Money… how it works (video)

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The reason the workings of our monetary system are taught incorrectly is that the details of how it operates in practice are too complex for students to study in a reasonable period as part of an undergraduate course. Instead they learn an oversimplified cartoon version of reality. Teaching simplified models is not necessarily a bad thing so long as the choice of simplifications are well made. It is done all the time in physics and chemistry without problem. Unfortunately the choice of simplifications made in the teaching of our monetary system have led a great many economists to some disastrously wrong conclusions about the behaviour of money.

 

 

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  • Simon

    The bath tub has grown to the size of a duck pond over the last 55 years or so, with about 100X more money in the economy, and new debt being created faster than it was being paid off. The Public debt alone is forecast to be 1.5 trillion in 2015, which will be a doubling from when the Coalition were elected in 2010. The duck pond will be the size of a small lake if we carry on with the same growth in money supply over the next 50 years as previously.
    What are the consequences of having this huge and growing debt burden ? Higher tax, reduced public services, possible inflation to erode debt, higher interest rates in the future because our creditors may not believe they will be repaid, probable default, possible exchange controls as the government tries to confiscate people’s savings to pay for it’s obligations, and other undesriable effects.

    • Mick

      We won’t be having high growth in the money supply any time soon.

      Currently there are few people wanting to borrow and so the government is doing all the borrowing to prevent the bathtub emptying. The past 5 years, and probably the next five years or more will be a battle to stop the bathtub from emptying. The Japanese have been having this battle for 20 years!

      • Simon

        Agreed. The last 40 years have been an exceptional time, very unlikely to be repeated for a very long time. The government is borrowing as much as possible to make up for the lack of it in the private sector. The money supply has grown hugely since 1970, and especially between 1997 and 2008. People now wish to pay down debt, and banks are more cautious after the profligacy of earlier times. We need an injection of debt free money to replace the debt money, to prevent the Japanese situation. I think most people will be lucky to see the price of their house beat general inflation over the next 20 years, and in a way that is not a bad thing as it will make property affordable again for many.

    • Ralph Musgrave

      Simon,
      The national debt, contrary to popular belief, is not really a “burden”. First, the real or “inflation adjusted” rate of interest we pay on it is about zero.
      Second, if those much over-rated “bond vigilantes” decided they didn’t like the look of UK debt, that would have no effect whatever on the interest we pay on EXISTING debt. And the average maturity of UK debt is LONG compared to that of many countries (the US in particular). That is, a relatively small proportion of UK debt matures each year and may need renewing each year.
      Third, if the vigilantes really do raise the interest rate demanded for NEW UK debt, we just stick two fingers up at them and refuse to borrow. I.e. we just print money and buy back debt as it matures. And if anyone thinks that would have a huge inflationary effect should consider the fact that printing money and buying back debt is exactly what we and other countries have done BIG TIME recently under the guise of QE.
      But to the extent that QE does have too inflationary an effect, that’s no problem: we just raise taxes. And the latter would have a DEFLATIONARY effect that would counter the INFLATIONARY effect of QE.
      Note that the latter tax hike WOULD NOT depress living standards or necessitate the “cut in public services” to which you refer. The purpose of the tax hike (to repeat) would simply be to prevent excess demand and inflation. I.e. the purpose of the tax hike would just to keep the economy humming along at capacity.

      • Simon

        I would much rather the government did not borrow at all, and created it’s own money, or at least the Bank of England did free from political influence. People relying on an income from the interest on gilts would have to look elsewhere.

      • John Morrison

        Are you saying that we can do reasonably well by gaming the existing system? That is by keeping inflation matching interest rates to cancel out their effect. I suspect that is how living standards of ordinary people in the UK were raised during the 1970s. I remember the yearly wage rises. You knew that prices had gone up too but it still felt good. Money was not invested in the hope of gain but it was still invested to reduce its loss in value. It seems an astonishing effect of propaganda that we are afraid of inflation when most of us are up to out necks in debt.

  • Conrad Jones (Cheam)

    Excellent Video.

    The root cause of misleading information has it’s heart at the Academic Teaching Level. Politicians and News Media often rely upon these Text Books as reference material, and are confident in people who have passed examinations in theses Subjects even if the Theories are incorrect.

  • Ralph Musgrave.

    Congratulations to the Positive Money team for drawing attention to that Michael Reiss video. I love it. It’s much the best and simplest introduction to the subject I’ve come across.

  • John Morrison

    Excellent video. Banks exchanging personal IOUs for bank authorised spendable IOUs is a very illuminating description that I have not come across before.

    The problem with the bathtub model is that is only describes spendable IOUs. Everlasting money is not included in the model. This seems reasonable as spendable IOUs now predominate but although the quantity of everlasting money is small, it is the very basis of the reforms being proposed. If we want to understand the dynamics of moving to everlasting money then we need a model that includes it.

    • Mick

      You are completely right about the bathtub… its an approximation based of ignoring the everlasting component. But cramming so much into a 13mins was already hard enough! Maybe one day I or someone else will make an extended version with extra detail… Get me some funding and I’ll start tomorrow! :-)

      • John Morrison

        I appreciate that brevity is important and certainly your economy with words and the complete lack of hysteria in the voice you use do a lot to make the video accessible. My worry is that already comments seem to be more focused on solving the bathtub problem rather than a move towards everlasting money. I understand that a lot of work will have gone into what you have done and you will probably have to repair your life. Maybe I should prepare a video explaining simply how a fair money system should work using everlasting money issued by the nation in return for the service of its citizens but I don’t mind at all of you beat me to it. I see need to put across more strongly that everlasting nationally issued money is the solution and that was how it was always meant to be.

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  • Anthony

    I don’t have a problem with the bath tub metaphor ignoring “everlasting money”… it doesn’t really, you just need to imagine an “empty” bath tub having a little puddle that remains… that’s the everlasting money.

    If you really wanted to incorporate it into the metaphor, just draw the tub with the drain slightly up the side of the tub.

    I *do* have a problem with the tap and the drain. They imply that there is something (the water/money) that exists outside the tub when the whole point is that it doesn’t. However, that’s true for every simple physical metaphor I can think of too so it’s good enough… it just breaks down at that point…. which is fine as long as that’s recognised.

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