On Economic Basics: Investment and Trading; Free Trade and Regulation; Revenue and Deficits; Capital and Labor

[Felis Leo]

Without debt financing this earnings gap would be entirely unlivable.

Debt financing to overcome the earnings gap only prolongs the inevitable. Eventually, once people's ability to earn wanes, they have to come and see consumer bankruptcy lawyers like me.

 

[bomberfox]

Debt financing to overcome the earnings gap only prolongs the inevitable. Eventually, once people's ability to earn wanes, they have to come and see consumer bankruptcy lawyers like me.

I had no idea that was your job

 

[Felis Leo]

I had no idea that was your job

Yep. The misery of the victims of our predatory lending system I have seen could fill a book. But, you know, attorney-client confidentiality and all that.

 

[NWRatCon]

They have improved the core countries but i would argue that the countries that are on the periphery have rather varying results, some have not seen any improvement at all. The debt, massive privatization, and forbidding industry supports have crushed many countries.

I'd be interested in your opinion on which countries have not gained.

 

[bomberfox]

I'd be interested in your opinion on which countries have not gained.

Many African countries, countries that have been under multi decade embargos, sweatshop workers, anywhere where nestle owns the water supply, etc. the metrics we use to say who has gained tend to be not very well thought out. Some of these things are features, not a bug.

 

[NWRatCon]

Many African countries, countries that have been under multi decade embargos, sweatshop workers, anywhere where nestle owns the water supply, etc. the metrics we use to say who has gained tend to be not very well thought out. Some of these things are features, not a bug.

You raise a couple of interesting points. First is the lack of credible metrics. As the interviewee noted in another thread, it's hard to get this information, especially when the country is poor. So data sets are difficult to piece together. Second is a point touched on briefly earlier, relative deprivation. In some circumstances, poor people don't "know" they're poor, because they have nothing to compare it to. In others, the disparity is obvious to all parties (such as in Gaza, or under apartheid). From such, conflicts proceed.

 

[bomberfox]

You raise a couple of interesting points. First is the lack of credible metrics. As the interviewee noted in another thread, it's hard to get this information, especially when the country is poor. So data sets are difficult to piece together. Second is a point touched on briefly earlier, relative deprivation. In some circumstances, poor people don't "know" they're poor, because they have nothing to compare it to. In others, the disparity is obvious to all parties (such as in Gaza, or under apartheid). From such, conflicts proceed.

Yeah i was more alluding to the reasons people like Steven Pinker are wrong because they use bad metrics and methodology, thats different than difficulty.

 

[NWRatCon]

In reference to another thread, one poster has repeatedly claimed that "tax cuts don't cause deficits." It's such a basic misunderstanding, and so commonly repeated, that I thought it should be brought into this discussion. It stems from not distinguishing between "deficit" and "debt".

I gave a hypothetical, but I'll simplify it here:

If A "earns" $100/day, that is revenue. If A owes $90/day that is debt. When revenues exceed debt, that is a surplus. A deficit occurs when debt instead exceeds revenue. If, for example, A retires and only "earns" $50/day, but still owes $90/day, that is a deficit (of $40/day).

Typically, though, debt is not "due" all at once. "Debt load" refers to the total amount of money someone owes (e,g. credit cards, student loans, car loans, and mortgages). It's essentially the sum of all your liabilities. Periodic payments on loans are called "debt service", and the interest rate on such loans is called the "debt cost".

Per Google AI: "The average American household holds approximately $105,000 in debt. This includes a variety of debt types, including mortgages, auto loans, student loans, and credit card debt. Specifically, the average balances are: $24,297 for auto loans, $6,730 for credit card debt, and $35,208 for student loan debt."

Turning to government accounting, most US government revenue comes from taxes. The United States also carries a debt load. Like a mortgage or other debt, it isn't payable all at once. Most of this debt is in the form of Treasury bonds (Treasuries), where the government "borrows" money from investors to pay its obligations - the national debt. (The interest rate paid on Treasuries is the bonds yield.) The amount such obligations exceed revenues, is the national deficit.

Cutting taxes reduces revenues immediately. If revenues fall short of obligations, that can create or increase the deficit. To cover that shortfall (commonly referred to as "deficit spending"), the government issues more Treasuries. Issuing Treasuries, though, creates more debt, and the obligation to service that debt increases the national debt.

So, cutting taxes reduces revenues and typically increases the deficit. Covering shortfalls increases the debt. They are related, but separate effects.

 

[JohnfrmClevelan]

I didn't get to the latter concepts of "trade deficits" and discontinuity of value that were also raised in your post. "• Trade deficits aren't harmful"

What tariffs do is artificially change the established "value" of a good or commodity based upon geography. Artificial in the sense that it is not based upon real-world circumstances (e.g., like shipping charges, or the distances upon which they are based). Relatedly, a "trade deficit" is a somewhat artificial construct. The reality is that a trade is a trade. Value is given for value received. The concept of a "trade deficit" (more properly the "Balance of Trade") is that there is some outside consideration that makes such a trade "uneven". There is not, actually, a monetary basis for making that determination, except in the abstract and on a "meta"/cumulative basis.

I happen to agree that trade deficits rarely have real world detriments, except cumulatively. This is really a hold-over conception from the age of Mercantilism. It has very little validity in a global or modern economy, as any such deficits are frequently balanced out by investments in other instruments, like Treasury bonds, which are not included in the measurement of "trade balances".

"An Imbalance of Savings and Investments​

To many in the world of economics, a trade deficit is about an imbalance between a country’s savings and investment rates.

This means that a country is spending more money on imports than it makes on its exports. Under the rules of economic accounting, it must make up for that shortfall. The U.S. can do just that by either borrowing money from foreign lenders or permitting foreign investment in U.S. assets.

This foreign lending and investment can be seen as a vote of confidence in the U.S. economy and a source of long-term economic growth, if the borrowed money or foreign investment is used wisely (such as in productivity growth).

This was the case with the U.S. for several decades in the 1800s.4 The foreign money went into railroads and other public infrastructure, which helped the U.S. develop economically."

Trade Deficit: Advantages and Disadvantages (Investopedia)

In the real world, countries that have excess funds available are quite willing to invest those funds in US government and corporate bonds, because they are viewed as stable. Indeed, the inflation and volatility caused by the on-again-off-again tariff policy is creating a real-world problem, because yields on bonds (which is what the bondholder has to pay out) is going up as investor confidence goes down. That means government "borrowing" is getting more expensive, and for no rational reason.

I have a quibble with some of the standard terminology, because it's misleading.

First, buying treasuries is in no way "investing" in the economy; it is merely a place to park dollars that you aren't going to use. Foreign investment in corporate bonds, on the other hand, goes to real production. The dollars get used.

Second, the old idea that investment comes from savings is backwards, as pointed out by some very smart guys not so long ago. (This conversation unfolded on one message board in particular, which has since been taken down, unfortunately. Bit of history lost there.) This stems from the (also fairly recent) understanding that banks don't lend out deposits, they create money by expanding their balance sheets. So borrowing to invest results in the creation of money, counted as savings. Investment comes first. That was their big insight.

The shortfall experienced with trade deficits isn't in any way made up for by the sale of treasuries. Dollars don't matter much here - the shortfall comes in the form of a demand leakage. Some of our national income has been spent on foreign goods, and not all of it has been returned by buying our exports; this loss of demand is made up for by a combination of deficit spending and increased public sector debt, both of which add to GDP. The result is an increase in treasuries held by foreign parties, which is more or less permanent (we'll see about that permanence sometime soon if trump's tariff war drags out).

 

[NWRatCon]

I have a quibble with some of the standard terminology, because it's misleading.

I have a quibble with your quibble.

First, buying treasuries is in no way "investing" in the economy; it is merely a place to park dollars that you aren't going to use. Foreign investment in corporate bonds, on the other hand, goes to real production. The dollars get used.

My quibble: what is "investment"? In a way, all investment is "parking dollars". Sometimes, more effectively than others. We call it "capitalism", using excess "capital" by "investing" it, and getting a "return" on investment. The form of return varies based upon the kind of investment. But, the basic concept is to use "investment" as a medium of exchanging value for value. (I'm ignoring for now the problems with this exchange of value and the distortions of the economy which occurr.)

So, buying Treasuries is, in fact, investing. They are "parked" to get a "return". Dollars run to safety, and, until presently, US Treasuries are considered one of safest of investments.

Second, the old idea that investment comes from savings is backwards, as pointed out by some very smart guys not so long ago. (This conversation unfolded on one message board in particular, which has since been taken down, unfortunately. Bit of history lost there.) This stems from the (also fairly recent) understanding that banks don't lend out deposits, they create money by expanding their balance sheets. So borrowing to invest results in the creation of money, counted as savings. Investment comes first. That was their big insight.

I'm not sure I follow the concept, so I'm not sure I disagree... or agree? I tend, however to disagree that banks are "creating money." Rather, I think they are siphoning value from other people's money. We often, however, conflate the concepts of saving and investment - or artificially segregate different forms of investment. We'll have to explore that further. I can get passionate about how bad the financial sector can be for the community - taking advantage of the privileged position their function has for the economy.

The shortfall experienced with trade deficits isn't in any way made up for by the sale of treasuries. Dollars don't matter much here - the shortfall comes in the form of a demand leakage. Some of our national income has been spent on foreign goods, and not all of it has been returned by buying our exports; this loss of demand is made up for by a combination of deficit spending and increased public sector debt, both of which add to GDP. The result is an increase in treasuries held by foreign parties, which is more or less permanent (we'll see about that permanence sometime soon if trump's tariff war drags out).

Here I fundamentally disagree (I think). It's a far more convoluted and complex relationship, but will be fodder for some interesting conversation. I'd love to read a fuller explanation of "demand leakage".

 

[JohnfrmClevelan]

My quibble: what is "investment"?

I'm talking about real investment, investing money for the production of a good or service. If money isn't going to a company, it's not real investment. Buying stocks secondhand - not real investment. Buying an IPO - real investment. Buying a treasury, no, buying a corporate bond, yes.

In a way, all investment is "parking dollars". Sometimes, more effectively than others. We call it "capitalism", using excess "capital" by "investing" it, and getting a "return" on investment. The form of return varies based upon the kind of investment. But, the basic concept is to use "investment" as a medium of exchanging value for value. (I'm ignoring for now the problems with this exchange of value and the distortions of the economy which occurr.)

Here's the difference between treasuries and other investments: when you buy a treasury, the dollars leave the economy. When you buy anything else, your dollars just end up in somebody else's hands.

So, buying Treasuries is, in fact, investing. They are "parked" to get a "return". Dollars run to safety, and, until presently, US Treasuries are considered one of safest of investments.

Treasuries are "investments" in the personal finance sense, but as they do not go toward the production of anything, they are not the real investment I am talking about.

I'm not sure I follow the concept, so I'm not sure I disagree... or agree? I tend, however to disagree that banks are "creating money." Rather, I think they are siphoning value from other people's money. We often, however, conflate the concepts of saving and investment - or artificially segregate different forms of investment. We'll have to explore that further. I can get passionate about how bad the financial sector can be for the community - taking advantage of the privileged position their function has for the economy.

Here is the seminal paper on the subject, and it is quite recent, considering how long this question has been relevant.

https://economicsociology.org/wp-content/uploads/2014/04/money-creation-in-the-modern-economy.pdf

There have been three main theories about banking; banks as financial intermediaries, fractional reserve, and credit creation. Up until fairly recently, you could find economists to back up any one of them; now, most are in agreement that the credit creation explanation is the one that fits the operational realities of banking.

A lost century in economics: Three theories of banking and the conclusive evidence – Professor Werner

professorwerner.org

Anyway, when banking was explained to me, a light came on. I think it's fascinating stuff, but few people share that enthusiasm.

Here I fundamentally disagree (I think). It's a far more convoluted and complex relationship, but will be fodder for some interesting conversation. I'd love to read a fuller explanation of "demand leakage".

Demand leakage comes straight from my first post about the circular flow of income. There is an explanation on the Wikipedia page, or I would be happy to talk about it myself.

 

[NWRatCon]

I'm talking about real investment, investing money for the production of a good or service. If money isn't going to a company, it's not real investment. Buying stocks secondhand - not real investment. Buying an IPO - real investment. Buying a treasury, no, buying a corporate bond, yes.

Hmm. Still disagree. I do have significant concern about the distortions in the economy created by "financial institutions", but I do not agree - seriously object - to the assertion that Treasuries are not an investment. Many of those Treasuries support infrastructure investment and a significant number of consumer's salaries.

I guess my core objection is that your definition of "investment" is too narrow, but, at the same time, I agree that there is a significant difference between the "productive economy" and many businesses and economic activities that do not directly benefit the general economy (e.g. Hedge Funds).

Here's the difference between treasuries and other investments: when you buy a treasury, the dollars leave the economy. When you buy anything else, your dollars just end up in somebody else's hands.

Not necessarily. The government is a significant participant in both the domestic and international economies. Government contracts alone support several industry segments, and in many the government is the prime participant (think "Military- Industrial Complex"). Treasuries support many of those activities.

Treasuries are "investments" in the personal finance sense, but as they do not go toward the production of anything, they are not the real investment I am talking about.

For the reasons above, I completely disagree. You are segregating one market segment and defining that as the "productive economy". Production doesn't occur without consumers. Service businesses make up a huge portion of GDP, not only in the United States, but in many countries around the world.

Here is the seminal paper on the subject, and it is quite recent, considering how long this question has been relevant.

https://economicsociology.org/wp-content/uploads/2014/04/money-creation-in-the-modern-economy.pdf

There have been three main theories about banking; banks as financial intermediaries, fractional reserve, and credit creation. Up until fairly recently, you could find economists to back up any one of them; now, most are in agreement that the credit creation explanation is the one that fits the operational realities of banking.

A lost century in economics: Three theories of banking and the conclusive evidence – Professor Werner

professorwerner.org

Anyway, when banking was explained to me, a light came on. I think it's fascinating stuff, but few people share that enthusiasm.

Demand leakage comes straight from my first post about the circular flow of income. There is an explanation on the Wikipedia page, or I would be happy to talk about it myself.

I'm going to look into this. I come from the financial planning side of things, so that's what affects my perspective.

 

[JohnfrmClevelan]

Hmm. Still disagree. I do have significant concern about the distortions in the economy created by "financial institutions", but I do not agree - seriously object - to the assertion that Treasuries are not an investment. Many of those Treasuries support infrastructure investment and a significant number of consumer's salaries.

Here is the life cycle of a treasury bond: Treasury issues bonds, private sector buys those bonds, and the government spends the proceeds (pre-existing reserves) right back into the economy. The net result is an increase in bonds held by the private sector as savings, a boost in aggregate demand (from the government spending), and no change in the number of dollars. The government has essentially paid for their spending by issuing more bonds and spending them into the economy. The sale is just an operation to exchange bonds for pre-existing reserves, which are spendable. It's like trading somebody four quarters for a dollar so they can use a vending machine.

In this operation, no private sector assets are used, or even tied up - the private sector still has all of the dollars they started with. What has happened is that money in the PS has shifted from savers (buyers of treasuries) to earners of government spending. PS banks are only intermediaries here, and don't really gain much besides what they can skim off from the transactions.

So what is really being invested here? The government is funding itself with bonds. Deficit spending is a straight addition of financial assets from the government to the PS. The treasuries will bring a small return, sure, but that is a small price (zero, actually) for the government to pay in order to control the number of reserves in play. And the pile of treasuries just sits there, not doing much at all, and it grows every year because we net save. It doesn't matter who holds those treasuries either - Americans, China, Japan, whomever - the national debt is where dollars are retired.

I guess my core objection is that your definition of "investment" is too narrow, but, at the same time, I agree that there is a significant difference between the "productive economy" and many businesses and economic activities that do not directly benefit the general economy (e.g. Hedge Funds).

Differentiating between investment in real production and investment that is really just money and instruments changing hands without affecting production, I think, is a useful thing for understanding how things work. This is especially true when people refer to treasuries as "investment in government spending," which it clearly is not. The government isn't borrowing money in the normal sense; this debt doesn't need to be extinguished, and existing debt doesn't affect the government's ability to spend more in the future. That's not true of household debt or corporate debt.

Not necessarily. The government is a significant participant in both the domestic and international economies. Government contracts alone support several industry segments, and in many the government is the prime participant (think "Military- Industrial Complex"). Treasuries support many of those activities.

That's all true, but that wasn't my point. I was pointing out the difference between buying a treasury and buying shares of stock or a corporate bond. When you buy a treasury, the dollars - at least temporarily - are removed from circulation. When the government deficit spends, they return, but that act of deficit spending adds net dollars to the economy (the sale of treasuries being a wash). None of that is true of other investment vehicles, real or financial. All PS financial transactions - bank loans, corporate bonds, etc. - all net out to zero. One man has money, another man is in debt. The PS is a closed system financially; it cannot create net financial assets on its own. Net financial assets must come from the government, or a foreign country (and we run trade deficits).

1/2

 

[JohnfrmClevelan]

For the reasons above, I completely disagree. You are segregating one market segment and defining that as the "productive economy". Production doesn't occur without consumers. Service businesses make up a huge portion of GDP, not only in the United States, but in many countries around the world.

I certainly wasn't suggesting that services were not part of the productive economy. Just that a lot of "investments" are merely shuffling money and stocks between people. That's why they aren't included in GDP calculations. That goes for treasuries as well; you are just giving the government the quarters it needs in exchange for something of equal (or better) value.

I'm going to look into this. I come from the financial planning side of things, so that's what affects my perspective.

Some knowledge of double-entry accounting really helps here. Those papers can be a bit dense, but they are both enlightening if you can plow through them.

2/2

 

[medi]

Firstly, I was wondering about this thread suddenly screeching to a halt in the middle of May. Glad to see a restart. (Well, I didn't hear the screeching, but ... )

Secondly, back in the middle of May when I did have some time to study some of the excellent posts here it hit me that one really strange way to learn about basic economics, outside the classroom and the boardroom, is to live in a situation where there is a thriving black market.

Not sure / Don't remember why I didn't post that "black market" thought back a few weeks ago when that hit me, but better late than never might apply here.

Plus, if you have never lived in such a situation, there really aren't any textbooks that can teach you how that works. I mean, truly works. But a black market can sure teach you some basic stuff. AND if it is a thriving black market that means there is going to be a thriving exchange rate going that is also not regulated by the economic chiefs of a given region/nation. And learning about exchange rates in that sort of environment adds to the education.

By the way, there are similar lessons to be learned in the second-hand market business; which is amazingly close to the way a black market works. Here in Japan we have this company that started out as Book-Off and then was so successful at that they were able to branch off into appliances and all sorts of stuff.

The used car market could be a close second to the other second-hand shops, but second-hand home appliances sales, clothes and such are maybe a little better for study.

As having been in the field of aviation some years back, I think one way to judge if a given economy is working just fine is to look at photos of how many passenger planes are sitting in that big desert parking lot in that southeastern state, which I am not remembering for sure which one as I type this. Of course, that Covid stuff messed up the tourist and flying business and that "Monopoly Game" idea; which wasn't so bad. (Saw that in one of the posts, I think.)

Yep, economics --- heck of a topic; but I can't say as I ever much cared for that subject when I was forced to study that. And a weird thing about this aging thing is remembering what prices were 50-60 years or so ago. It's amazing how the prices and wages just keep going up and up and up. That's a tough one to wrap an old brain around.

 

[AConcernedCitizen]

I'll throw in my two cents worth. If I had to simplify capitalism into one sentence. it would be: "Get people working making good and services that others want and are willing to pay money for"

That is not capitalism. That describes every economic system in which money exists.

 

[AConcernedCitizen]

It's like trading somebody four quarters for a dollar so they can use a vending machine.

It's more like trading someone four quarters for $1.10 so that they can use the vending machine.

It is an investment from a personal finance standpoint, since you've made a 10% return on your investment. But it is also an investment in the real sense that you are talking about, even though it might not initially seem that way.

The person can't get their Tollhouse cookie without those quarters, and the machine won't take their bill or dime. By facilitating the transaction, you are setting a circulation of wealth in motion. The vending machine owner now has $1.00 more of income that they wouldn't have had if you hadn't traded your four quarters. If they spend that dollar on a cup of coffee, then the café owner has $1.00 more to spend on pizza. And then the pizzeria has $1.00 more to spend, etc.

So ultimately, while it facially seems like trading four quarters for a $1.10 so someone can use the vending machine is just shuffling money around, rather than a real investment, you have actually increased the GDP by $1 multiplied by whatever the spending multiplier is.

So at a MPC of 0.8, that trade of four quarters for $1.10 would have added $5 to the GDP.

 

[JohnfrmClevelan]

It's more like trading someone four quarters for $1.10 so that they can use the vending machine.

It is an investment from a personal finance standpoint, since you've made a 10% return on your investment. But it is also an investment in the real sense that you are talking about, even though it might not initially seem that way.

The person can't get their Tollhouse cookie without those quarters, and the machine won't take their bill or dime. By facilitating the transaction, you are setting a circulation of wealth in motion. The vending machine owner now has $1.00 more of income that they wouldn't have had if you hadn't traded your four quarters. If they spend that dollar on a cup of coffee, then the café owner has $1.00 more to spend on pizza. And then the pizzeria has $1.00 more to spend, etc.

So ultimately, while it facially seems like trading four quarters for a $1.10 so someone can use the vending machine is just shuffling money around, rather than a real investment, you have actually increased the GDP by $1 multiplied by whatever the spending multiplier is.

So at a MPC of 0.8, that trade of four quarters for $1.10 would have added $5 to the GDP.

In this analogy, the government also owns the vending machine. All of these hoops that they jump through to spend are self-imposed, but the end result is the same - the government creates and spends its own money, be it bonds or dollars. That's the important point here - operationally, a government with its own currency doesn't need bond buyers in order to finance itself. They are self-funding.

 

[AConcernedCitizen]

In this analogy, the government also owns the vending machine. All of these hoops that they jump through to spend are self-imposed, but the end result is the same - the government creates and spends its own money, be it bonds or dollars. That's the important point here - operationally, a government with its own currency doesn't need bond buyers in order to finance itself. They are self-funding.

The government creates the currency, but not the value of the currency.

They are not self-funding because they still need investors, not to invest currency, but rather to invest the actual value that gives the currency they create its value equivalency.

But I was actually referring to money-shuffling in general. For example:

I'm talking about real investment, investing money for the production of a good or service. If money isn't going to a company, it's not real investment. Buying stocks secondhand - not real investment. Buying an IPO - real investment.

Suppose Jane invests her hard earned money in shares of SPY which John is selling. John then uses the proceeds to invest in an IPO.

Jane created the value through her labour, so her investment of value that she created is a real investment that is contributing value to the system.

In a sense, John is “merely” acting as a middleman between the value that Jane created and the company that the value is ultimately getting invested in. But without John, the investment may never have happened. Middlemen exist because they often add value to the system.

John and Jane are both investing in the sense of contributing to the system of facilitating production, as well as the sense of getting a personal return on their investment.

 

[NWRatCon]

It's more like trading someone four quarters for $1.10 so that they can use the vending machine.

It is an investment from a personal finance standpoint, since you've made a 10% return on your investment. But it is also an investment in the real sense that you are talking about, even though it might not initially seem that way.
...
So at a MPC of 0.8, that trade of four quarters for $1.10 would have added $5 to the GDP.

In this analogy, the government also owns the vending machine. All of these hoops that they jump through to spend are self-imposed, but the end result is the same - the government creates and spends its own money, be it bonds or dollars. That's the important point here - operationally, a government with its own currency doesn't need bond buyers in order to finance itself. They are self-funding.

I'm really a nerd, because this is fun! Y'all have introduced a couple of important concepts: The creation of money and the circulation of money in the economy. And, in a way, "how money is destroyed." There is a lot of theory involved in all of this, so I think maybe some definitions are in order to keep the players in mind.

And some confession. I'm not an economist by training, and I've been out of the financial game (except informally) for a decade, but I started this thread as sort of a clearinghouse to discuss economic operations since so much discussion (and policy) seems to be - shall we say - "outside the mainstream" of economic theory, to be polite. It seems clear this is ambitious as this discussion can get esoteric quite quickly. I try to be accurate, though, so I'll identify sources and provide links as I can, and to be careful about what I post. But here goes. First "money supply":

In olden-golden days - pun intended - the "money supply" had been strictly limited and controlled by governments. (That is not, however, to say that trade was. That gets into the black market discussion, which I hope to discuss too.) It's funny, too, because economists can't even decide what constitutes "money" anymore. Central banks still play an important role in money creation and accounting, but even they measure it in very different ways.

Here's a short example from Wikipedia:

"In macroeconomics, money supply (or money stock) refers to the total volume of money held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circulation (i.e. physical cash) and demand deposits (depositors' easily accessed assets on the books of financial institutions). Money supply data is recorded and published, usually by the national statistical agency or the central bank of the country. Empirical money supply measures are usually named M1, M2, M3, etc., according to how wide a definition of money they embrace."
....
There are several standard measures of the money supply,[4] classified along a spectrum or continuum between narrow and broad monetary aggregates. Narrow measures include only the most liquid assets: those most easily used to spend (currency, checkable deposits). Broader measures add less liquid types of assets (certificates of deposit, etc.).

This continuum corresponds to the way that different types of money are more or less controlled by monetary policy. Narrow measures include those more directly affected and controlled by monetary policy, whereas broader measures are less closely related to monetary-policy actions.

The different types of money are typically classified as "M"s. The "M"s usually range from M0 (narrowest) to M3 (and M4 in some countries[6]) (broadest), but which "M"s, if any, are actually focused on in central bank communications depends on the particular institution. A typical layout for each of the "M"s is as follows for the United States: [a chart follows]"

Continues

 

[NWRatCon]

"Economists have grappled with the concept of money for centuries. For some, money is a complicated phenomenon which is difficult to define and which, in its modern form, seems almost impossible to explain. After all, what is money—a numeraire, a medium of exchange, a store of value, a means of payment, a unit of account, a measure of wealth, a simple debt, a delayed form of reciprocal altruism, a reference point in accumulation, an institution, or some combination of these?"

https://www.researchgate.net/publication/5208277_The_Role_of_the_State_and_the_Hierarchy_of_Money

Both of you are discussing money as the circulating value of exchange. That is how banks can "create" value/money outside of the central bank (and how bitcoin can exist), and how it can circulate throughout the economy. We're discussing how it is used as a medium of exchange (mostly). Money, literally, makes the economic world go round.

( from Wikipedia:

• M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.[11]
• MB: is referred to as the monetary base or total currency.[7] This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.[12]
• M1: Bank reserves are not included in M1.
• M2: Represents M1 and "close substitutes" for M1.[13] M2 is a broader classification of money than M1.
• M3: M2 plus large and long-term deposits. Since March, 23, 2006, M3 is no longer published by the US central bank, as one of Alan Greenspan's last acts, because of its expense. [14] However, there are still estimates produced by various private institutions.
• MZM: Money with zero maturity. It measures the supply of financial assets redeemable at par on demand.[15][16]

Creation of money
Both central banks and commercial banks play a role in the process of money creation. In short, in the fractional-reserve banking system used throughout the world, money can be subdivided into two types:[17][18][19]

central bank money – obligations of a central bank, including currency and central bank depository accounts
commercial bank money – obligations of commercial banks, including checking accounts and savings accounts. In the money supply statistics, central bank money is MB while the commercial bank money is divided up into the M1–M3 components, where it makes up the non-M0 component.)

By far the largest part of the money used by individuals and firms to execute economic actions are commercial bank money, i.e. deposits issued by banks and other financial institutions.)

John was earlier discussing how banks "create" money. This is the sense defined by M 1-3, where I was at the time discussing it much more narrowly, M0. (At least I think that's where we diverged.)

Money does circulate - in the form of wages, purchases, deposits, loans, taxes, etc. - in a flow, sometimes referred to as the velocity of money.

Velocity of Money: Definition, Formula, and Examples

The velocity of money is a measurement of the rate at which consumers and businesses exchange money in an economy.

www.investopedia.com

"What Is the Velocity of Money?​

The velocity of money is the rate at which money is exchanged in an economy. It is commonly measured by the number of times that a unit of currency moves from one entity to another within a given period of time. Simply put, it's the rate at which consumers and businesses in an economy collectively spend money.

The velocity of money is usually measured as a ratio of gross domestic product (GDP) to a country's M1 or M2 money supply. The word velocity is used here to reference the speed at which money changes hands."

Continued

 

[NWRatCon]

Another important concept is

Fractional-reserve banking - Wikipedia

en.wikipedia.org

"Fractional-reserve banking is the system of banking in all countries worldwide, under which banks that take deposits from the public keep only part of their deposit liabilities in liquid assets as a reserve, typically lending the remainder to borrowers. Bank reserves are held as cash in the bank or as balances in the bank's account at the central bank. Fractional-reserve banking differs from the hypothetical alternative model, full-reserve banking, in which banks would keep all depositor funds on hand as reserves.

The country's central bank may determine a minimum amount that banks must hold in reserves, called the "reserve requirement" or "reserve ratio". Most commercial banks hold more than this minimum amount as excess reserves. Some countries, e.g. the core Anglosphere countries of the United States, the United Kingdom, Canada, Australia, and New Zealand, and the three Scandinavian countries, do not impose reserve requirements at all."

It is this "fractional reserve" system that creates issues with "bank runs" and "too big to fail" institutions. The bank literally does not hold sufficient funds to cover all deposits. But it is also how banks "create money" (as well as profits).

I posted all this to put a context under your discussion. Please proceed...

 

[JohnfrmClevelan]

Another important concept is

Fractional-reserve banking - Wikipedia

en.wikipedia.org

"Fractional-reserve banking is the system of banking in all countries worldwide, under which banks that take deposits from the public keep only part of their deposit liabilities in liquid assets as a reserve, typically lending the remainder to borrowers. Bank reserves are held as cash in the bank or as balances in the bank's account at the central bank. Fractional-reserve banking differs from the hypothetical alternative model, full-reserve banking, in which banks would keep all depositor funds on hand as reserves.

The country's central bank may determine a minimum amount that banks must hold in reserves, called the "reserve requirement" or "reserve ratio". Most commercial banks hold more than this minimum amount as excess reserves. Some countries, e.g. the core Anglosphere countries of the United States, the United Kingdom, Canada, Australia, and New Zealand, and the three Scandinavian countries, do not impose reserve requirements at all."

It is this "fractional reserve" system that creates issues with "bank runs" and "too big to fail" institutions. The bank literally does not hold sufficient funds to cover all deposits. But it is also how banks "create money" (as well as profits).

I posted all this to put a context under your discussion. Please proceed...

I'll start here, because the fractional reserve system is not what we (or anybody else) uses. In the old fractional reserve story that we got in high school, banks would need to collect "hard" money to lend out. They would keep 10% in reserve, and lend out the rest. Presumably in gym bags full of cash, if you got a large loan.

What it got right was that, even in the fractional reserve story, banks created credit, because your deposit was not backed by reserves, it was just a number on a ledger. The "multiplying up" of money required credit in some form. Interbank transactions would be handled like they are now, with reserves being the settlement funds, and the settlement agent (the central bank) would settle up net interbank transactions by moving reserves between banks' reserve accounts.

What it got wrong was the handling of reserves on bank ledgers. Reserves are used strictly for settlement. If you get cash from an ATM, your bank has settled up that much of your account. If you write a check, reserves are transferred by the CB as I described above. And when you get a loan, banks create the funds 100% by credit. Interbank transactions result in banks marking accounts up and down, and end-of-the-day settlement squares everything up.

Banks never held anywhere close to enough cash to cover bank runs. A simplified bank ledger looks something like this: liabilities = 100% customer accounts; assets = 80% promissory notes, 10% reserves, and 10% capital (easily liquidatable assets like corporate paper). If there is a bank run today, and a bank can't handle it by selling assets, the Fed can step in and buy bank assets.

Reserves are for settlement, so they are the first things to go when people start withdrawing funds or moving them to other banks. When we had a reserve requirement, it was based on a % those bank liabilities (customer accounts) that had no restrictions on withdrawals (like checking). Capital is there to cover loan defaults; it is based on a % of bank assets.

Theoretically, a strict reserve requirement would limit the amount of money banks can create via loans. In practice, the CB always provides enough reserves to allow for whatever demand for bank loans there is. If they didn't do this, they would lose control of interest rates, as scarce reserves would be bid up by banks seeking to make loans. But banks have always skirted reserve requirements anyway (like sweep accounts, which would move M1 funds to M2 accounts temporarily for the purpose of undercounting the M1 liabilities that were used to calculate their reserve requirement).

 

[JohnfrmClevelan]

In the U.S., MB refers to central bank liabilities (reserves + cash in peoples' hands). M0 is cash in peoples' hands. M1 is what we use to transact with - bank accounts with no withdrawal restrictions and cash in our pockets. M2-M3 refers to savings instruments and less liquid forms of bank money, which I don't consider too important in the grand scheme of things, because we don't really use it. So my somewhat inaccurate shorthand is to just say "M1 money" when I'm referring to bank-created money, just because it's easier.

Anyway, the take-home lesson of banking mechanics is that the government doesn't directly try to control the amount of M1. They prefer to be able to control/influence interest rates instead. The demand for loans (those which are ultimately approved) is what dictates the size of M1.

Returning to the circular flow of income, where our income makes up the bulk of what we spend to consume our production, if we spend 100% of our income, we would have a steady state economy, 0% growth, which never happens. Instead, we (as a nation) always net save some income, and that loss of demand is made up for with deficit spending (a sure thing) and increased private sector credit (happens most of the time). The goal is to grow GDP every year (or period), so demand injections need to be larger than demand leakages.

When a business gets a bank loan to increase production, that immediately increases the national income; they pay for labor and materials before any new production is sold. The new money (increased income) provides (hopefully) enough new demand to consume increased production. (Businesses also get money from people investing pre-existing money, but this is captured in I, and is not considered savings from income.)

This is all stemming from that circular flow of income model, but I haven't found any fault with it yet.

 

[JohnfrmClevelan]

The government creates the currency, but not the value of the currency.

They are not self-funding because they still need investors, not to invest currency, but rather to invest the actual value that gives the currency they create its value equivalency.

But I was actually referring to money-shuffling in general. For example:



Suppose Jane invests her hard earned money in shares of SPY which John is selling. John then uses the proceeds to invest in an IPO.

Jane created the value through her labour, so her investment of value that she created is a real investment that is contributing value to the system.

In a sense, John is “merely” acting as a middleman between the value that Jane created and the company that the value is ultimately getting invested in. But without John, the investment may never have happened. Middlemen exist because they often add value to the system.

John and Jane are both investing in the sense of contributing to the system of facilitating production, as well as the sense of getting a personal return on their investment.

That's all true, but I'm just talking about financial stuff. I consider labor's contribution a given, otherwise they wouldn't get paid for their labor.