Tobin & the end of banking

I’m writing about this subject with some trepidation. Many economists who have entered the fray have made fools of themselves; and many who triumphantly point out their errors usually go on to make some of their own. Several years ago, Paul Krugman fell into the former trap, with this uncharacteristically confused blog. But virtually all of his critics introduce new errors – usually, that bank reserves don’t matter, or relatedly, that a central bank can’t control the money supply – it can, just not in the way of the crude multiplier.

Which of these two camps I will end up falling into remains to be seen. Either way, what’s more important is to introduce something novel. I don’t really have a ‘general theory’ of banks and money, just a series of observations which lead me to an unlikely synthesis of many competing positions.

Terminology. I should get this out of the way up front. I’m only going to designate base money (bank reserves & physical cash) as ‘money’. Tobin thinks this is a clear distinction, if somewhat old school – so be it. From the perspective of semantic efficiency, there is nothing to be gained from calling a deposit ‘money’, just call it a ‘deposit’.

Banks and central banks create deposits, but only central banks create money. And money is very different to deposits. You can’t default on money. So money is not a liability. Bank reserves are the electronic equivalent of physical cash.

Central banks create deposits in the banking system and reserves when they buy assets. Banks create deposits when they make loans.

Deposits can be a ‘means of payment’, when they are held as on-demand loans we make to banks, and when banks have the liquidity to honour the loans. Deposits with longer maturities are term loans like any other.

Are banks unique? Yes, because they can create purchasing power at will. This is at the core of the dispute between Steve Keen and Krugman, which I will summarise, and try to clarify:

Sometimes leverage increases spending on goods and services (usually called ‘aggregate demand’), sometimes it doesn’t. For example, I could go straight to my bank now and take out a £10,000 loan, which gets credited to my bank account as an increase in deposits.

Let’s say I am purely motivated by proving a point. If I choose to spend that money on something I was not otherwise going to purchase, aggregate demand rises, if I choose to hold the deposit because I want to keep my options open, nothing happens to aggregate demand.

Only banks can create deposits like that. But Krugman also has a point, in one sense: let’s say I decide to ‘spend the money’ in one year’s time – then, in a year’s time there is an increase in demand without any change in leverage. So preferences are important, and leverage needs to be interpreted.

Banks, bubbles, and Minsky. James Tobin was clearly troubled by the following observation: when banks make new loans, they create new deposits (ignore the situation where the loan is immediately withdrawn as cash). We all agree on this. So deposit growth will occur if credit conditions are eased. Now this does not have to be caused by a decline in interest rates, it could be caused by a change in banks’ willingness to lend, or regulatory standards, or an increase in demand for loans. What troubled Tobin was the fact that a very large increase in deposits appears to occur without any increase in demand for deposits, but simply because of loans growth.

This does not fit with a view of households and firms holding portfolios of assets consistent with a set of preferences. It appears to be the case that deregulation of a mortgage market, for example, will trigger an increase in holdings of deposits. In fact this very phenomena was observed by the Bank of England during the housing boom.

Tobin tries to make peace with himself using the following line of reasoning: if there are ‘too many’ deposits relative to what people want, the yield on other assets will fall, and the returns to banks will decline – he doesn’t really detail precisely how, but the implication is that demand for bank loans will be substituted with alternative, now cheaper, forms of competing finance. Also, in the standard view of demand for deposits, lower interest rates increase demand – so falling yields on competing assets make deposits relatively more attractive. That at least is the theory behind some kind of equilibrium result of portfolio rebalancing – all in response to an increase in lending. It’s a shame Tobin didn’t detail the stages in this line of thinking. It leads to very interesting conclusions.

Let’s try and think about how this process might actually occur – it is a variant of the conventional view that Nick Rowe outlines, that the ‘demand for money’ is a function of the interest rate. This debate would also benefit from calling deposits ‘deposits’ and base money ‘money’, and specifying which interest-bearing assets we are talking about – because the apparently simple rebalancing of portfolios may not be so simple.

Consider the situation in the mid-2000s when young families in the UK were purchasing houses using large amounts of debt from much older home owners who had significant equity in their homes. In principle this did not need to affect aggregate demand – there’s a change of ownership of the housing stock, and the older generation transform their home equity into (at least initially) a bank deposit.

Now in Tobin’s ‘equilibrium’ framework this sudden increase of deposits in the share of wealth should result in some shift in portfolios which undermines the profitability of banks and self-regulates the system. This is totally unconvincing. First of all, let’s think about individuals’ portfolio preferences. Behavioural finance has a well established concept called the ‘endowment effect’. It’s another way of saying, people don’t have portfolio ‘preferences’, they simply hold whatever assets they ‘inherit’. If sellers of houses receive deposits in exchange for home equity, they hold … deposits.

The supply of deposits is starting to create its own demand. And it’s very easy to see where Keen/Minsky comes in (and Bernanke/Gertler, and Soros). The supply of housing has long lags. So an easing of credit conditions often causes house prices to appreciate rapidly. This has multiple self-reinforcing effects: rising prices drive up collateral values, which results in even easier credit conditions; this releases more equity than people thought they had; and because virtually no one buying a house knows how to ‘value’ it, people use adaptive expectations which creates speculative demand for property, which drives prices up further. None of this necessarily causes bank profits to fall, or results in a substitution of the role of equity or other assets in finance. No: it causes bubbles, rapid growth in deposits, and then busts – with highly unpredictable effects on the yields of other assets – and banks are at the heart of the process.

Matters are made even worse if banks respond to declining returns on assets by increasing their leverage – a perceptive observation which dates back to Hayek.

So I hate to be so reasonable, but Tobin, Keen (Minsky), and Krugman are all in some sense right – Keen a lot more so than Tobin and Krugman.

CBs can control deposit growth with bank reserves. Let me now address this uncontroversial topic. Most of the time the central bank sets interest rates – the price at which banks can borrow reserves – and allows the financial system determine the rate of growth in deposits (Scott Fullwiler has a superb blog on this). This is not determined solely by banks – although, subject to regulation, they determine the supply of credit – but also by borrowers. In this sense, the phrase ‘banks create money (deposits!)’ could just as easily be ‘borrowers create deposits’.

Now there is an asymmetry in the role of central banks in the growth of deposits. Anyone who has witnessed a currency board in operation or, I suspect, anyone who worked closely with Volcker at the Fed, will know that it is very easy for a central bank to cause a collapse in deposit growth: aggressively shrink the stock or availability of reserves. Some will say, well that’s just raising the target interest rate. True. Which illustrates clearly that targeting interest rates or targeting reserves are two sides of the same coin. A central bank can either say, I’ll supply X quantity of reserves, and to hell with interest rates (in a strict currency board the supply of reserves is delegated by the CB to the balance of payments), or the central bank can target a rate of interest and supply reserves on demand – the situation Scott Fullwiler describes. Choosing to do the latter definitively does not mean that altering the supply of reserves has no effect.

There is an asymmetry because the central bank cannot engage in the opposite exercise. This is where a lot of weak analysis preceded QE – and I included Cochrane’s bizarre view that only the IOR averted hyperinflation! If banks don’t want to lend, or more relevantly, the private sector does not want to borrow, supplying all the reserves in the world will not create endogenous deposit growth. The only way the CB can create deposit growth in this situation is to buy assets (as with QE), which increases reserves and new deposits in equal measure, or to do helicopter drops. If this is done on large enough scale, the central bank could engineer whatever rate of deposit growth it wants.

The future of banking. Should we have 100% reserve backing of banks? Here’s my problem with this: We already do. Let me explain: deposit guarantees are worth nothing unless they are backed by the central bank’s ability to create reserves. So deposit insurance amounts to saying that the central bank will provide reserves on demand if needed to cover insured deposits (this, of course, does not preclude the likelihood that the government would bond-finance any claim).[1]

Now in the UK during the financial crisis, the government pretty much said ‘no depositor will lose any money’. In other words, the government provides a 100% guarantee of deposits when there is a systemic risk. Well, that means that in a panic, the central bank has created reserves and contingent reserves equal to 100% of deposits. Of course, this is only true if there is systemic risk, so it’s a contingent backing.

A curious question is why does anyone’s hold deposits with banks in excess of those covered by deposit insurance. All it takes to get a 100% guarantee is to open an online broker account and put anything in excess of the insured level into T-bills. Perhaps we should tax anyone who doesn’t – for laziness.

The more interesting issue is will genuine technology-driven disintermediation kill off the banking sector. To address this we need to consider why banks exist. This fundamental question is often obscured. Tobin for example simply states, “Financial intermediaries typically assume liabilities of smaller default risk and greater predictability of value than their assets.” He goes on to say how they do this: through administrative efficiency, pooling of risk, and regulation – including capital ratios and deposit insurance.

This is weak analysis. The two fundamental issues that banks address are a) a coordination problem, and b) payment and settlement. On one side of the coordination problem are agents with excess financial capital, differentiated along three axes: amount, risk and maturity. On the other side are those in need of financial capital, again differentiated by size, risk and maturity. Separate to this is the payment function.

Now banking is in fact a highly cumbersome and inefficient way of addressing the coordination problem. Individuals should be free to choose how to save along each axis, and so should those in need of capital. Instead of matching the discreet needs of both sides, banks offer savings deposits or demand deposits at zero credit risk (if govt guaranteed), to those with excess liquidity – and on the other side of their balance sheets offer loans which are differentiated by size, maturity and risk, which the banks try to price accordingly. The bank takes all the risk associated with this mismatch, and is therefore forced to maintain expensive buffers, of capital and liquidity. Both sides of the intermediation are losing to bank profits. It is highly likely that people hold inefficiently high amounts of savings as deposits, and similarly the cost of capital to many borrowers is too high.

Intriguingly, technology and securitisation have solved this coordination problem. Today, an individual can choose to have any percentage of their financial assets in anything from T-bills, to long duration government bonds, to equities, to corporate bonds, to online loans. Securitisation means an individual can choose any combination of size, maturity and risk – in a diversified portfolio. Other than a minimal level of deposits to meet payments, it is hard to see why anyone should hold them.

The oddity is the shortage of one-stop shop providers. If individuals want 100% ‘deposit’ insurance for large deposits, why don’t they just open an account with an online broker and invest in T-bills? Would it take much for a broker to issue credit cards? Some already do.

Lending is also being dis-intermediated by online exchanges. Individuals can lend to diversified portfolios of borrowers directly. And banks do not appear to have more efficient pricing – quite the reverse. If it can happen with receivables, SME loans, credit card debt, why not mortgages?

So, banks are unique. They have played a central role in previous booms and busts. But there are early signs that their days may be numbered. Does that mean no more crises? I doubt it. It probably means that future crises will be very different.

[1]I have ammended this paragraph following a very useful twitter exchange with Frances Coppola. In summary, a confusing semantic issue arises with insured deposits. I am saying  that insured deposits are contingent claims on reserves. But “backing” deposits with reserves, does not, in my view, mean deposits = reserves. In fact, it starkly reveals their different properties.

About The Author

Eric Lonergan is a macro hedge fund manager, economist, and writer. His most recent book is Supercharge Me, co-authored with Corinne Sawers. He is also author of the international bestseller, Angrynomics, co-written with Mark Blyth, and published by Agenda. It was listed on the Financial Times must reads for Summer 2020. Prior to Angrynomics, he has written Money (2nd ed) published by Routledge. He has written for Foreign AffairsThe Financial Times, and The Economist. He also advises governments and policymakers. He first advocated expanding the tools of central banks to including cash transfers to households in the Financial Times in 2002. In December 2008, he advocated the policy as the most efficient way out of recession post-financial crisis, contributing to a growing debate over the need for ‘helicopter money’.

21 Responses

  1. Peter Golovatscheff

    Thanks for a thought-provoking post once again, Eric!

    I think you managed to avoid the most obvious traps. I don’t have any clear errors to point at, but I’d like you to clarify one thing. You say:

    “On one side of the coordination problem are agents with excess financial capital, differentiated along three axes: amount, risk and maturity. On the other side are those in need of financial capital, again differentiated by size, risk and maturity.”

    Let’s say you have a credit line (overdraft) with a bank, connected to a deposit account with zero balance. You use your credit line to buy a car from me, we finalize the transaction, and I end up holding a ‘deposit’. Would you say that I had excess financial capital? (I’d say I had a car and wanted to sell it, and now that I sold it, I still might not have “excess financial capital”.) Were you in need of financial capital? (Well, you were in need of a car. Based on how I’d define “financial capital”, you possessed financial capital in form of a credit line with the bank to start with.)

    I hope you see that my point is not really about terminology. There is a deeper issue behind it. It is somewhat related to what you say earlier in the post: “Bank reserves are the electronic equivalent of physical cash.” Could we try to turn this around and see if it still makes sense? Cash is the physical equivalent of (or, more accurately, refers to) bank reserves. And bank reserves are essentially credit balances in the books of the central bank. In other words: Cash refers to a credit balance (bookkeeping). What is a credit balance? It is a record which states that something is owed to the ‘holder’ of this credit balance. It is the opposite of a ‘debit balance’, and together these balances are records of a credit/debt relationship.

    I’m not sure if I can convince you that what I say above makes sense, until I get you to consider the possibility that what is owed is not ‘money’, but is only denominated in monetary terms — i.e. only the price of what is owed is explicitly stated, ex ante. What it is that is owed is decided on the market, between creditors and debtors acting as buyers and sellers, respectively. Thus, what it is that was owed, is known only ex post.

    Well, I guess I ask for too many “leaps of faith” here. But consider it? I’m more than happy to elaborate. I’m building my understanding of the economy on these premises, and so far it seems to make a lot of sense, at least to me.

    • Eric Lonergan

      Hi Peter, I don’t get your point. Can you provide an example without using overdrafts to illustrate. Introducing an overdraft is a big like introducing contingent claims, it raises the level of analytical complexity!

      • Peter Golovatscheff

        I see. The funny thing is that thinking in terms of overdrafts (instead of more traditional bank loans) actually simplifies things when using the viewpoint I’m suggesting (‘deposits’ are not created when a loan is granted but only when a purchase is made). Perhaps Keynes * could help to explain my thinking around overdrafts.

        But we don’t need to make that jump now. You can very well think in terms of a more traditional loan, in which case I would have written: “You use the deposit just created to buy a car from me, we finalize the transaction, and I end up holding a ‘deposit’.”

        * Keynes in A Treatise on Money, Bk 1, Ch 3, 8ii(i.) “Deposits and Overdrafts”: “… it is the total of the cash-deposits and the unused overdraft facilities outstanding which together make up the total of Cash Facilities. Properly speaking, unused overdraft facilities – since they represent a liability of the bank – ought, in the same way as acceptances, to appear on both sides of the account. But at present this is not so, with the result that there exists in unused overdraft facilities a form of Bank-Money of growing importance, of which we have no statistical record whatever, whether as regards the absolute aggregate amount of it or as regards the fluctuations in this amount from time to time.
        Thus the Cash Facilities, which are truly cash for the purposes of the Theory of the Value of Money, by no means correspond to the Bank Deposits which are published.”

      • Eric Lonergan

        Hi Peter, I think I agree with a lot of that. I too like the example of overdrafts. In fact I think people often underestimate the significance of bank reserves because when a CB is targeting the level of interest rates, it is committing to provide reserveson demand at that price, and because it does no bank actually needs to hold reserves. But it is a huge mistake to deduce that reserves don’t matter.

        Re your previous comment, I don’t know what “bank reserves are essentially credit balances” means. I have noticed in this discussion that when people redescribed a term with the prefix “essentially” or something similar, they actually mean it is not the case – viz Frances Coppola describing hyperinflation as “basically” default, or distinguishing between hyperinflation and “actual default”. “Hyperinflation” describes a specific phenomenon, as does “default” and they are not the same! Bank reserves are not “essentially” credit balances. A credit implies someone owes some else something. The CB owes the holder of base money nothing. Also, the value of base money resides from a very different set of conditions than the value of a “credit”.

        I can define credit/liability/debt/obligation very clearly, and bank reserves and physical cash do not fit the definition. To make any progress on this, I think you have to provide a very clear description of what a “credit/liability/debt/obligation” is, and then what “base money” is, and then let’s see if we are designating the same thing. Anything else is obfuscation!

  2. Peter Golovatscheff

    Eric, I think we can get forward based on your reply. Let’s see! (There is some ‘incommensurability’ involved here… Btw, I probably picked “essence” from Schumpeter who loved to use it.)

    Regarding bank reserves and currency in circulation (together, ‘base money/monetary base’). Your viewpoint, as I interpret it, is this: These are “money” or “money-things”, and any credit balances in the monetary system refer to these. The viewpoint I suggest is this: Let’s have a look at the central bank ledger. There are credit balances which correspond with this base money. Could we view all base money as a credit balance in this ledger? This would allow us to adopt a pure “bookkeeping view” of the system. We don’t have any need to define “money”, and instead of “money”, even “base money”, we can talk about credit balances. It matters a great deal in what kind of ledger (central bank, commercial bank, a merchant, etc) credit balances are recorded, but they are all credit balances nevertheless.

    This is, of course, a somewhat radical viewpoint, because it can (correctly) be interpreted as denying the existence of a thing called “money” (the medium-of-exchange and store-of-value parts of it). This makes it difficult to adopt the viewpoint. “Think it possible that money might not exist”, you can hear me asking. Perhaps it is too much to ask? (I contacted you because you seem to be a smart and open-minded guy philosophizing about “money” — not because I want to show you are wrong.)

    You write: “The CB owes the holder of base money nothing.” I agree with you. But what does a commercial bank owe a holder of a deposit (a credit balance with the bank)? (Schumpeter, among others, has entertained the thought that a commercial bank doesn’t really owe anything to its depositors.) You, and almost everyone around us, seem to say that the bank owes the depositor a credit balance with the central bank (base money). But this answer leads us to a “closed circuit”, the possibility of which can be illustrated with various thought experiments. Here’s one: Let’s say you go to your bank’s branch office and try to withdraw £20,000. They say “Eric, come back tomorrow and you’ll get the cash. Right now we don’t have that kind of sum.” Technicalities aside, it could be that your bank then uses its overdraft with the central bank (I’m not sure if this is possible in the UK) and the central bank creates a new credit balance in its ledger (that’s the “cash” you end up holding tomorrow) which it will match with a new debit balance (your bank’s debt to the central bank). The outcome: You held a credit balance with your bank. (Who held the corresponding debit balance? Not the bank but its debtors.) Now you hold a credit balance with the central bank. (Who holds the corresponding debit balance? The central bank’s debtors, with your bank among them.)

    We could also entertain the (real) possibility of establishing a “super central bank”, so that the current holders of cash and bank reserves would be allowed to go to the normal central bank and ask it to give them credit balances at the “super central bank” instead. These balances we would call “super base money” (naturally strictly electronic; no “super cash”, to make Ken Rogoff and Andy Haldane happier). Would that make the normal central bank owe us something?

    What am I getting at? I try to argue for a viewpoint where our current (not imaginary) monetary system exists strictly for bookkeeping purposes. No “money” is created or destroyed. Credit and debit balances are created and destroyed — credit and debit entries made — as part of trade; buying and selling. The amount of total credit balances in the economy goes (momentarily) up when a new debt is incurred and (momentarily) down when debt is repaid. These credit balances are not “purchasing power”, but arise from purchasing power (i.e. ability to debit) being used. The system is fairly simple, and there’s no mysticism connected with making credit and debit entries, unlike there is with “creating money”.

    I’m not asking you to take all this at face value — no one should –, but my hope is that I could be able to offer you some interesting insights. I’ve been building my understanding of the economy by looking at it through this “lense” for some time now. It seems to offer us solutions to many prevailing problems in economics. One of those, of course, is the missing definition of “money”; the fact that gave rise to your post and millions of pages by others.

    (On hyperinflation… I believe this is a case of you using a more narrow definition of ‘default’ than Frances, and that’s all there is to it. To me, hyperinflation is definitely a default, but on an implicit promise: I view this as the society’s promise to its individual members. You, on the other hand, talk about a default on an explicit promise. From an individual’s viewpoint, the loss is pretty much identical in both cases. Why Frances wants to make this point might have to do with the fact that the central bank, acting in agreement with other authorities, can help us avoid defaults on those explicit promises indefinitely — by guaranteeing all deposits — but not without risking a default on the implicit promises on a later stage.)

  3. Peter Golovatscheff

    Think about the “super central bank” in my thought experiment above. Suddenly, after its establishment, all other credit balances (previous “base money”/HPM/whatnot included) seem to refer to its “super reserves” (credit balances). The “money pyramid” has got a new top. If you don’t trust Mark Carney, just take your deposit to the Super CB. That’s what the new (Labour?) government did — it started banking with Super CB. Bank of England, The Old Lady of Threadneedle Street, had for instance this baggage of physical currency, which seemed to be outdated like the bank itself. Gold in vaults, and all that stuff. Too conservative.

    • Eric Lonergan

      Hi Peter,

      There is a very important methodological issue, which I think is a stumbling block. If I want to, I can describe “hyperinflation” as a “default”. But the point of any sound analysis is, in part, to accurately identify different phenomena – and not to conflate different things. That is partly why clear definitions help. Definitions are an attempt to denote discrete things. For example: (A) Hyperinflation = rapidly rising aggregate prices; (B) default = missing a payment of interest or principal on a debt. Rapidly rising aggregate prices ≠ missing a payment on a debt. I am afraid that (A) ≠ (B) is not a subject that can even be debated, it is a logical fact: there are two distinct phenomena which can be identified, which are not the same. Of course there is scope for clarification. For example, “Are rapidly rising prices a breach of a promise or commitment?” That depends: was a promise made, is a “promise” or “commitment” along these lines the same phenomena as a “debt”? Clearly, not if we define a “debt” as “a financial obligation with commitments to repay principal and/or interest”. If we define “debt” much more broadly as “any phenomena that entails a commitment” then there are circumstances where hyperinflation could be a breach of a commitment, clearly – and so too would failing to meet a commitment to carbon emissions. The ledger of “debts” is extraordinarily broad, and entails all (public) commitments. We need to be clear what we are analysing.

      I have noticed that many people in the area of monetary economics do not define, “debt” “credit” “default” “money” – and this may explain a lot. By failing to explicitly define these terms there is huge scope for conflating distinct phenomena. “Money = debt” is a very clear example of this, I believe.

      So, in order to proceed, can you give me a very precise definition of “bank reserves” and “physical cash” (we can drop “base money”). Then can you give me a strict definition of what you mean by a “credit balance”. Let’s check we are referring to the same things. Once we agree on what these phenomena actually are we can decide if they are the same or different. Perhaps this will help.

      • Peter Golovatscheff

        Thanks, Eric!

        I think you ask relevant questions regarding hyperinflation, and you state your argument in a clear way. It is in no way a default in any strict sense of the word. So I don’t see a need to discuss that further.

        The definitions you’re after:

        A “credit balance” is a record in a ledger (bookkeeping), and it records a debt (owed) to the owner of this balance. The existence of a credit balance implies — following the rules of bookkeeping — the existence of a debit balance somewhere in the system. We can define “debit balance” as a record of a debt which the owner of the balance has incurred.

        Both “bank reserves” and “physical cash”, or “currency”, refer to a credit balance in a central bank ledger. When studying the CB balance sheet, we find there credit balances under titles like “Currency in circulation” and “Reserve balances”. The difference between these two is that “physical cash” is a “bearer credit balance”, whereas the owners of “bank reserves” are duly recorded in the CB ledger.

        How does this sound?

      • Eric Lonergan

        Peter – I think those definitions clarify matters. The holder of a ‘credit balance’ is ‘owed’ money, the holder of a ‘debit balance’ owes money. ‘Money’ is either physical cash or bank reserves. The holder of cash is owed nothing – cash need not show in any ‘ledger’, likewise, the creator of bank reserves & cash owes nothing, because bank reserves are only transfered, never redeemed.

  4. Peter Golovatscheff


    Now we are getting close to the bottom of the matter. You naturally think that what these credit balances refer to, i.e. what is owed, is “money” (ultimately “cash”). I used to think so, too. But the (novel) view I’ve now adopted challenges this. According to the “bookkeeping view”, these credit balances are (only) denominated in an abstract unit of account (e.g, USD). In other words, they refer to a price. (For an overview of the “abstract unit of account” concept, see, for instance, .)

    A price of what? A price of whatever is bought and sold. It might go like this: A creditor (owner of a credit balance) goes on the market, looking for goods or services, and chances upon a debtor (owner of a debit balance). The debtor is selling and the creditor is buying. (Of course, it is likely that they don’t know each other’s balance, nor should they know.) Assuming the creditor is interested in buying what the debtor is selling, they agree on a price. A transaction is made. And it is this transaction that is recorded in our monetary bookkeeping system. By selling, the debtor has redeemed (part of) his debt (to the amount of the agreed price), and that will be reflected in his reduced debit balance in the bank ledger (let us assume we are dealing through a bank; and you might want to think of the debt in terms of overdrafts, because it gives a more accurate picture of this reality). Similarly, the creditor’s credit balance is reduced. Now — only ex post — we know what was it that was owed. It was the object of the transaction, often a good or a service. And only ex post can we establish a direct link between a single creditor and a single debtor, brought together most likely by the “invisible hand” (or, market forces).

    Think of this as an alternative way to view the world. You cannot prove the view wrong by just positing that money-as-a-thing exists. But you might be able to prove it wrong by proving the point you make above: “cash need not show in any ‘ledger’”. What do you mean by this?

    • Peter Golovatscheff

      In case you look at Buiter’s paper, I’ll better clarify: It doesn’t correspond with the “bookkeeping view”. Buiter still thinks that currencies like USD and GBP are “money” which serves as a “means of payment”, in addition to their function as numéraire (abstract unit of account). My position is that USD and GBP are only abstract units of account that are used to express the nominal value of a credit balance. These credit balances refer to prices denominated in USD or GBP.

    • Eric Lonergan

      The key point for me, Peter, is that the issuer of cash and/or reserves owes nothing. It is true that other ‘debitors’ could settle their debts with goods other than money, but they still owe creditors something.

      Yes, many cash transactions appear in no ledgers. Think of a bunch of poker players using cash to place bets … They can either settle every round, or someone can keep score and settle the difference at the end. That’s pretty much how payment in the economy works: in banking, banks keep score and settle the net position using reserves; the cash economy operates with no ledger and payment and settlement occurs when cash is handed over.

      • Peter Golovatscheff


        As I said, a commercial bank doesn’t owe its depositors anything more than a CB does. I have tried to prove this point, but I don’t think you are able to think it possible (for you, “money” exists — period), and thus my point escapes you. I can only ask you to consider the possibility that my view is novel, and so you need to come up with some fairly novel ideas, too, if you are willing to prove my view wrong.

        I also have said that in the case of “physical cash”, the changes in the ownership of this credit balance (a balance which is recorded in the ledger) are not recorded in any ledger. “Currency in circulation” is a bearer credit balance. The whole point of this kind of credit balance is that the ownership changes by physical hand-over which is an impossible transaction to track for a “central bookkeeper”. But the ownership does change whether it is recorded or not, and the balance itself exists in the CB ledger as long as a corresponding debit balance exists.

        Again, my whole point is that “money” is not a “means of payment” and cannot be used to settle debts — no matter how we are used to view it. It can only be used to rearrange debt relations. When these are arranged through central bookkeepers like banks (including the CB), the debt relationship is always between and individual and more or less the society as whole. A creditor through a bank can choose among all kinds of debtors, and a debtor through a bank can choose among all kinds creditors. Any direct link between a single debtor and a single creditor can usually be established only ex post, after these two have transacted.

        You might want to check if you get something more out of my earlier comments after all this back-and-forth?

      • Eric Lonergan

        Peter – I think it is incorrect to say that ‘a commercial bank does not owe its depositors anything more that a CB does’, because a commercial bank can default on a deposit, but a CB cannot default on cash, or reserves. That is the whole point I am making. A deposit is a loan made to banks. Physical cash is not a loan made to CBs, and nor are bank reserves. That is beyond dispute, and is a distinguishing characteristic of a physical cash and reserves compared to deposits.

        One question: let’s imagine that 10% of the physical cash is in fact counterfeit, but so perfectly counterfeited that it is indistinguishable from that produced by the CB. It is therefore cash which is not registered as a liability of the CB, because the CB does not even know it exists, but it is being used in the economy. Is this counterfeited cash a debt? And if so, whose debt is it?

      • Eric Lonergan

        A final point, Peter. Have you looked at currency boards? They make it very clear that all deposits in the banking system are claims on reserves – because if there is constant capital outflow, base money shrinks and the banking system collapses.

      • Peter Golovatscheff

        You write: “It is true that other ‘debitors’ could settle their debts with goods other than money, but they still owe creditors something.”

        Where we disagree is this: “goods other than money”. I’m trying to explain how payments cannot be made in “money”, how the monetary system is there to track debts, including the repayments (which are made by selling something; “in kind”) of these debts. I explain — not just posit, but explain — how “money” is not a good. I also explain how “money” is a credit balance, and thus directly related to debt — instead of just positing that “money=debt”.

  5. Peter Golovatscheff


    Nothing in science should be beyond dispute, and especially not in economics. What makes one say that something is beyond dispute is the view one has adopted; a view which relies on this something not being disputed. That’s why I’ve been trying to tell you that mine is a wholly different view.

    You write: “a commercial bank can default on a deposit… A deposit is a loan made to banks. Physical cash is not a loan made to CBs, and nor are bank reserves.”

    You are surely aware of the controversiality connected to “making a loan” when it comes to deposits. If my credit balance at the bank is increased when I sell something, did I make a loan to the bank, or did I receive a payment? As far as I know, your answer is that both are correct. I made a loan and I received a payment. My answer is: I neither made a loan to the bank nor did I receive a payment. Instead, it was recorded in our “social bookkeeping system” (Schumpeter’s term) that I am owed more than I was owed before. Again, owed something the price of which is expressed in an abstract unit of account (eg, USD), but without ex ante knowledge of what it is that is owed (this leaves me with almost infinite amount of options when it comes to, effectively, “choosing” what is owed).

    We have established certain rules that govern our financial system. One of them is that you can demand a commercial bank to exchange your credit balance in the bank’s ledger to a credit balance in another bank’s ledger. And this another bank can be the central bank. This kind of rule (which is based on convention, and which I don’t question as such) makes it look like the bank owes the depositor “money”, a word we in the modern world have got used to associate with a credit balance in the CB ledger (“banknote” could be defined as “portable evidence of an anonymous credit balance in a bank’s ledger). But as I said, all this exchange of credit balances is about rearranging existing credit/debt relationships. (I should point out that is a macro perspective.) Any final repayment of debt takes place when a debtor makes a sale. In conventional language: When the “money” arrives on debtor’s deposit account, his debt is already paid. He can incur new debt by spending this “money”, or he can close what effectively is his agreed credit line (overdraft) with the bank, in which case the bank will debit his deposit account and credit his “loan account” (these entries are not necessary in the case of actual overdraft). (You might see how I basically reconcile overdraft and a “traditional loan” here.)

    When it comes to counterfeits, it might be good to look at the Operation Bernhard: . Of course there is no real liability connected to these counterfeits. And that’s the reason why your enemy is willing to flood your economy with this kind of “money”. Not to help you, but to disturb the system. There is no debit balance anywhere in the system corresponding to these fake “credit balances”. The laws of accounting are broken, and it will have unpredictable but most likely negative consequences for the economy. The public’s trust in “currency” is trust in the existence of real debit balances (recording real liabilities) that correspond with the credit balances held by the public.

      • Peter Golovatscheff

        You are talking about the use of “chips” or “tokens”? Tokens in the hands of the “casino” are close to worthless pieces of some usually cheap material. These tokens (banknotes can be seen as tokens, too) acquire a new role when we link them directly — even if just orally/mentally, by common consent — to a credit balance. In a poker game, the idea is that the players buy (whether their accounts are debited in some common physical ledger or not) a certain amount of chips in the start of the game. In this way the chips acquire a price (often denominated in a common unit of account). Hand-over of chips between players will affect both the “loser’s” and the “winner’s” net balance, whether these individual balances are recorded in any physical ledger or not (hopefully the latter, because tokens remove the need to make this kind of account entries).

        The technicalities connected to any ‘settlement’ of final direct debts depends on whether we are at a casino or just playing with friends in a private home. I say “direct debts” because very often the ‘settlement’ ( ≠ payment) only introduces an intermediary (eg, a bank) and doesn’t mean that the debtor, “on the spot”, pays his debt or that the creditor receives a payment. (I probably use language — e.g, ‘payment’, ‘settlement’ — differently from what you are used to, but I hope you see how I try to justify my choices.)

      • Peter Golovatscheff

        Oh, I know this sounds complicated. I’m not suggesting that people should think like this when conducting their business, on an individual/microeconomic level. I’m trying to adopt a macroeconomic viewpoint. In other words, I’m not describing how things appear to individuals, but how they appear to the “great planner”.

        I believe there lies a “fallacy of composition” in the way we usually think about “money” in macroeconomics.

      • Peter Golovatscheff

        Notice, too, that what is true regarding “chips in the hands of the casino”, is also true regarding “central bank notes in the hands of the central bank”. They, so to speak, adopt their intrinsic value, which is usually close to zero both in real and nominal terms, until they (again) enter our “economic game” and adopt a “bookkeeping role”.

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