Download Endogenous Money and Banking Activity

ENDOGENOUS MONEY
AND BANKING ACTIVITY
Some Notes on the Workings of Modern Payment Systems
Sergio ROSSI
Working Paper N° 309
November 1998
Abstract
This paper attempts to highlight some key elements of the workings of modern banking. These
elements are worth bearing in mind when constructing a monetary theory of production for an
analytical explanation of banking activity based on the book-entry nature of money. Considering
the endogenous-money view put forth by the Post-Keynesian tradition, the paper tries to show the
importance of drawing a rigorous distinction between monetary and financial intermediation. It will
point out the peculiar characteristics of monetary flows, discarding the approach in physical terms
adhered to by both Post-Keynesians and circuit theorists. The analysis is illustrated by a stylised
example of interbank clearing, which emphasises the logical distinction existing between money,
credit, and deposits.
Keywords
Circuit theory, clearing and settlement systems, endogenous money, financial intermediation,
modern banking, monetary emission, payment systems.
Introduction*
‘Banks do two things in this economy. First, they act as financial intermediaries. [...] Second, they provide
transactions services, making payments as demanded by the households.’
Stanley Fischer (1983: 4)
‘Until we get our concepts semantically in order, little progress in the dialogue and discussion over the cause
vs effect role of money can be expected.’
Paul Davidson (1988: 163)
Over the past twenty years or so, a Post-Keynesian (PK hereafter) macroeconomic theory
of monetary economies has been worked out, mainly in the United Kingdom and the
United States (with ramifications in both continental Europe and Canada), whose origin
may be traced back to the years of the Radcliffe Committee report.1 This theory aims at
studying the workings of a monetised production economy in Keynes's sense, i.e. an
entrepreneurial economic system where (bank) money is essential both in the short- and in
the long-run. From the pioneering work of Kaldor (1970, 1986 [1982]), P. Davidson (1978
[1972]), P. Davidson and S. Weintraub (1973), S. Weintraub (1978), Kaldor and Trevithick
(1981), and Minsky (1982) -- to list only some of the most cited sources --, PK monetary
theory has been developed and refined, with some analytical disagreement yet to be settled,
by authors such as Moore (1979, 1983, 1985, 1988b, 1989b, 1991), Chick (1984, 1986,
1993, 1996), Lavoie (1984, 1985, 1992), Dow and Dow (1989), Rousseas (1989), Wray
(1990, 1992, 1995), Palley (1991, 1996), Pollin (1991), Howells (1995, 1996), Arestis and
Howells (1996), Dow (1996a, 1996b, 1997), and Arestis (1997).2 Without attempting here
either a critical survey of this school of thought or an exegesis of Keynes's work,3 the
hallmark of the PK research programme in monetary economics may be defined as
twofold. It stems from the view that ‘money matters’, and elaborates on the idea that the
supply of (bank) money is ‘credit-driven and demand-determined’ -- to use two common
PK expressions to which we shall return. To be sure, ‘both phrases signify that moneyholding, monetary exchange, money prices, monetary calculation, and the monetary
financing of production are integral to a capitalist economy’ (Cottrell 1994: 590).
It is no exaggeration to maintain that there is a general consensus among PK monetary
theorists that money is the consequence of economic activity and not the cause of it. This
view has been labelled the endogenous-money approach to modern production economies,
in contrast with the exogenous monetary mass characterising monetarist theory and, more
generally, neoclassical economics. However, there still exists a conceptual controversy as to
what monetary endogeneity exactly means in the real world (see e.g. Davidson (1988: 15663)). On the one hand, the very notion of endogeneity may have different meanings,
according to the focus of the analysis, and it is necessary to distinguish causality from
1
controllability of economic variables (see e.g. Desai (1987), Moore (1988b: 144-64), and
Wray (1992: 297-300)). On the other hand, there are points of disagreement on the
structural relationship between monetary authority's policy reaction function and banks'
behaviour (see e.g. Palley (1991, 1996), and Pollin (1991)). Central bank's intervention and
interest rate policy are indeed the main focus of present competing views within this
tradition, involving issues such as mark-up pricing policy and liquidity preference, both
from the standpoint of the banking firm (see Hewitson (1995: 290-8) for a good overview).
This paper attempts to highlight some key elements of the workings of modern banking,
which might be worth considering in order to construct a monetary theory of production
providing an analytical explanation of banking activity in accordance with the (endogenous)
nature of bank money. Within PK literature, the turning point of our approach has best
been expressed by Moore, when he observed that ‘[p]erhaps the easiest way to understand
the meaning of monetary endogeneity is to focus on the behavior of the banking system
and the deposit creation process. As is well known, banks create transactions deposits
whenever they grant loans. Banks are also financial intermediaries, and make a profit by
lending at a markup over their borrowing rate’ (Moore 1989a: 479, italics ours). The point
is worth emphasising, for it is often misunderstood -- not to say entirely neglected -- even
by contemporary (PK) writers.4 Thus, Section 1 will present the analysis of financial
intermediation from a ‘bank money’ point of view, along the broad lines of what probably
is the most realistic theory of modern banking within a monetary production economy.
Yet, authors like Kaldor and Moore (but many other Post-Keynesians as well) do not make
(explicit) the crucial distinction between money and credit,5 so important for constructing a
monetary theory of production in compliance with the banking nature of money.
Furthermore, PK analysis does not distinguish money from bank deposits, since it is based
on the idea that bank liabilities are money.6 Section 2 focuses on these crucial issues. It will
explore the primary function of monetary intermediation by referring to the work of Schmitt
(1966, 1972, 1975, 1984), Cencini (1984, 1988, 1995, 1997, 1999) and, subsidiarily, of some
adherents to the so-called theory of the monetary circuit (see Graziani (1988a, 1988b, 1990,
1994) for excellent surveys). Section 3 illustrates with a stylised example how important it is
to be clear about the twofold nature of bank intermediation, by analysing the book-entry
operations recorded for the settlement of interbank debt within a national economy. The
last section provides some concluding remarks.
2
1. Banks as financial intermediaries
A common statement in PK monetary analysis has it that ‘[b]anks, after all, are essentially
in the business of selling credit’ (Moore 1988a: 373).7 To be precise, commercial banks
participate in the process of financial intermediation, by means of which deficit-spending
units borrow from saving units -- via some middleman institutions for reasons that do not
concern us here8 -- the proceeds they need to finance their net flow of expenditures. ‘The
banking system is an intermediary in the sense that it facilitates the transfer of real
resources from surplus to deficit spending units’ (Ball 1964: 168). As pointed out by
Moore, ‘[l]ike all financial intermediaries, commercial banks make their profits on the rate
spread between the asset and liability side of their balance sheets’ (Moore 1988b: 49).9
Indeed, Moore is perhaps the author who has most emphasised the workings of the
banking firm within the PK paradigm.10 According to him, ‘[b]anks may be considered as
two-input, two-output firms. The two inputs (bank liabilities) are retail and wholesale
deposits; the two outputs (bank assets) are retail and wholesale lending’ (Moore 1985: 13).
Owing to the principle of double-entry accounting, total bank lending is identical to
total bank deposits at any point of time for any individual bank and for the banking system
as a whole, as we are going to see. In Tobin's words, ‘depositors entrust to bankers
whatever amounts the bankers lend’ (Tobin 1987 [1963]: 272), since each and every loan is
recorded -- in one and the same act -- on both sides of the bankers' balance sheet
systematically. In fact, as suggested by Fama in his famous Journal of Monetary Economics
paper, ‘the concern with banks in macroeconomics centers on their role as portfolio
managers, whereby they purchase securities from individuals and firms (and a loan is, after
all, just a purchase of securities) which they then offer as portfolio holdings (deposits) to
other individuals and firms’ (Fama 1980: 44).11 On that account, an important development
of PK thought has centred on Keynes's (1936) liquidity preference theory, and more
specifically on financial institutions' liquidity preference12 (see e.g. Dow (1996a: 498-504;
1997: 70-6)). Dow and Dow argue persuasively that, ‘[j]ust like non-bank wealth-holders,
banks too are subject to liquidity preference in structuring their portfolios’ (Dow and Dow
1989: 154). Since they operate in a non-ergodic economic system -- where the future is
uncertain and unpredictable (Davidson 1978 [1972]) --, banks usually risk-assess the
creditworthiness of their potential borrowers before passing any new loan agreement, a
practice implemented by all financial institutions to avert collapse.
Now, what fundamentally distinguishes banks from other financial intermediaries -such as building societies in the United Kingdom or savings and loan funds in the United
States -- is the observation that only banks can ‘create’ means of payment (Tobin 1987
[1963]: 275). As noted by Wray, any economic agent can of course issue IOUs by
3
acknowledging his or her debt towards another agent, ‘but these [IOUs] cannot become
“credit” or “money” unless they are accepted’ (Wray 1995: 274). The ‘moneyness’ of a
(private) liability is portrayed as depending on the willingness of the public to accept it as a
means of payment within a given geographic area. In other words, people use (bank)
money because, so the argument goes, they all agree(d) to discharge their debts by means
of it.13 This is indeed the convention-based analysis put forward by leading monetary
practitioners (see Goodhart (1989 [1975]: 111)), and within the academic profession it is
usually confirmed by the view that ‘modern banking systems function on the bedrock of
the confidence generated by the lender-of-last resort function of the central bank’ (Dow
1996a: 498).14 All this will be elaborated in the following sections. Let us concentrate here
on the canonical distinction between banks and other financial intermediaries. Specifically,
PK monetary theorists claim that ‘it is possible for banks to advance credit to cover spending
and then to recapture deposits’ (Wray 1990: 267, italics ours). Indeed, as the argument goes,
any bank experiencing a lack of deposits may always turn to the domestic central bank, to
borrow the liquidity which ultimately guarantees the smooth functioning of the overall
payment system.15 This exclusive property of the banking system is meant to correspond to
the well-known principle according to which loans make deposits -- the distinguishing
tenet of unorthodox monetary theory (see e.g. Realfonzo (1998: Chapter 6)) --, and
contrasts with the traditional view that bank borrowing is the cause of bank lending
(‘deposits make loans’), as for any other (non-bank) financial institution. In the words of
Kaldor and Trevithick, ‘[i]n a system where the money supply consists largely of deposits
of private banks, an increase in bank lending is necessarily reflected in a corresponding
increase in bank deposits, since the increased spending automatically swells the deposits of
the recipients’ (Kaldor and Trevithick 1981: 7).
Within this framework, reference to bookkeeping rules provides no analytical insight.
Indeed the two-sidedness of banks' balance sheets is a battology for the analysis of the
banking firm. An investigation focusing on either total accounting magnitudes or their
dynamic variation over a given period of time cannot provide a satisfactory explanation of
why loans make deposits. As a matter of fact, neither a static nor a dynamic analysis of
banks' balance sheet can logically determine the direction of causality between loans and
deposits, which are merely the two faces of the same reality: the existing money-income.
Attention must be paid to the final cause of bank lending in the process by means of which
deposits are formed. In so doing, the ‘income generating-finance process’ -- to use
Davidson's (1988) phrase -- must be considered, if we aim at constructing a monetary
theory of production explaining why banking activity and the production process
participate together in the same macroeconomic reality.16 As Lavoie puts it, ‘[a]ny
production in a modern or in an “entrepreneur” economy is of a monetary nature’ (Lavoie
4
1984: 774). Hence let us start from the allegation that ‘[t]he additional debts of banks are
issued and used to accept and pay for additional offer contracts of producers and workers’
(Davidson 1988: 164). For the sake of clarity, let us make tabula rasa of any existing bank
deposit, so that the new flow of production must be financed entirely ex nihilo (to avoid the
temptation to explain a deposit's formation by having recourse to a pre-existent deposit,
whose origin would remain mysterious). In period P, firm F organises production following
its ‘animal spirits’ and according to Keynes's (1936) principle of effective demand, and asks
a bank, B, to pay the factors of this production: the wage-earners, W.17 Table 1 shows the
result of the payment on the factors market.
Table 1
Bank
liabilities
Workers
assets
x£
Firm
x£
Whilst the ‘mechanics’ of the double entry recorded in Table 1 is straightforward and
uncontroverted, it is not so for the heuristic explanation of the underlying payment. In the
situation just described, PK monetary economists correctly emphasise that firms need to
finance their expenditures on the factors market by obtaining the necessary loans from the
banks. They are also right in noting that ‘[t]hese flows of credit then reappear as deposits
on the liability side of the balance sheet of banks when firms use these loans to remunerate
their factors of production’ (Lavoie 1984: 774).18 All this verifies the causality from loans to
deposits, and may substantiate the claim that ‘the basic function of the banking system is to
create new monetary units that make production (and, to a lesser extent, consumption)
possible’ (p. 775). What may still deserve investigating is the widespread belief that the
banking system creates the necessary credit to finance the income-generating process (that is,
current production).
Indeed, one must bear in mind Keynes's General Theory analysis, particularly where the
author -- after an entire chapter devoted to "The Choice of Units" -- considers labour as
literally the sole factor of production (Keynes 1936: 213-15). Granting the etymological
definition of the word ‘factor’ (i.e. creator), one may ask if the banking system can logically
create something of its own, in addition to the result of human effort.19 The answer is
negative, at least at this stage of the analysis. On reflection, one may in fact observe that
the credit granted by banks to firms to finance production has its ultimate origin in the
credit granted by workers to banks, at the very moment current wages are paid.20 So much so that,
ultimately, Hicks's distinction between an ‘overdraft economy’ and an ‘autoeconomy’ does
5
not capture the essence of modern banking. To verify this claim, it is sufficient here to
reconsider Table 1. As a result of the payment of wages, F is necessarily debited by the
bank with the cost of production, and its debt is entered on the assets side of the bank's
balance sheet. Indeed, this entry is recorded even if the firm were to finance production
out of its cash flow, instead of using an overdraft facility provided by banks (through
negotiation). Simultaneously, the factors of production own a positive purchasing power
over current output in the form of a bank deposit, recorded as a liability for B. In the
words of Graziani, ‘[a] picture of the economy taken immediately after the payment of
wages would reveal that the whole of the existing money stock is a debt of the firms and a
credit of wage earners towards the banks’ (Graziani 1996: 143). Put differently, and as
astonishing as it may appear, every production brings about the deposits necessary to
finance it,21 independently of the behaviour of economic units (i.e. households and firms,
inclusive of the general government sector). The financing of production with a preexistent deposit does not pertain to the anatomy of modern banking, and indeed cannot be
explained in this context without implying metaphysical creations. Neither commercial
banks, nor the banking system as a whole creates credit, as is still (too) often maintained
within academic circles by referring to the anachronistic idea of seigniorage. In fact, this
critique is but a restatement of the argument that, for banks, the only source of profits lies
in an efficient portfolio management by means of which their interest rates' spread is
maximised. In other words, banks do not create income by themselves when they monetise
the production process through the payment of wages. Their role, though essential for the
macroeconomy, has nothing to do with the ‘spontaneous generation’ of purchasing power,
which must be produced in order to exist in reality. As noticed by Fama, ‘the payments
mechanism provided by banks is a pure accounting system of exchange wherein transfers
of wealth take place via debits and credits that give rise to sales and purchases of securities
in the portfolios against which the sending and receiving accounts have claims’ (Fama
1980: 47).
On the whole, it is possible to claim that the volume of bank lending both determines
and is at once determined by bank borrowing.22 To the extent that the principle of effective
demand enables firms to determine their needs for ‘initial finance’,23 bank loans to
remunerate the factors of current output lead to the simultaneous formation of equivalent
deposits to the benefit of workers (see above, Table 1). Because of the two-sidedness of
banks' balance sheet, reinterpretation of this operation shows in the last analysis that the
newly-formed deposits are lent ipso facto to firms, to cover current production costs by
means of the financial market. Wage-earners save in fact all their current income at the very
moment firms pay their remuneration. So much so that workers thus own a financial
capital which they will spend later to obtain in real terms what they already own under the
6
monetary form of bank deposits (Schmitt 1984: 484-92). ‘The reality of our modern
monetary systems is thus based on the simultaneous application of the two principles,
“loans make deposits” and “deposits make loans”, where the first refers to the fact that
deposits are created through the loans granted by banks to firms, while the second states
that the deposits earned by workers are immediately lent to firms to cover financially their
costs of production’ (Cencini 1997: 275). This is the logical result of a rigorous analysis of
the flows giving rise to the double entry recorded in Table 1, although it might seem
contradictory at first.
Thus some clarifications are in order, before further investigating the workings of
modern payment systems. At this stage, the reader might indeed point to the pretended
circularity of the above explanation, so that the whole argument of this paper would be
fatally flawed, and therefore easily dismissed. Are we claiming that loans make deposits
which make loans, in an infinite (time-dimensional) causal chain that ultimately may be
interpreted as a multiplication of the original magnitude? Are we claiming that wageearners must willingly lend the newly-formed deposits to firms as soon as the latter
remunerate the ‘productive services’ of the former, in order to avoid fatal ‘leakages’ that
may spark off an economic crisis? Are we claiming that firms can always obtain on the
market for produced goods the ‘final finance’ they need to repay their debts towards the
rest of the economy? Are we claiming that banks always accommodate any loan request by
entrepreneurs in search of the initial finance necessary to implement new production plans?
The answers to these questions are all negative. Let us try to substantiate them briefly by
taking the relevant questions in the reverse order.
As argued by PK structuralists, commercial banks may, and indeed do, vary the interest
rate charged for new loans, according to the assessment of the risk involved in opening
new credit lines. The amount of credit granted by banks to firms is in fact influenced by
perceived borrowers' risk, and varies with respect to borrowers' creditworthiness, the causal
factor being the specific rate of interest fixed by the lending institution on a case-by-case
basis (see e.g. Dow (1997: 74-5)). An argument put forward by the liquidity preference
school within PK monetary theory concerns indeed banks' behaviour in case of an
economic downturn, when some projects do not raise the necessary funds because of
pessimistic expectations generated within a non-ergodic system. Yet simple accounting
logic reveals that, once granted, every bank loan brings about the simultaneous formation of
identical deposits within the domestic banking system. In Chick's words, ‘[t]hese deposits
must be held somewhere in the economy, willingly or unwillingly, and the increased
holdings count as saving, voluntary or involuntary’ (Chick 1996: 13-14). No leakage is
logically possible. The essential mechanic rule of double-entry bookkeeping averts it. To
7
fear a leakage from the banking system in the process of financial intermediation is a
contradiction in terms, even when international speculation is brought into the picture.24, 25
Yet the fact that bank deposits cannot leave the (banking) system until they are
destroyed by firms' repayment of the corresponding debts,26 does not mean that firms can
always sell all their current output on the market for produced goods. In short, as PK
writers have stressed correctly, ‘animal spirits’ may turn out to be wrong, and consequently
some items might be unsold on the goods market. However, to focus on the points at issue
here, if we concentrate attention on deposit formation only, we understand (as it may be
inferred from above) that firms' unsold goods and services on the corresponding markets
are necessarily sold on the financial market, when wage-earners automatically lend to firms
the newly-formed deposits (i.e. current income) via banks' intermediation (see Schmitt
(1984: 152-65)). More precisely, the double entry recorded in Table 1 represents the result
of the sale of total current output on the financial market, an operation defined by the wageearners' involuntary saving at the very moment of their remuneration. ‘Income creation is
not a credit operation, but the income created is simultaneously the object of a credit
operation. As soon as income is born, it is thus lent by its holders until its “withdrawal”.
This means that income is instantaneously transformed into saving or, identically, into
capital’ (Schmitt 1984: 158, our translation).27 As a matter of fact, it must be recalled that
until final purchase on the goods market takes place -- where consumption occurs in
strictly economic terms --, workers (or more generally income holders) own a claim over a
bank deposit that testifies their financial ownership over the newly-produced output. In a
nutshell, as soon as wages are paid, wage-earners (willingly or not) substitute their bank
deposits with a drawing right over current output, so much so that the corresponding
deposits are lent at once to firms, in an operation testifying the latter's debt resulting from
production. This ‘mechanical’ lending means -- let us say it once more -- that when they
remunerate the production factors, firms automatically borrow all the newly-formed
income (enabling them to finance current production) from (and independently of the
behaviour of) original income holders, W. This is what Table 1 tells us in the final analysis.
To summarise, the working of modern banking is essentially unaffected by agents' forms
of behaviour, once bank managers have decided to grant a loan to finance production (on
the basis of a creditworthiness assessment that might of course take into account the bank's
liquidity preference schedule).28 As a matter of fact, for any bank the unorthodox linkage
that runs from making loans to collecting deposits must be understood within the
mechanics of double-entry accounting recording payments on the factors market. Simple
economic analysis of the bookkeeping entry resulting from the income generating-finance
process makes it also clear that the ultimate financing of production cannot be created by
the banking system, which intervenes as a mere catalyst. Infinite recursive causality
8
between loans and deposits is broken down by understanding that any bank deposit is
originally formed on the labour market as the result of firms' borrowing to remunerate
production factors, and the ultimate source of bank financing of production lies in the
wage-earners' simultaneous deposit formation. Further, deposit multiplication is ruled out
as soon as one perceives that payments on the goods market are of the opposite algebraic
sign to payments on the factors market.29 Clearly, a deposit's formation on the latter is the
first leg of a macroeconomic phenomenon that has the same deposit's destruction on the
former as its second leg, the two legs being logically separated in chronological time (see
e.g. Schmitt (1996a: 137)).
2. Banks as monetary intermediaries
As the previous section has shown, deposit formation is the result of the ‘joint effort’ of
banking and the production process. More precisely, banks emit a number of money units
for the remuneration of current workers, whose product is the very content of the newlyformed deposits. In other words, the banking system issues the monetary form where matter
and energy are moulded into according to the project devised by human beings and
implemented within the productive sphere. ‘From the beginning, banking and productive
systems thus contribute to the determination of a unique macroeconomic structure’
(Cencini 1997: 276). In neoclassical terms, the monetary sector and the real sector operate
concomitantly to determine the macroeconomic magnitude par excellence: money-income. In
PK terms, monetary endogeneity is best explained by the relation established between bank
lending and entrepreneurs' ‘animal spirits’ every time the expected effective demand is
deemed profitable for the banking firm as well. The payment of wages is the operation that
gives rise to a (newly-formed) bank deposit, a drawing right over current output in the
hand of wage-earners or, generally speaking, of all economic units who take their place as
income holders. So, as Lavoie (1984: 774-5) observed, the income generating-finance
process ends up forming a money stock. Yet it is worth stressing at this juncture that the
money stock never is a sum of money proper. In fact, the result of bank lending is a certain
amount of bank deposits, the sum of the latter defining the existing monetary stock.30 But
as Arestis and Howells have recently emphasised in their "Theoretical Reflections on
Endogenous Money", there remains a problem in trying to capture the essentials of the
flow of bank lending in an analysis concentrating on the behaviour of the money stock. As
Arestis has it, ‘[there] is a logical objection to trying to represent an analysis of flows in a
diagram designed to show the behaviour of stocks’ (Arestis 1997: 56). Specifically, Arestis
and Howells suggest going beyond the tradition of drawing money supply curves -- that is,
using stock diagrams --, by investigating the realised flow ‘resulting from the interaction of
9
the demand for credit with the demand for the resulting deposits’ (Arestis and Howells
1996: 550).
Like the great majority of professional economists, however, Arestis and Howells make
use of a conception of economic flows strongly influenced by physics.31 The realised flow
resulting from the interaction quoted above is in fact a stock ‘on the wing’ (to use
Robertson's language).32 Like the motion of a mobile in a given space (over a set time span,
which enables one to measure velocity), the monetary flow -- or the flow of money -- is
indeed assimilated by Arestis and Howells (but by many others, too) to an observable
movement of the corresponding stock, i.e. a deposit circulation from lenders (say, W) to
borrowers (F, in the case of the financing of production) through the banking system's
balance-sheet identity. Now, quite apart from the simultaneity of loans and deposits in the
income generating-finance process investigated above, in monetary economics the idea of a
flow being a stock set into motion -- at a given (or variable) velocity, as in the physical
world -- might be questioned analytically. As a matter of fact, in his synthesis of the socalled circuit theory relating money and production, Lavoie maintains that ‘[i]nitially,
money appears under the form of a flow. It is only at the end of the circuit that money will
become a stock’ (Lavoie 1987: 71-2, our translation).33 This means that money is a flow,
whose result is a stock under the form of a bank deposit. Unlike, say, water, oil or blood,
money is not a (liquid) stock that can flow in a pre-existent circuit. Whilst any hydraulic
circuit, or pipeline, exists independently of the ‘matter’ flowing into it, the circuit of money
does not exist (cannot be retraced) independently of money. According to the modern
theory of the monetary circuit, there is thus a strong case for breaking down the link with
physics, and to start thinking in different (macroeconomic) terms. We shall explore this
route in the remainder of this section.
As Bernard Schmitt put it in personal conversation recently (May 1996), ‘double-entry
accounting records the result of monetary flows and not the flows themselves’. In-depth
analysis of monetary endogeneity should therefore start from a bookkeeping attempt to
depict the very flows giving rise to the money stock.34 Table 1* may thus be considered as
the analytical ‘flow-account’ of the payment of wages, whose result is entered as in Table 1
above.35 Economic agents have an asterisk here in order to remind the reader that the
corresponding flows do not show up in actual banks' balance sheet (recording their result
only).
10
Table 1*
Bank
liabilities
assets
(1) Firm*
x£
(3) Workers*
x£
(2) Firm*
x£
(4) Workers* x£
The entries in Table 1* are balanced ‘diagonally’, which may surprise the reader. Let us thus
emphasise that these entries are flows, that is, actions (by contrast, stocks are the result of
these actions).36 The first entry (1) in Table 1* defines the creation of a number (x) of money
units for the firm requiring the payment of wages: as is well known, money is in fact
created as a bank's spontaneous acknowledgement of debt towards the economy (see e.g.
Keynes (1930: 5-6), but also Realfonzo (1998: 39-43)). Without this creation, firms would
never be able to remunerate their production factors, even in the case of an ‘autoeconomy’
(see above). The second and third entries define the transfer of the same units from the firm
(entry (2)) to its workers (entry (3)), through the bank's balance sheet owing to the banking
nature of money. This double entry represents in fact the debit of the firm and the credit of
its workers for current production. Entry (4) defines the restitution of the means of payment,
surrendered by workers in order to be credited with the newly-formed deposit (see Table 1
for the result). As Parguez puts it, ‘[m]oney hoarding is logically impossible’ (Parguez 1984: 115,
our translation).37 Indeed, entry (4) is the sine qua non condition for workers to be really paid
for current production.
Entries (1) to (4) are given in one and the same ‘impulse’, and are logically simultaneous.
They epitomise the circular flow characterising every payment. They substantiate the view
that the distinguishing feature of modern banking -- in contrast to non-bank financial
intermediation -- is to issue payments within the economy. Precisely, the monetary aspect
of any payment is a wave-like emission; it is a flux-reflux occurring instantaneously. The
circular flow of money, and the nature of ‘monetary payments’, may therefore be
represented graphically as in Figure 1.
11
B
(1)
(4)
W
F
(2)
(3)
B
Figure 1
Every time a payment is made, the four flows depicted in Figure 1 are issued necessarily
and simultaneously (F and W stand for the payer and the payee respectively). If only flows
(1) and (2) were issued, then the payment would be aborted, and the result of the whole
operation would be nil (as it would be if only flows (3) and (4) were emitted). Particularly, if
flow (4) were left out, or issued later than flows (1) to (3), then the payee (W in the case at
hand) would receive a promise to pay only (i.e. the bank's spontaneous acknowledgement
of debt). For the payee to be really paid, (s)he must obtain a claim over a bank deposit,
certifying that (s)he owns a real good in its monetary form. In fact, flow (4) completes the
payment by crediting the payee with a deposit that testifies objectively the restitution of the
means of payment to the issuing bank. From the banking system's standpoint, ‘[m]oney
supply and money demand are simply different sides of the balance sheet’ (Wray 1990:
74).38 Clearly, owing to the vehicular nature of bank money, each payment entails the four
monetary flows depicted in Figure 1, and involves the payer (F), the payee (W), and a bank
(B), in what might be labelled a triangular (social) relation (see Ingham (1996) for an
interesting discussion of the latter).39
At present it is possible to verify that banks are not creators of money logically.40 In fact,
being simultaneously entered on the assets and the liabilities side of a bank's balance sheet,
for the payer (F*) as well as for the payee (W*), money flows literally define -- to use
Schmitt's (1975: 13-14) expression -- an asset-liability for every economic agent and for the
issuing bank as well (see Table 1*). The very idea of money as an asset-liability implies the
creation-destruction of the instrument necessary both to measure and to circulate output,41
every time a payment is issued by a bank.42 Strictly speaking, money as such is a purely
numerical (that is, incorporeal) counter. ‘Being a unit of account, money is neither a net
asset nor a net liability, but simultaneously an asset and a liability whose function is that of
“counting”’ the object of economic transactions (Cencini 1995: 13, italics in the original).
Hence, nothing is either created or destroyed in what might be called appropriately a monetary
intermediation, for money is neither a net asset nor a net liability of the banking system. ‘In
simple words, the creation of money is nothing other than the use of double entry book-
12
keeping to provide the economy with numbers’ (Cencini 1997: 273-4). Indeed, in our
numerical example ‘the bank creates x and x units of money in one and the same
“impulse”’, because ‘the creation of x units of money necessarily implies the simultaneous
creation of x units of money’ (Schmitt 1996a: 134). To illustrate this argument, let us
depict both the flows and their result in a single picture (Figure 2).
+ x (Workers)
+
(Bank) 0 _
time
-x (Firm)
Figure 2
Banks cannot create anything, the only possible net creation resulting from the intellectual
effort of human beings who project a more useful form matter and energy may be
moulded into. All that banks can do is to start from zero and maintain the statu quo, as their
balance-sheet identity easily demonstrates at any point in time. Yet the very process of
bank intermediation enables banks to create simultaneously a positive number of money
units (x) and the same negative number of money units (x), in any payment they issue
for the public. Starting from zero (0) banks can in fact create the pair {x ; x}, whose
elements add up to zero indeed (x x  0), but that also entails the creation of a positive
and a negative number (x) ‘counting’ the payment at hand objectively.43
To refer to the income generating-finance process, ‘[t]he definition of a negative sum of
money is quite precise: even in the case where the firm owns a sufficient amount of
“circulating capital”, the bank pays the factor of production, [W], by debiting the enterprise.
With respect to the bank, [W] holds a net credit (i.e. a positive sum of money) and,
correspondingly, the firm holds a net debit (a negative sum of money)’ (Schmitt 1996a:
133). It is thus possible to substantiate the argument put forth in Section 1, where we
maintained that no payment on the factors market is (or can be) financed with prior saving
logically. The same argument applies in fact to any other payment, on the goods market
and on financial markets as well, in so far as the payer is debited by the bank issuing the
payment even if (s)he owns a pre-existent (positive) deposit.
Let us briefly investigate a payment on the financial market, where an already-existing
deposit is transferred from its initial holder, IH, to a borrower. Suppose indeed that client
C asks his bank for a ‘consumption loan’. If C can satisfy the bank's managers with the
13
necessary guarantees of repayment at the due date, the loan is granted (at the negotiated
interest rate). In bookkeeping terms, the result is entered as (2) in Table 2 (where y < x).
Table 2
Bank
liabilities
assets
(1) IH
x£
F
x£
(2) C
y£
IH
y£
F
x£
(3) IH
C
x - y£
y£
The first entry (1) in Table 2 records the result of the current income generating-finance
process, inasmuch as firms are indebted towards the banking system for the newly-formed
deposits (on the simplifying assumption that they do not have a wage-fund at their disposal
to compensate their current debt with a pre-existent credit). The second entry (2) is the result
of bank intermediation as requested by one of its clients, C, who borrows a part (y) of the
income owned by IH. Entry (3) simply is the net outcome of the two previous entries, and
demonstrates that IH and C have, together, the purchasing power necessary to consume
total current output, that is, the very object of F's debt.
Now, it might be useful to observe that the monetary flows giving rise to entry (2) in
Table 2 are the sine qua non condition for the exchange between C and IH on the financial
market. Let us consider both the monetary aspect and the financial aspect of the relevant
bank intermediation in a single picture (Figure 3).
-y B
+y
(1)
(4)
+ y claim on a bank deposit
C
-y non-bank financial claims
(2)
-y
IH
+y
(3)
+y
B
-y
Figure 3
To concentrate attention on monetary flows first, one may observe that y units of money
are created positively and negatively for both agents, C and IH, in one and the same motion (i.e.
14
an electric impulse). In bookkeeping terms, C is credited-debited with y units of money
(flows 1 and 2), as is the case for IH (flows 3 and 4) simultaneously.44 The purpose of this
monetary intermediation is precisely to enable C to borrow the requested income from IH. It
is testified by C's cession of non-bank financial claims (e.g. securities) in exchange for a
claim over a bank deposit previously held by IH. Bank financial intermediation is indeed the
transfer of current purchasing power from present income holders to borrowers, in
exchange for the right given to lenders, IH, to withdraw in the future an equivalent deposit
(inclusive of interest capitalisation) originally owned by C. As the late Sir John Hicks vividly
noted in his posthumous Market Theory of Money:
The purchaser of a bill is, in effect, making a loan to the issuer; he is willing to lend,
in this form, because he is assured [...] that the loan, when the time comes, will be
repaid. [...] The lender has just to wait until the “ship comes home”. Even before that
happens, the bill is represented by the cargo, or some part of it, so that the lender can
think of himself as entitled to something more than a promise; indeed, as we saw, he
has something against which he can exercise a legal claim.
(Hicks 1989: 52)
To sum up, one can observe that payments on the factors market as well as on the
financial market are carried out through the circular flow of money, leaving behind a series
of bookkeeping entries that define the result of, respectively, the formation and the transfer
of money-income. It should take only a moment's reflection to convince the reader that
payments on the goods market are issued according to the same principle, firms taking the
place of income holders in an operation that represents the consumption of current output
in economic terms, that is, the destruction of money-income (see Schmitt (1984: 405-27)
and Cencini (1988: 82-97; 1995: 15-21) for further developments).
The conclusion of this line of argument is that monetary and financial intermediation
are the two faces of every payment, and can be understood only by a rigorous investigation
of the book-entry nature of money. Within any national economy, bank money is
endogenously issued as the numerical means of payment every time an economic
transaction takes place, the object of the latter being output under the form of a bank
deposit. As we have been trying to show, income is formed (on the factors market),
transferred (on financial markets), and destroyed (on the goods market) via bank
intermediation in its double function of ‘money-purveying’ and ‘credit-purveying’ -- to use
Keynes's words. It is thus possible to observe, ultimately, that every payment is analogous
to the emission of a quantum of light, in the sense that it has both a wave-like characteristic
and a corpuscular characteristic. The wave-like emission is the monetary flow of positive
15
and negative numbers; the ‘particle’ is the associated real flow of output under the form of
bank deposits, which are thus a store of value in the ultimate analysis45 (Figure 4).46
Deposit formation
-x
Wave
F
+x
Particle
F
-x
Deposit transfer
+x
W
-x
-x
W
+x
W
+x
W
-x
Deposit destruction
+x
IH
-x
IH
+x
-x
+x
F
-x
IH
+x
IH
-x
F
+x
chronological time
t
t"
t'
Figure 447
To quote Vallageas, ‘[t]he object of the circuit cannot be anything else than the value of the
real object, because money does not exist indeed: it is but a form of the real object, called
commodity’ (Vallageas 1985: 51, our translation).48
3. An example of bank (dual) intermediation: the clearing system
So far, to simplify discussion we have assumed a monetary production economy with a
single bank, B, that could also be considered analytically as the banking system as a whole.
To provide further analytical evidence in support of the argument we have been
developing, it is time to introduce the two tiers of the banking system explicitly. In fact,
modern payment systems involve a multitude of banks within any developed economy, and
often a transaction implies the intervention of more than a single bank for the payment to
be made. This raises the question of how any bank, B1, can make a payment in favour of
another bank, B2, within the same monetary system.
Assume, for example, that the above-analysed operation on the factors market, between
a firm and its workers, involves Barclays Bank and Lloyds Bank as, respectively, the bank
of the payer (F) and the bank of one of the payees (W). Let us represent in Table 3 the
bookkeeping result for the payment of wages as recorded in the balance sheets of the
commercial banks.
16
Table 3
Barclays Bank
liabilities
Lloyds Bank
Lloyds Bank
liabilities
assets
x£
F
x£
W
assets
x£
Barclays Bank
x£
If the two banks represented in Table 3 were one and the same (branch of the same) bank,
the result would be identical to the double entry recorded in Table 1. Now, since we are
confronted here with a payment involving two distinct banks, we also have to deal with the
resulting interbank imbalance. In fact, the double book-entries in Table 3 testify that -- as a
consequence of the payment on the labour market -- Barclays Bank has a debt towards
Lloyds Bank. If so, then what?
As is well known among both practitioners and experts of banking systems, ‘[t]he banks
do not accept bank money in interbank transactions, but ultimately require their claims to
be settled in central bank money’ (Deutsche Bundesbank 1994: 46). Indeed, as is the case
with the public, no bank whatsoever can make a payment on its own simply by issuing its
spontaneous acknowledgement of debt towards any other bank within the national
economy. In so far as every payment concerning the (non-bank) public must be issued by a
third party (i.e. a bank), as the examples of the previous sections have shown, each
transaction in the interbank market -- that is, the market where commercial banks settle
their reciprocal debts -- has to be literally monetised by the intervention of an institution
super partes. As Graziani neatly puts it, ‘[t]he role of the Central Bank is in fact of acting as
third party between single banks so far as their reciprocal payments are concerned’
(Graziani 1990: 18). This is tantamount to saying that the essence of central banking is to
catalyse interbank payments, the central bank acting as the bank of the various commercial
banks operating in a pyramidal system where the latter deal with the public (i.e. firms and
households, whereas the general government sector usually banks directly with the central
bank)49 (Figure 5).
Central bank
Bank 1
Client 1
Bank 2
Client 2
Figure 5
17
Client 3
Client 4
Let us suppose, to simplify, that the payment recorded in Table 3 is the unique
transaction over the period (say, a business day) considered for the settlement of interbank
imbalances. The central bank has to intervene in order to clear the reciprocal positions of
Barclays and Lloyds, so that the latter can really be paid for its transaction with the former
by the end of the day. As a central bank official has it, ‘the Bank of England operates the
core of the payment system, effecting the transfers between the banks which are direct
members of the system’ (Trundle 1998: 1). By holding settlement accounts for all banks
participating in CHAPS,50 the Bank of England plays indeed the role of monetary
intermediary between Barclays and Lloyds (see Figure 5 for the wave-like emission of
central bank money), taking over both the debt and the credit formed in the ‘horizontal’
interbank market, and substituting them with two corresponding ‘vertical’ relations (Table
4).
Table 4
Barclays Bank
liabilities
Lloyds Bank
liabilities
assets
assets
Lloyds Bank
x£
F
x£
W
x£
Barclays Bank
x£
Bank of England
x£
Lloyds Bank
x£
Barclays Bank
x£
Bank of England x£
Bank of England
x£
F
x£
W
x£
Bank of England x£
Bank of England
liabilities
Lloyds Bank
assets
x£
Barclays Bank
x£
Now, if the clearing operation ended up as in Table 4, the central bank would issue its
spontaneous acknowledgement of debt in an operation that ultimately leaves the payee's
bank (Lloyds) unpaid. In fact, at this stage of the payment, the positions in the interbank
system are not settled yet. Lloyds Bank has a credit towards the Bank of England, recorded
in its settlement account in central bank money to replace an equivalent credit towards
Barclays (the latter having a debt towards the central bank in replacement of the
corresponding debt towards Lloyds). In practice, ‘[t]he Bank [of England] does not pay
interest on balances held on these accounts’ (European Monetary Institute 1996: 617)51 and
the indebted bank must settle its position in central bank money by the end of the day (at
the latest).52 So, Lloyds spends its deposit at the Bank of England immediately, to purchase
the financial assets that Barclays is selling in order to capture -- either directly or through its
cash account held by the clearing institution -- the funds necessary to clear its position (that
18
is, to repay its debt) towards the central bank. ‘Whether these assets are deposited within
the clearing house's accounts as “real securities” of the member banks, or supplied when
final settlements are due, is irrelevant’ (Cencini 1995: 41). Overall, central bank (positive
and negative) balances are in fact compensated by means of a financial intermediation that
may be represented as in Table 5.
Table 5
Barclays Bank
liabilities
Lloyds Bank
liabilities
assets
Bank of England x£
F
x£
bonds
x£
Bank of England x£
bonds
x£
F
assets
W
x£
x£
Bank of England x£
Bank of England x£
financial assets
x£
W
financial assets
x£
x£
Bank of England
liabilities
assets
Lloyds Bank
x£
Barclays Bank x£
Barclays Bank
x£
Lloyds Bank
x£
Considering the whole clearing operation, one can thus easily observe the neutrality of
central bank intervention in the interbank system. The settlement accounts at the Bank of
England are cleared at the end of the CHAPS day -- but possibly instantaneously, within
real-time gross settlement (RTGS) systems --, in so far as both commercial banks are
credited-debited (or debited-credited) in central bank money, for an interbank payment that
ultimately enables them to transfer a purchasing power from one to the other. As a matter
of fact, the securities sold by Barclays to fund its imbalance towards Lloyds (or towards the
central bank, after substitution) represent a financial claim over domestic output, deposited
within the banking system. Specifically, the financial assets recorded in Lloyds' balance
sheet represent the goods and services that are the object of F's debt towards Barclays.
Hence they represent in the ultimate analysis W's property right over the fraction of current
production that corresponds precisely to his/her remuneration. Indeed, F's debt recorded
by Barclays Bank has the current output owned by W as its object (as would be the case
with a single bank, see Table 1), the whole transaction being mediated by the two tiers of
the interbank payment system.
Now, the preceding discussion may be referred to in order to invalidate the traditional
analysis underlying the lender-of-last-resort (LLR) function of the central bank. As Moore
19
observes, ‘[t]he terminology “lender of last resort” has come to be associated with lending
to financial institutions that are in serious difficulty’ (Moore 1988b: 119). In terms of
‘critical realism’,53 from this ‘partial event-regularity’ most (PK) studies in monetary
economics have proceeded on the assumption that ‘[c]entral banks are the residual
monopoly suppliers of domestic liquidity. They are always able to buy unlimited quantities
of assets for their portfolios. They finance these purchases simply by issuing their own
liabilities, which are domestic money’ (p. 275). In the light of the distinction between
monetary and financial intermediation, the confusion between the money-purveying and
the credit-purveying function should be evident by now.
As a matter of fact, the clearing mechanism briefly investigated above makes it plain
that interbank debts are settled in central bank money through a transfer of selected eligible
assets between commercial banks. Central bank intermediation only provides the
(numerical) means of payment, the (real) object of it being non-bank financial assets
(securities) that have nothing to do with any alleged monetary creation whatsoever. Let us
reconsider our stylised example. In fact, the Bank of England does not buy the bonds sold
by Barclays for its portfolio. A quick look at the central bank's balance sheet in Table 5 -epitomising the result of any clearing operation -- shows that the bonds are simply
conveyed from the seller (Barclays) to the purchaser (Lloyds), in an interbank settlement
defining the transfer of a purchasing power between two private banks (for the payment
made between their respective clients, F and W). Hence, contrary to Moore's assertion, the
central bank does not finance the purchase of securities by issuing its spontaneous
acknowledgement of debt. Central bank's accounts are the mere instrumental device by
means of which the so-called LLR function enables domestic commercial banks ‘to comply
as rigorously as possible with the principle of the daily balance of credits and deposits,
limiting the risk that their activity could lead to an over-emission capable of modifying,
albeit temporarily, the money-output relationship’ (Cencini 1995: 44).
All in all, to focus on the issue central to this section, central bank intervention is not to
be mixed up with the medieval idea of seigniorage, because no single unit of purchasing
power is created in the whole clearing process. Money-income results from the
monetisation of current production costs only, even when the payer's and the payee's banks
are distinct as in the case at hand. Since W is a client of a bank different from F's one, the
latter has to recover -- through liability management -- the deposit originated by the credit
granted to the firm. Until this has been done, in fact, the bank of the payee has a promise
to pay only, an issue bound to raise the problem known as ‘payment float’ in the jargon of
settlement systems' experts.54 Owing to the vehicular nature of money, the spontaneous
acknowledgement of debt issued by Barclays conveys the information that Lloyds is indeed
going to be paid. In order to do so, Barclays must issue bank bonds or, more generally, has
20
to sell financial assets on the interbank market, so as to borrow from its counterpart (either
directly or, more probably, via central bank mediation so as to make it seem at first sight a
loan of last resort) the newly-formed purchasing power necessary for the final settlement.
The disequilibrium in the interbank market (see Table 3) is cleared daily -- or immediately
within RTGS systems -- through the workings of the clearing process, where the LLR
intervention of the central bank is, in theory and in practice as well, a mere intermediation
(involving both a monetary and a financial aspect) within the national banking system.55
Conclusion
A brief analysis of modern payment systems that distinguishes the twofold (and
simultaneous) function of banks as monetary and financial intermediaries has been
attempted here, along the lines of the endogenous-money debate. A monetary theory of
production explaining the income generating-finance process through the distinction of
monetary and financial intermediation may be an important step towards the understanding
of the workings of book-entry payment systems. So much so that nowadays the
development of both electronic funds transfer systems and e-money products makes it
perhaps more difficult to grasp the very nature of money by simply looking at banks'
balance sheet composition (and expansion).56 Further, considering the monetary circuit as
the movement of the money stock among bank depositors does not go to the root of the
phenomenon. The relevant theoretical analyses put forth by leading ‘circulationists’ (also
dubbed circuitistes) do not go so far as to consider the asset-liability definition of bank
money. As Deleplace and Nell (1996: 12) point out in their "Introduction" to the PostKeynesian and circulation approaches to money, the exact meaning of monetary
endogeneity remains ambiguous in both schools of thought. The ambiguity is reinforced by
a rather loose conceptual analysis of money and credit, the two being often conceived of as
proxies for the same ‘monetary object’. Yet, ‘explaining the peculiarity of money,
specifically how it differs from finance, is a necessary piece of any theory of a monetary
economy’ (Deleplace and Nell 1996: 33), which is precisely what this paper strives to
clarify.
An in-depth investigation into the very process of (endogenous) money emission has
perhaps its most useful implications for the analysis of actual macroeconomic pathologies
such as inflation and unemployment (see e.g. Cencini (1996: 51-60) and Schmitt (1996b:
96-105)). By explaining the anatomy of monetary production economies, where the
banking system intervenes as a pure intermediary between economic agents, the new
monetary theory can ultimately highlight the origin of the peculiar discrepancies existing in
a disorderly payment system. Starting from the mechanisms governing monetary order, and
21
in particular from the vehicular nature of bank money, one can indeed explain why a given
domestic economy suffers from an excessive demand that may have a depressing effect on
money's purchasing power. This ‘structural’ monetary analysis of a macroeconomic
morbidity like inflation is based on an economic framework in which the (logical)
distinction between money emission and financial intermediation is not yet conformed to
empirically in present-day banking systems. The current endogeneity-of-money view and
the related theory of banking activity fail to recognise this disorder, so that our notes on the
workings of modern payment systems have to end here.
22
Notes
*
This paper originates in a number of stimulating discussions the author had with Prof. Victoria Chick,
Prof. Sheila Dow, Dr Giuseppe Fontana, Prof. Geoff Harcourt, Prof. Malcolm Sawyer, and Dr Alberto
Zazzaro, as well as with other participants in the Second Postgraduate Economics Conference at the
University of Leeds (UK) of 7 November 1997. The author also wishes to thank wholeheartedly Prof.
Alvaro Cencini, Prof. Victoria Chick, Curzio De Gottardi, Prof. Sheila Dow, Dr Giuseppe Fontana, Prof.
Augusto Graziani, Prof. Peter Howells, Nadia Piffaretti, and Dr Alberto Zazzaro for constructive criticism
of earlier versions of the paper. Nadia Piffaretti also provided bibliographic assistance, and Simona Cain
made an invaluable contribution in improving the style of the English manuscript. The result, however, is
the author's sole responsibility, and the usual disclaimers apply. Financial support by both the Swiss
National Science Foundation (grant number 81FR–048788) and the Cultural Commission of Canton
Ticino (grant number 2966/97) is gratefully acknowledged.
1
See Musella and Panico (1995: Part I) for the leading PK analyses at the time of the (1957-9) British
Committee on the Working of the Monetary System (known as the Radcliffe Committee).
2
See also several PK contributions in the important volume recently edited by Deleplace and Nell (1996).
3
Recent critical reviews of PK monetary economics are provided by Cottrell (1994) and Hewitson (1995).
Moore (1988b: Chapter 8) and Dow (1997: 61-7) explore in detail Keynes's analytical standpoint across his
monetary writings.
4
Moore (1988b: 195), however, pertinently observes that Keynes already used to distinguish between the
two functions of the banking system -- i.e. ‘money-purveying’ and ‘credit-purveying’ -- in early drafts of
his (1930) Treatise on Money. Hence, albeit basically correct, the very synthetic concept of credit-money
does not help us to clarify the point, and may even lead one astray.
5
Moore's (1988b) influential book contains numerous passages where this distinction is blurred, as pointed
out by Sawyer (1996: 59).
6
To quote but an example: ‘An offer to supply goods is simultaneously an offer to demand money. [...] An
offer to supply goods is simultaneously an offer to demand transactions deposits’ (Moore 1989a: 482).
Similar statements can easily be found in several other PK contributions.
7
In his public lecture at University College London, Kaldor, too, spoke of the banks' role ‘as suppliers of
credit’ (Kaldor 1970: 7).
8
To quote Tobin, ‘intermediation permits borrowers who wish to expand their investments in real assets to
be accommodated at lower rates [of interest] and easier terms than if they had to borrow directly from the
lenders. If the creditors of financial intermediaries had to hold instead the kinds of obligations that private
borrowers are capable of providing, they would certainly insist on higher rates and stricter terms’ (Tobin
1987 [1963]: 275).
9
Note that from this standpoint the banking sector cannot be distinguished from other firms functionally.
It trades in bank deposits as, say, a merchant would trade in bottled wine, both trying to optimise their
input-output matrix so as to maximise profits and market shares by handling liquidity.
10
In what follows, the terms ‘bank’ and ‘banking firm’ will both refer to commercial banks alone. When
reference is made to both the central bank and the commercial banks operating within the same payment
system, the expression ‘banking system’ will be used. See Section 3 for elaboration on this point.
11
From a macroeconomic viewpoint, the evidence that banks may buy non-marketable securities in exchange
for marketable deposits (see e.g. Moore (1998: 344-8)) does not conceptually affect the basic principle we
are addressing here, which concerns the double-entry nature of any financial intermediation.
12
Wray (1995: 280) emphasises that the liquidity-preference concept ‘is a short-hand way of referring to a
very complex economic behavior’, which in its broadest form may be viewed as a preference for a liquid
asset over less liquid (or illiquid) assets (Dow and Dow 1989: 148-9). To put it another way, ‘[l]iquidity is a
characteristic of assets’ (Wray 1992: 301). See also note 9.
23
13
Money is often compared to ordinary language, in the sense that both are said to be valuable according to
people's willingness to use them for (facilitating) social interactions. As far as the dismal science is
concerned, the argument centres on economies of scale and revolves around transactions costs. ‘To state
the obvious: the advantage of money presupposes a monetary system. We have here a typical example of
the way in which the rational choice explanations of neoclassical economics soon became locked into
slightly absurd circularities. Money is an advantage to the individual only if others use it; but, according to
the theory, they can only rationally use it if it can be shown to be an individual advantage’ (Ingham 1996:
515). For an interesting though difficult treatment of the money-language analogy, see M. Shell (1982)
Money, Language and Thought: Literary and Philosophical Economies from the Medieval to the Modern Era, Berkeley:
University of California Press (especially Chapter 1).
14
See also Hicks (1967: 59).
15
The cost of this central bank facility is seen as either exogenously given or varying endogenously with the
proportion of central bank's intervention in the interbank market. These competing views within PK
monetary theory are labelled, respectively, accommodationism and structuralism (see e.g. Palley (1991),
and Pollin (1991)). Recently Palley has put forth an attempt to reconcile these two interpretations, by
arguing convincingly that ‘the differences between these competing approaches can be understood in
terms of (1) the treatment of the interaction between the monetary authority's policy reaction function and
the asset and liability management activities of banks, and (2) beliefs regarding the feasibility of predicating
monetary policy on targeted adjustments of the quantity of reserves’ (Palley 1996: 585). Cf. infra, Section 3.
16
See also Weintraub (1978: 66-7). To claim the opposite would reinstate a dichotomous view of monetary
production economies, according to which ‘real’ magnitudes are all that matters and the ‘monetary sector’
is only a veil.
17
Of course, actual wages may result from negotiation between F and W, which may also involve both
parties' expectations about the short-term inflation rate. However, the point worth stressing here is that
the result of this bilateral process is a number of wage-units paid to W and recorded ipso facto by the
banking system which monetises the operation.
18
It might be worth recalling here that in A Treatise on Money Keynes proposes ‘to mean identically the same
thing by the three expressions: (1) the community's money-income; (2) the earnings of the factors of production; and
(3) the cost of production’ (Keynes 1930: 123, italics in the original).
19
Note that economic activity logically cannot invalidate Lavoisier's principle of the conservation of both
matter and energy (‘nothing is created, nothing is destroyed’). The result of (human) labour is a creation
insofar as the factors of production mould matter and energy according to a thought-project (see Schmitt
(1984: 91-3) and Cencini (1985: 75) on this point). The payment of wages is the operation that integrates
the result of production within a number of money units, thus forming a net value in the whole economy.
20
Over the whole production period (say, a calendar month) an arithmetical record of the wages accruing to
workers may be kept by their employer, who runs it down to zero at the very moment wages are paid.
This proves that the payment of wages, which is an instantaneous operation, refers in fact to a period of
time taken as a whole. Indeed, ‘wages are the instantaneous definition of a production occupying a finite
period of time’ (Schmitt and Cencini 1982: 139). In this precise sense, the payment of the wage bill defines
a quantum of time, that is, an indivisible unit (Schmitt 1982).
21
We leave aside the question of interest rates, because it is not germane to the present analysis, centred on
the macroeconomic laws (of a logical nature) governing a monetised production system.
22
Two-way causality between loans and deposits exists at any point in time because of double-entry
bookkeeping. Owing to the very principle of double entry, it is logically impossible to claim that the entry
on the one side can be valid before the corresponding entry on the other side of the balance sheet is made.
If, for practical reasons, a banker's stroke of the pen is made on the liability side first, the whole operation
has its economic meaning only when the second half of it appears on the asset side (and vice versa).
Moreover, electronic payment systems nowadays have made it technically possible to record any operation
24
on both sides of a bank's balance sheet at the same time (that is, by the same electric impulse),
demonstrating in practice the present theoretical argument.
23
On the concepts of ‘initial’ and ‘final’ finance, see e.g. Lavoie (1987: 69) and Graziani (1990: 14-16), who
elaborate on Keynes's Economic Journal (1937) finance motive. See also Chick (1996: 14), who stresses the
importance of distinguishing ‘finance’ from ‘funding’.
24
The accounting law of double entry guarantees that any form of economic behaviour does not alter the
mechanic two-sided recording of its actual result in the banking system's balance sheet. In the case of
(even purely speculative) operations with the foreign sector, only the deposits' property rights move across
national borders (see e.g. Hicks (1967: 7)). As Stanley Fischer has it, ‘an American wishing to purchase
British goods would instruct his bank to transfer ownership over his deposits worth the appropriate amount
to the account of the British exporter’ (Fischer 1983: 15, italics ours). Any movement of financial claims
leaves the object of these claims (that is, a bank deposit) in the banking system where it defines a positive
purchasing power over domestic output, as was clearly perceived by Rueff in his analysis of international
payments (see e.g. Cencini (1995: 152-4)).
25
Note also that fiat money (i.e. coins and bank notes) is merely a physical representation (of a fraction) of
bank deposits, and as such its bookkeeping record is logically entered into the banking system -- namely,
into the central bank's balance sheet. The claim made by Ann-Marie Meulendyke (1988: 391) -- a senior
economist at the Federal Reserve Bank of New York and a University of Chicago graduate -- that
‘[c]urrency, for instance, is not a bank liability’, does not go to the root of the phenomenon. See also
Palley (1991: 398, n. 3).
26
Rossi (1997: 150) provides a very short description of how this destruction happens.
27
‘La création des revenus n'est pas une opération de crédit, mais les revenus créés sont aussitôt l'objet d'une
opération de crédit. Dès que les revenus sont nés, ils sont donc prêtés par leurs titulaires jusqu'au moment
de leur « retrait ». C'est dire que les revenus sont instantanément transformés en épargne ou, identiquement,
en capital’ (Schmitt 1984: 158).
28
Bank lending to finance consumption may be analysed in the same way. It simply is a transaction where a
deficit-spender on the market for produced goods borrows the required funds from a net purchaser of
financial assets, the whole operation being mediated and monetised by the banking system. As Moore has
it, ‘bank loans are made at the initiative of bank borrowers, not the banks themselves’ (Moore 1988a: 373).
By contrast with a loan to finance production, this time an already-existing deposit (i.e. prior saving) is lent
to the deficit-spending unit. But it is also possible to note that a modern analysis of bank money can bring
to the fore a macroeconomic law in the most rigorous terms. This law has indeed been worked out by
Schmitt over the last thirty years (see e.g. Schmitt (1975)), and may be referred to as the sales-purchases
identity. For every economic unit, the total (outgoing) flow of expenditures is identically equal to the total
(incoming) flow of earnings over any given period, because logically there can never exist either a net
purchase or a net sale for any agent in the whole economy. An agent's net purchase on the market for
produced goods is inescapably funded by a net sale of financial assets (for the same agent), because any
cession of a bank deposit -- either owned or borrowed -- in exchange for a commodity defines the cession
of a financial claim over domestic output. So, the concept of ‘convenience lending’ recently put forth by
Moore (1988b: 298) within the PK tradition may perhaps indicate that in the final analysis the
endogenous-money approach is correct in addressing the fact that any net seller on the market for
produced goods is, simultaneously, a net purchaser of financial assets (the reverse holds true, too). Indeed,
though still mixing up money, credit, and deposits in a rather confusing manner, Moore pinpoints that ‘the
act of sale of currently produced goods and services in exchange for money is exactly like selling on credit,
or buying a financial asset, or running a surplus, or saving, in the period within which it occurs’ (p. 299).
There thus seems to be a strong case for further research along these lines.
29
From this analysis, one can infer that pure financial operations -- like stock-market speculations -- are
neither deposit forming (that is, income generating) nor deposit destroying (income consuming) for the
economy as a whole, only the claim over existing deposits being transferred among agents in a
redistributive (zero-sum) process.
25
30
Strictly speaking, ‘[i]t is by no means true that money flows, for money is a flow. Surely, flows cannot flow’
(Schmitt 1996b: 88). So, reference to the stock of money (which can circulate within the economy at an
observable velocity) must be understood as indicating the existing mass of bank deposits (see e.g. Keynes
(1930: 34)). As a matter of fact, for any national economy the following identity may be written at any
point in time:  money stock   bank deposits.
31
See Schmitt (1986: 118-27) for an interesting comparison between physics and economics.
32
See Robertson (1937 [1922]: 29).
33
‘Initialement, la monnaie apparaît sous la forme d'un flux. Ce n'est qu'en fin de circuit que la monnaie se
constituera en stock’ (Lavoie 1987: 71-2).
34
Recall, by contrast, that PK monetary tradition focuses on the flows depicted by the movement of
(monetary) stocks.
35
The flow-account analysis has been set forth by Schmitt (1996c: 983). De Gottardi (1997) attempts to
apply it to both income formation and income destruction. It is worth stressing that a ‘flow-of-funds’
analysis -- like that carried out in Wray's balance-sheet approach to money (Wray 1990: Chapter 9) -- still
lies on a concept of flow as a moving stock. Albeit fruitful from the standpoint of financial intermediation
analysis, the models put forth by Wray (1990: 267-83) lack a rigorous and clear-cut distinction between
bank money (flow) and bank deposits (stock). In such a framework, monetary intermediation is simply
misunderstood, not to say ignored.
36
To stress the fact that entries in Table 1* are flows (and not stocks ‘on the wing’), in this paragraph we
shall italicise the actions represented in bookkeeping form.
37
‘La thésaurisation de monnaie est inconcevable en logique’ (Parguez 1984: 115). In fact, it is logically possible to
hold the result of a flow (that is, a stock), not the flow itself.
38
Wray (1990: 24) rightly notes that money has always been endogenously created, independently of the
existing institutional relations. Further, he defines money reflux ‘as the return of issued liabilities to the
issuer’ (Wray 1990: 25). However, he does not go far enough to observe the instantaneous reflux of money
as soon as the latter is created, in any kind of payment. Both the examples he gives (p. 25) refer indeed to
a material sign (bank notes, cheques) that can of course circulate within the economy (at a finite,
observable velocity) and be stocked in agents' portfolios as ‘a temporary abode of purchasing power’. As a
matter of fact, the argument put forth by Wray to support the endogeneity-of-money approach centres on
the view that ‘money is endogenously created as assets are produced and financed, and is endogenously
destroyed as positions are liquidated’ (Wray 1990: 73), the two phenomena being reported to be separated
in chronological time (so that it would be possible to calculate velocity). Similar ideas stem from an
analytical confusion between money and income (and between their respective circuits as well). They are
but a corollary of the ‘money illusion’ identifying flows with stocks ‘on the wing’.
39
In his 1966 LSE lectures, Hicks already noticed that ‘[e]very transaction involves three parties, buyer,
seller, and banker’ (Hicks 1967: 11). On the payment's triangular relationship, see also Graziani (1990: 11;
1994: 61-3). Analysis of a payment involving two distinct banks (the payer's bank and the payee's bank) is
dealt with in Section 3.
40
In Section 1 we already noted that banks are not creators of credit, because they are in fact intermediaries
between lenders and borrowers.
41
Note that the creation-destruction of money -- issued ex nihilo by banks -- is not pointless at all in the
macroeconomy. It is instrumental in measuring output objectively, as well as in circulating it among
economic units (that is, the non-bank public). See e.g. Cencini (1995: Chapter 1).
42
This is precisely what is yet misunderstood by both PK and circuit theorists, who -- being trapped in the
money-credit confusion raised above -- cannot see that money is created and destroyed in the same motion
necessarily. According to Wray, for instance, ‘the length of time between an act of spending (in which
money is created) and an act of payment (using the means of payment to destroy the debt and money) is
26
extremely variable’ (Wray 1990: 15). Specifically, the existence of money over a finite period of time is,
according to Graziani (1994: 21), the necessary condition in order to measure it. Yet, it is plain that ‘[a]
payment lasts the space of an instant and so does money’ (Cencini 1997: 274), because the latter is issued
every time the former has to be carried out, as is well put by Schmitt: ‘Money and payments are one and
the same thing. No money, if correctly defined, exists either before or after a given payment’ (Schmitt
1996b: 88).
43
See Schmitt (1984: 465-80) for a thorough explanation. Let us emphasise that whilst the expression x x
 0 may be considered tautological, it is nevertheless not a truism (or a battology). It contains indeed a
positive information, whereas the expression 0  0 (or x  x) contains no information at all. Notice also
that there exists a distinction between nil (whence ex nihilo) and zero, a distinction which is not merely
semantic or philosophical. Literally, nil means ‘nothing; no number or amount’ (The Concise Oxford
Dictionary of Current English, ed. by Della Thompson, Oxford: Clarendon Press, ninth edition, 1995, p. 920).
By contrast, zero is the arithmetical value denoted by 0, which can be written as x  (x), that is, more
simply, as x  x, x  (see ‘zero-sum’, op. cit., p. 1630).
44
For a verification, simply substitute F* and W* with, respectively, C* and IH* in Table 1* above.
45
This also explains why bank deposits are ‘generally accepted’ within the domestic economy. They actually
are the monetary form under which output exists before final consumption occurs. Clearly, money's
purchasing power does not depend on either banks' credibility or the imprimatur of the State, as is usually
thought of.
46
To simplify the picture, the banking system is implicit in Figure 4. See Cencini (1988: 87-96) for analytical
elaboration.
47
Note that t, t' and t" are points of time (i.e. instantaneous events).
48
‘L'objet du circuit ne peut être que la valeur de l'objet réel, car la monnaie n'existe pas vraiment: elle n'est
qu'une forme de l'objet réel, appelé marchandise’ (Vallageas 1985: 51).
49
For a modern analysis of the central bank as the bank of the State, see Cencini (1995: 46-9).
50
CHAPS stands for Clearing House Automated Payment System. For a detailed description of both the
workings of UK payment systems and their recent developments, see the second edition of the so-called
‘Blue Book’ published by the European Monetary Institute (1996: Chapter 15, especially pp. 614-34).
51
As a rule, central bank accounts for payment purposes in the interbank system do not bear interest. In
Germany, for instance, ‘[a]ccounts at the Bundesbank do not bear interest’, so that, in general, ‘[f]inancial
institutions maintain hardly any balances on their current accounts [at the central bank]’ (European
Monetary Institute 1996: 92 and 397).
52
Large-value electronic funds transfer systems (a reality of several domestic payment systems within
developed economies) usually provide so-called end-of-day procedures to enable final settlement of
interbank debts before the clearing house's closing time. Sale and repurchase agreements (repos) -- by
means of which securities are sold spot with the right and obligation to repurchase them at a specific price
on a future date or on demand -- are perhaps the most used financial arrangement to settle interbank
imbalances by the end of the clearing day. Generally speaking, fully-collateralised overdrafts are in fact the
most secure form of interbank settlements from a systemic-risk viewpoint. In this respect several
interbank payment systems within the European Union (EU) have recently moved towards a real-time
settlement protocol, working on a transaction-by-transaction basis in order to enhance both the efficiency
and the robustness of the overall payment system (national and international). For a recent overview of
the main features of electronic interbank funds transfer systems in relation to cross-border transactions,
see e.g.: Bank for International Settlements (1995) Cross-Border Securities Settlements, Basle: Bank for
International Settlements, March; European Monetary Institute (1997) EU Securities Settlement Systems: Issues
Related to Stage Three of EMU, Frankfurt am Main: European Monetary Institute, February.
53
See T. Lawson (1997) Economics and Reality, ("Economics as Social Theory"), London and New York:
Routledge.
27
54
In the language of a central banker, ‘[w]e can distinguish credit float and debit float. Credit float arises
when a bank debits a client's account before transferring the funds to the beneficiary's bank or when the
receiving bank delays crediting the beneficiary's account. Such float represents an interest-free loan from
the bank customers to their bank. Debit float is connected with the processing of cheques and arises when
a bank credits the payee before receiving money from [the] payer's bank or when the payer's account is
debited with delay after funds are paid to the payee's bank. In such case the bank customers have the
advantage of float at the expense of banks’ (Senderowicz 1998: 3).
55
In this connection, Realfonzo, referring to the work of Schumpeter, rightly notes that ‘clearing between
the debit and credit relations of the agents and amongst the banks constitutes “the core” of the payment
system’ (Realfonzo 1998: 40).
56
For a theoretical approach to e-money separating the money-purveying from the credit-purveying
function, see Piffaretti (1998: 14-17).
28
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