[H] Deductive Theory of Modern Money (2) — Monetary Circuit Theory and the Ponzi-like Structure of Modern Money

This series on the "Deductive Theory of Modern Money" has been rewritten to be more compact as a definitive edition on my site below. Please feel free to view it there. This article corresponds to the second section of the linked article.

This article is a continuation of the following article.

1. Irving Fisher's 100% Money

Now, let's start this time from this diagram at the end of the previous one.

To review the previous article, 1 million yen in Bank of Japan (BOJ) current account deposits was created through lending from the BOJ to a private bank, and 5 million yen in bank deposits was created through lending from the private bank to a private company.

The private company is trying to build a house by hiring someone from the household sector for 1 million yen. To do this, it withdrew 1 million yen in cash from its deposits. However, this pushed the bank into a state where it would default if even one more yen were withdrawn.

What should be done? There are two directions.One is for the private bank to increase its borrowing from the BOJ to increase its BOJ current account deposits—from the BOJ's perspective, for the BOJ to supply BOJ current account deposits to the private bank. And the other is to reduce the private bank's lending to the private company.

Let's take the latter path this time.This is because if the private company only intends to use 1 million yen, it is not rational to have borrowed 5 million yen. Although we are not considering it in this series, in reality, there is interest, and borrowing money that one does not even use only needlessly increases interest costs.

For that reason, let's have the private company repay 4 million yen of its excess bank deposits.As a result, the private company's deposits (assets) and loan liabilities, and the private bank's loan assets and deposits (liabilities), all disappear by 4 million yen.

As is often said in the context of credit money theory, bank lending is the creation of money, and conversely, repayment to a bank is the destruction of money.The money stock, as the total amount of money held by the private sector (excluding financial institutions), decreased at once from 5 million yen to 1 million yen due to this repayment.

On the other hand, private sector debt has decreased as well. We should recall that in bank-style currency issuance, money is born with debt as its flip side, and net assets always remain zero.

Also, at this time, the private bank holds only 1 million yen in bank deposits against the original 1 million yen in BOJ current account deposits. This is what is known as the 100% reserve, 100% money state of Irving Fisher, whose paper I translated in the following article.

In the current diagram, since 1 million yen has been withdrawn as cash, the BOJ current account deposit is also zero, but if, for example, 250,000 yen of this cash were returned as a deposit, by depositing it with the BOJ, the BOJ current account deposit would also become 250,000 yen; in this way, the private bank always has BOJ current account deposits prepared in the same amount as its own bank deposits as liabilities.

In this 100% money state, the bank will not fall into a state of default (in transactions with other banks or private entities).This is because reserves are secured to handle all withdrawals and interbank settlements.

Conversely, the possibility of default remains only if the BOJ demands repayment. If some of the customer's 1 million yen in bank deposits is withdrawn as cash, reserves decrease by that amount, and if the BOJ demands repayment of 1 million yen at that time, the bank cannot pay it back.

Of course, the BOJ would have no motive to do such a thing. There is no point in the BOJ, which supports the financial system as the "lender of last resort," performing unreasonable collection, bankrupting banks, and destroying the financial system.

2. People work, things are made, and net assets increase

Now, returning to the topic, let's do what we originally wanted to do here. The private company hires someone from the household sector for 1 million yen to build a house.What happens when this is done?

First, the cash held by private companies is passed to households as wages, and in exchange, the private companies receive the house in inventory. Since it cost 1 million yen to build, its value can be considered 1 million yen for the time being.

The point is that, in this way, it is only by conducting business activities and producing something that the net assets of this world have increased by 1 million yen The asset known as cash has not decreased, as it has merely moved, and in addition, a real asset in the form of the house in inventory has been created.

Now, regarding this house in inventory, the only entity that can buy it is the household that worked earlier. This is because that is the only place where money exists right now, and fundamentally, there are no other entities in this world. For this reason, let us sell this house to the household.

This time, the household's cash is passed to the company, and the house in inventory becomes the household's asset.

3. Money reunites with its counterpart debt and returns to nothingness

In this way, the private company has finished one cycle of business: taking out a loan, using that money to produce goods, and selling them. Therefore, let us repay the debt. First, return the cash to the bank account. The private company receives bank deposits instead of cash, and the bank receives cash assets and liabilities in the form of deposits.

The bank returns that cash to the Bank of Japan current account.

When cash returns to the Bank of Japan, it does not become an asset of the Bank of Japan. Instead, its name changes to Bank of Japan current account deposit, and the cash is removed from the balance sheet. The cash is likely placed in a vault, but it is not recognized on the balance sheet and does not function as money.

And, as described in the previous article regarding the scene of cash emergence, when cash is withdrawn (again), it comes out into the world in place of the Bank of Japan current account deposit.

Now, after performing the above transactions, the private company repays the debt with bank deposits and the following occurs.

The same thing happens as in the previous repayment of 4 million yen; this time, the private company's deposits and debts, and the private bank's claims and deposits, all disappear.

Here, if the private bank has no plans for further lending, it may as well repay its debt to the Bank of Japan. The result is as follows.

Money and debt all disappeared, and only the real asset—the house—remained as the result of money moving and people working.

Money created through bank-style currency issuance is born from the division of zero into plus (money) and minus (debt). As it moves, people's labor is organized, and real assets that produce actual benefits are created. Once that happens, money finishes its role, meets its counterpart debt, and they cancel each other out and vanish.

This is the view of money in monetary circuit theory, which sees the essence of money as transferable IOUs, credit theory of money, the endogenous money theory which posits that money is actually supplied through lending by private banks, or the view often mentioned by MMT proponents and their sympathizers who incorporate these ideas.

Money arises from nothing, moves people to produce real assets, and then returns to nothing. It is through this circulation of money that economic activity is conducted.

I touched upon this monetary circuit theory previously in the final section of the following article, '3-3, Ideological Content—Credit Theory of Money as a Philosophy of "Nothing"?'

4. On the Ponzi-like Nature of Modern Money

Now, although I did not consider it in this simple model, in reality, extra money is needed at each stage of the transactions we looked at this time. This is because the Bank of Japan and private banks charge interest, private companies take profits, and households also want to save.

This time, by ignoring all of these factors, the money created through credit creation as bank-style currency issuance circulated among people, mediated their relationships, and after it had made people work and produce goods, it disappeared as if nothing had happened.

However, in reality, it cannot disappear so peacefully.Because there is interest, more money is needed to make it disappear than at the beginning, and in the first place, the assumption that all the initial money returns to the bank is not realistic because corporate profits and household savings exist.

Then, in the end, for this one cycle to finish successfully, another entity running a similar cycle is required. If we call the former Cycle 1 and the latter Cycle 2, a considerable amount of money must flow from Cycle 2 to finish Cycle 1, which means that to finish Cycle 2, we need Cycle 3... and so on, it repeats.

In addition to this, considering that the amount of money socially required increases as the scale of economic activity grows, for this modern monetary system to run smoothly, the amount of money must continue to grow, and therefore (since money and debt are two sides of the same coin), the amount of debt must also continue to grow.

This mechanism is a "Ponzi-like" scheme where, in order to repay someone's debt, you must make someone else take on debt and bring money from there.

The reason I became interested in heterodox economics such as MMT is, as I mentioned in a previous article, the influence of Mr. Tsuneaki Onishi, who ran as a candidate for Reiwa Shinsengumi in the 2019 House of Councillors election.

The discussion in this fourth section is my own rewrite of (a part of) Mr. Onishi's long-held arguments. I would like to examine the entirety of Mr. Onishi's arguments in detail at some point.

I will end here for this time. Next time, I would like to introduce the government and think about government spending, focusing on the issue of government bonds.

The next article is here.

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