 years ago.

    The US has arrived at this place as a result of loss of com­petive­ness in world mar­kets. US cor­po­ra­tions realised decades ago that they could max­imise prof­its by set­ting up in cheaper parts of the world where wages were 10% of US wages. As a result, since 1980 the US has lost over ten mil­lion full time jobs.

    A ‘Debt Jubilee’ can’t solve these mas­sive under­ly­ing struc­tural problems.

    Could there be short to medium term ben­e­fits if Steve’s idea was adopted?
    Let’s say each house­hold is pro­vided with $30,000 to pri­mar­ily pay down debt. This would cer­tainly reduce the inter­est load on fam­i­lies with debt and stim­u­late demand. For those with no debt spend­ing the money would pro­vide even more demand (I’m assum­ing that every house­hold receives the money – if not this scheme would be unwork­able – those with no debt would imme­di­ately cre­ate some debt in order to receive the ben­e­fit). There are of course many other issues in the actual mech­a­nisms asso­ci­ated with this process. How do you pre­vent peo­ple from sim­ply redraw­ing on their home equity loan back up to their pre­vi­ous debt level? (for those under­wa­ter not an issue but what of every­one else?). How do you stop peo­ple from run­ning up their credit cards again? How do you con­trol such spend­ing? Can you?

    If the ‘Jubilee’ money is spent then it will indeed pro­vide some short to medium term relief for the US econ­omy but the national debt will have risen sev­eral tril­lion dol­lars in the mean­time. The ‘Jubilee’ idea seems pred­i­cated on the assump­tion that if we can fix this cur­rent depres­sion then every­thing will revert to a prop­erly func­tion­ing (per­haps new) eco­nomic model.

    The real issue in the US is well pay­ing full time jobs which are grad­u­ally dis­ap­pear­ing. Who is going to make the invest­ment in jobs in the US with all their asso­ci­ated expenses when you can employ sim­i­larly qual­i­fied peo­ple all over Asia at 10–20% of the cost?

    These US (& also Euro­pean) struc­tural issues may not in fact be ‘solv­able’…. they may sim­ply reflect the world in the 21st cen­tury. It is what it is. A world pop­u­la­tion head­ing to 9 bil­lion means more cheap labour, not less.

  2. @Mahaish “what a numero from one coun­try is worth more or less than a numero from another coun­try. then whats the point.”

    The point, is first, to deny pri­vate insti­tu­tions the right to print money ad lib.

    This makes it impos­si­ble for the banks to cre­ate a Ponzi econ­omy off their own bat. True the Cen­tral Bank could achieve the same result. But in that case I’d favor a return to medi­ae­val forms of pun­ish­ment for those who com­mit treason.

    Oh, and as you were too busy to note, it would also make money laun­der­ing, finan­cial fraud, coun­ter­feit­ing, tax eva­sion, the vend­ing of ille­gal drugs, the trad­ing in slaves, the pay­ment of ille­gal polit­i­cal cam­paign con­tri­bu­tions, pay­ments to out of office pols like Tony Blair for ser­vices ren­dered, and the financ­ing of ter­ror­ism essen­tially impos­si­ble since every unit of cur­rency would have a unique iden­ti­fier and its move­ment would be tracked at every instant.

  3. @Steve H:

    We don’t actu­ally need employment ”

    Absolutely wrong!

    With­out work, peo­ple lose self-respect and have no respect from oth­ers, which leads on the one hand to deca­dence, crim­i­nal­ity or men­tal ill­ness, and on the other hand to elite plans for the exter­mi­na­tion of use­less eaters.

    Dur­ing the inter-war years, gas cham­bers were the thing. George Bernard Shaw repeat­edly spoke in favor of them. Leonard Dar­win, Charles’s fourth son, indi­cated in pri­vate his sup­port for “lethal cham­bers”. And the idea was not just pop­u­lar with dic­ta­tors and cranks. Although May­nard Keynes may not be on record as favor­ing exter­mi­na­tion poli­cies, he was, for many years, pres­i­dent of the British Eugen­ics Asso­ci­a­tion. (See Richard Overy’s excel­lent book, “The Twi­light Years”).

    Hitler gave gas cham­bers a bad name, so now we have more sub­tle exter­mi­na­tion pro­grams based on the teach­ing of non-reproductive sex, demor­al­iza­tion of the com­mon peo­ple of Europe through multi-culturalism and polit­i­cal cor­rect­ness aimed squarely at the sup­pres­sion of work­ing class revolt, and mass immi­gra­tion of more vig­or­ous and eco­nom­i­cally com­pet­i­tive third worlders to the west, i.e., a pro­gram of geno­cide of the Euro­pean work­ing class.

    So yes, we need to cre­ate jobs and recover those that have been off-shored to boost the prof­its of inter­na­tional cor­po­ra­tions such as Wal­mart (The wealth of the Walton/Walmart fam­ily now exceeds that of the poor­est 42% of the Amer­ica Population!)

  4. Steve Hummel says:


    Well, you DID quote me out of con­text. My actual state­ment was “We don’t actu­ally need employ­ment AS MUCH to main­tain pro­duc­tion in a tech­no­log­i­cally mod­ern econ­omy, and that need is con­tin­u­ally less­en­ing at an accel­er­at­ing speed.”

    With­out work, peo­ple lose self-respect and have no respect from oth­ers, which leads on the one hand to deca­dence, crim­i­nal­ity or men­tal ill­ness, and on the other hand to elite plans for the exter­mi­na­tion of use­less eaters.”

    These are largely cul­tural biases actu­ally. Humans are capa­ble of find­ing pos­i­tive and con­struc­tive pur­pose other than work. That plus I have absolutely noth­ing against work per se, or profit for that mat­ter. I just think that they make poor pri­mary pur­poses and values.

    And so far as “elite plans for the exter­mi­na­tion of use­less eaters.”.…that results more from one eyed devo­tion to abstractions.…..and no actual con­tem­pla­tion or expe­ri­enc­ing of basic human pos­si­bil­i­ties like con­fi­dence, hope, love and a sense of grace.

  5. @ Steve H
    “Humans are capa­ble of find­ing pos­i­tive and con­struc­tive pur­pose other than work”

    Sure, if allowed to. But why do you think they will be allowed to?

    As far as the elite are con­cerned the masses are just a stink­ing heap of mag­gots to be dis­posed of as soon as con­ve­niently pos­si­ble. Hence the drive to destroy the nation state as a a racial, cul­tural or reli­gious entity, com­bined with pro­grams for global depopulation.

    Inci­den­tally, do you spend your days hap­pily prac­tic­ing your boomerang throw, or are you actu­ally quite busily employed try­ing to climb some lad­der of pro­fes­sional advance­ment while coun­sel­ing less work for others?

    Not try­ing to be rude, but the idea that folks should be glad to have lit­tle or no real work seems odd com­ing from an intel­li­gent per­son who has been mar­gin­al­ized by unemployment.

  6. Steve Hummel says:

    Sure, if allowed to. But why do you think they will be allowed to?”

    I never said the polit­i­cal chal­lenges nec­es­sary for chang­ing the sys­tems would be easy, but I HAVE advo­cated “hit­ting the street” with the appro­pri­ate indig­na­tion and a sane and prac­ti­cal pro­gram for like 5–6 years now which was prior to the GFC itself.

    I teach High School and own a jet ski and boat rental busi­ness, but my pas­sion has always been my other intel­lec­tual and psy­cho­log­i­cal pur­suits. For­tu­nately those are rel­a­tively cheap and can’t be taken away from me unless or until the inter­net goes down.

  7. Alfred Burdett says:


    I’m glad you are well employed. I think every­one deserves the same oppor­tu­nity. Yes, we might see a world in which all enjoy greater leisure, but for now, for the unem­ployed, the ques­tion is whether they have a reg­u­lar job or not, and many in the West do not and can­not so long as they are forced into direct com­pe­ti­tion with Asian wage slaves work­ing for pen­nies an hour. That is the prob­lem that needs to be addressed imme­di­ately, and which can only be suc­cess­fully resolved through the return of jobs that have been off-shored.

    But I am not hope­ful about that. We are no longer in a demo­c­ra­tic world where nice peo­ple care for one another, or where we can con­sider con­struct­ing a bet­ter more Utopian world. We are in a world of plu­to­cratic glob­al­ized feu­dal­ism in which the masses are deemed a blight on the planet and are mostly to be dis­posed of. That it seems to me has to be the start­ing point of any real­is­tic debate about what is to be done.

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