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Let’s have more talk of “magic money trees”

Summary:
The term ‘money’ has multiple meanings. In everyday speech, people might say, “Bill Gates has a lot of money”. In that case, they are using in the term interchangeably with wealth. In other cases, people might talk about how the Fed creates (base) money, or how commercial banks create (deposit) money. That’s an entirely different concept, as bank deposits are not net wealth. I have no idea whether or not Bill Gates has a lot of cash or money in bank accounts, but he certainly has a lot of wealth. When people talk about the Federal government spending “money”, they are implicitly referring to money as a real asset, real cash balances. When they talk about the Fed creating money, they are discussing a nominal asset. All of this is useful background to a recent FT

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The term ‘money’ has multiple meanings. In everyday speech, people might say, “Bill Gates has a lot of money”. In that case, they are using in the term interchangeably with wealth. In other cases, people might talk about how the Fed creates (base) money, or how commercial banks create (deposit) money. That’s an entirely different concept, as bank deposits are not net wealth. I have no idea whether or not Bill Gates has a lot of cash or money in bank accounts, but he certainly has a lot of wealth.

When people talk about the Federal government spending “money”, they are implicitly referring to money as a real asset, real cash balances. When they talk about the Fed creating money, they are discussing a nominal asset.

All of this is useful background to a recent FT article by Thomas Hale, discussing “magic money trees”:

In a wide-ranging attack on the economics profession published in the New York Review of Books, David Graeber, the anthropologist, paid particularly close attention to the concept of money.

He pointed to Theresa May’s claim, during the UK general election in 2017, that “there is no magic money tree,” which was part of the debate on austerity and government spending:

The truly extraordinary thing about May’s phrase is that it isn’t true. There are plenty of magic money trees in Britain, as there are in any developed economy. They are called “banks.” Since modern money is simply credit, banks can and do create money literally out of nothing, simply by making loans. Almost all of the money circulating in Britain at the moment is bank-created in this way.

Graeber, reviewing a new book from Robert Skidelsky, goes on to cite a Positive Money poll showing most politicians “don’t know” where money comes from. The think-tank, which has generally spearheaded a view of the economy predicated on the above observation about money creation, also drew on this precise reference to the May speech in 2017, here.

We’re not saying May is right on government spending. But is the magic money tree meme, which has circulated widely, a useful or insightful way to think about banks? The answer is straightforwardly no, irrespective of your politics.

Hale does an excellent job explaining why banks are not actually magic money trees, in the sense of being able to create unlimited amounts of money.  But there’s a bigger problem with the Graeber comment, he implicitly confuses money as a medium of exchange with money as wealth.  Theresa May was obviously referring to money in the sense of wealth—real resources available to governments.  Governments have no trouble creating lots of money in the sense of medium of exchange; look at Venezuela and Zimbabwe.  But those countries are not able to finance a lavish welfare state, despite their ownership of “magic money trees”.

Governments need real resources to finance expensive government programs, not just “money”.  A government’s monopoly on printing fiat money does provide it with a modest profit, which can be used to finance government spending.  But that’s already factored into the budget.  Unless you favor radically higher inflation rates, then the revenue from money creation will remain trivial relative to the size of the modern state.   And even if the government is willing to engage in hyperinflationary policies, the resources from money creation (called ‘seignorage’) remain far too small to finance the spending plans of the left.

Here’s the best way to think about the issue.  The central bank has a policy objective, or target.  The monetary policy that achieves that target will produce some revenue as a side effect.  The government is already spending that revenue; it is already a part of the budgeting process.  Don’t look to money creation as a source of additional government revenue.

I’m actually pleased that the left is using the metaphor “magic money tree”.  I may be a former academic with my head in the clouds, but I think I have a pretty good idea how average voters would interpret spending promises that were to be financed with magic money trees.  So please, don’t stop using that metaphor.

HT:  Sam Bowman

Let’s have more talk of “magic money trees”

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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