It’s the grease that makes the economic wheels turn. But ask where your taxes go after you pay them; or how a bank makes a loan; or what it means when you hear central banks are ‘printing money,’ and you’ll get different answers depending on who you talk to.
Why should you care? Because a grasp of how the modern monetary system works is essential to understanding everything that has to do with money – from government austerity and stimulus spending, and everything in between.
Warren Mosler spent much of his life attempting to understand what modern money is, what drives its circulation, and how the internal ‘plumbing’ of the modern monetary system sits together.
What he discovered is a stranger picture than you would imagine. A word of warning, Mosler’s views on modern money are highly unconventional, running contrary to just about every economics textbook.
Q&A with Warren Mosler
Chris Lowe (CL): for readers who might not already know, CNBC calls you ‘one of the brightest minds in finance.’ You regularly comment on monetary matters and you’ve written two ground-breaking books on fiat money: Seven Deadly Innocent Frauds of Economic Policy, and Soft Currency Economics. But you’re about the furthest thing from an armchair theorist anyone can imagine.
You started your career in retail banking in the early 1970s, going on to work at Wall Street broker Bache & Co., at Bankers Trust, and at Chicago investment bank William Blair & Co. Then, in 1982, you cofounded your own investment fund, Illinois Income Investors (III).
It was a spectacular success. III had only one loss-making month in the 15 years you were at the helm. And financial newsletter MARHedge ranked it No.1 in the world through 1997, when you left.
Later, you even developed your own automobile line, Mosler Automotive. (Star Wars director George Lucas was the first to take delivery of one of his models – a supercharged, intercooled, V-8 supercar, the MT900S.)
And finally, you’re a pioneer in a new field of economics called Modern Money Theory (MMT)[i] that’s making big ripples in academia and on the policy level.
So, what first got you interested in business and Finance?
Warren Mosler (WM): The first thing was just getting out of school and going to work. I went to work in a small savings bank in my home state of Connecticut. That was probably my first interest – working in money and understanding how it works and how it doesn’t work.
CL: You have a BA in economics. But you’re largely self-taught. Can you remember any economics books that made a big impression on you?
WM: I read very little. But I read one of John Kenneth Galbraith’s books in the 1960s. I liked the idea that the world understands things one way when in fact it’s another way – which is what he was talking about. I used to take apart watches to try to figure out how they worked. I was that kind of kid.
CL: MMT describes the day-to-day realities of using government-backed tokens as money instead of gold or some other commodity. Is it fair to call MMT the study of the fiat money system?
WM: It’s the study of how any monetary system works. There’s quite a good level of understanding of how the gold standard worked, but almost no understanding of how a fiat system works. That’s why MMT has gotten that kind of attention.
CL: Up to 1971, the world economy was on the gold standard. Foreign central banks could still, theoretically at least, convert their dollar reserves into gold. And foreign currencies were exchangeable for dollars at a fixed price.
Since 1971, the supply of dollars is no longer linked to the supply of gold. And currencies ‘float’ against one another, based on supply and demand.
Why did the system change?
WM: No one goes off the gold standard because it’s working so well. We go off it during war, when it’s in the way of funding military spending, or during depressions, because it breaks down horribly. That’s what happened in the U.S. Most people forget. But we first exited the gold standard during the Great Depression.
CL: What led to that first break with gold?
WM: A good starting point is the Panic of 1907. That was a very bad gold-standard depression. The whole money system pretty much went down. And it got bailed out by a consortium of private banks led by J.P. Morgan.
After 1907, Congress decided we needed to have a central bank – the Federal Reserve – so that this would never happen again. And in 1913, it passed the Federal Reserve Act. This created the Federal Reserve System, America’s central bank.
Then, sure enough, in 1929, it happened again… we got another gold-standard depression. The idea that these gold-standard panics wouldn’t happen again with a central bank didn’t work.
In 1933, about half of the commercial banks in the U.S. were closed. They were insolvent. In 1934, they reopened off the gold standard and with deposit insurance. And there’s never been a gold standard-type panic since.
[In 1934, President Franklin D. Roosevelt signed the Gold Reserve Act. This limited the ability to convert dollars at a fixed exchange rate to gold to foreign central banks. It also revalued gold from $20 an ounce to $35 an ounce.]
It was going off the gold standard in 1934 – not the creation of the Fed – that prevented the kind of depressions we used to have. But they left the Fed there. Somebody had to vote on interest rates. So they just left it there.
CL: What was the trigger in 1971?
WM: Under the gold standard, the government would buy or sell gold – $35 an ounce was the most recent price they did that at. It was also supposed to be making sure it had sufficient gold reserves to back the dollars in circulation. But it didn’t…
A lot of people see 1971 as the big change in our monetary system. But we’ve really been ‘off gold’ since 1934. Of course, it wasn’t until 1971 – when France asked to convert its growing pile of dollar foreign exchange reserves into gold – that we went off the gold standard officially.
But if France had asked for the gold in 1935, we probably would have said no and formally gone off gold then. But I don’t know that. I’m just musing on what happened.
CL: So why do we all value paper money if there’s nothing tangible backing it?
WM: American economist Hyman Minsky used to say that anyone could print money… it’s a question of having somebody accept it and give you something in exchange. If I print my own ‘money’ and try to buy something with it, why would you sell me something? If I come with a bunch of raffle tickets, and there’s no prize, why would you buy them?
CL: I see your point. Why is there demand for fiat money, then, if it has no intrinsic value?
WM: Let’s start at the beginning… The government wants to provision itself. It wants soldiers. It wants a legal system. It wants to move goods and services that are currently in the private sector to the public sector.
How does it get them there? How does it move people from the private sector to the public sector?
Well, it could take slaves in a war and force them to do things for it. That used to be common. The British used to go into bars at night and hit people on the head and drag them out. They’d wake up in the morning on a ship in the Royal Navy.
There are different ways to get people out of the private sector and into the public sector. We pretend to be more civilized. The first thing we do is impose a tax on something that nobody has, such as U.S. dollars.
So, imagine, on day one, George Washington says, ‘Okay. There is this new thing called the U.S. dollar. And everybody owes me $100 in taxes. Or else you’ll lose your house or something.’
Of course, nobody has any dollars. What are they supposed to do to get them?
So, Washington says, ‘I’ll pay you $30,000 to serve in the Continental Army.’ Or, ‘I’ll pay your $10,000 for a new road.’ Or, ‘I’ll pay you $5 for a chicken.’
The government imposes a tax on something nobody has. Then it imposes a penalty for nonpayment of that tax. This creates what we call ‘unemployment’ – people looking for paid work that pays in that currency. Unemployment is not people looking for volunteer work at the American Cancer Society. They’re looking for money.
The reason we’re all working for U.S. dollars is because there is this incessant liability – this drain out of the economy – we call taxation. This creates a shortage of dollars. People are constantly faced with the need for dollars to pay off their tax liabilities.
Without tax payments at the end of the chain, fiat money loses its value. For instance, when the Civil War ended, the South didn’t collect taxes anymore. And the value of Confederate currency went to zero. It kept a million men in the field for five years. But it lost its value when the South could no longer collect taxes effectively. Or take somewhere like Lebanon. When tax collection ceased there, the currency stopped having any value.
CL: So money is an invention of the state… a government technology, if you like?
WM: I think John Maynard Keynes used to say, ‘The government writes the dictionary.’ The Japanese government taxes in yen. So, they have yen. Sterling is what you need to pay taxes in Britain. And so on.
What’s interesting is that any government that issues its own currency has to spend money first before it can collect it back in tax. It also has to spend money first before it can borrow it back. When a government that issues its own currency borrows, it’s actually just borrowing back money it just spent.
I was in Pompeii, in Italy, about two months ago. The guide was saying, ‘Here are the coins we found. The government would collect the coins and then it would spend the money on infrastructure. Because people wanted Pompeii to be a nice place to live.’
And I said, ‘Well, they spent the coins first and then collected them.’
And he goes, ‘No, no, no. They collect the coins in taxes first. And then they spent them.’
I asked him, ‘Where did the coins come from?’
‘The government made them.’
‘Okay. How did anybody get them?’
‘You’re saying they had to spend them first and then tax?’
I said, ‘Yeah, what else could they do?’
‘I don’t know.’
He was very confused…
CL: Most people think the government needs to collect dollars – either through taxes or borrowing – before it can spend.
WL: First, the government credits bank accounts when it spends. Then, it debits bank accounts when it taxes. You can’t debit an account first. That’s an overdraft – a negative balance. And a negative balance is a loan from the guy who allowed the negative balance: the government.
That would mean the government loaned the money first before it collected it for tax, which doesn’t make sense. As a simple accounting logic, you can’t debit an account without crediting it first.
What I’m telling you is known by all the senior staffers at the Fed. The way they say it is: You can’t do a ‘reserve drain’ without a ‘reserve add.’ They all know this. There’s nothing esoteric, or new, or secret about it. It’s how they function every day.
None of this stuff is really subject to any dispute. Some people don’t like it. Or they can’t reconcile it with what they’ve heard. But they can’t dispute it, either.
CL: One thing that shocked me – I think it was in your book Seven Deadly Innocent Frauds of Economic Policy – is that if you paid the IRS in cash for your taxes, they’d give you a receipt for your money and then shred the dollars.
WM: Well, the IRS doesn’t shred it. It gives it to some other agency that does the shredding. But yes – that’s what happens.
CL: Why doesn’t the government take those dollars and recycle them back into the system?
WM: If you pay them with old $20 bills, they’ll just throw them away. If you pay with new $20 bills, they may give them back to the banks. But today, it’s easier to give banks money off the new pile when they want it – it’s all wrapped up and nice and everything – than it is to take somebody’s old money with germs on it and try to wrap it up again.
It’s like selling tickets to a football game. Would you collect all the old tickets and try to reuse them? Or would you just tear them up and throw them away? It’s easier to just take them off the new roll than it is to collect them all and then try to sell them again. And nobody would ever think a football stadium should collect the tickets before it sells them.
CL: Then why does the government tax?
WM: The government has to have tax liabilities. Otherwise, nobody would be a seller of goods and services. Nobody would be selling labor or food or whatever else the government wants. Nobody would be looking for jobs that pay in dollars if there wasn’t a tax. So, the government has to tax to create the basic need for its currency.
CL: And why does the government borrow?
WM: The government used to borrow because, when it spent dollars, those dollars were convertible into gold. It didn’t want people being able to take all the gold out of Fort Knox. So, it sold Treasury securities. This borrowed back the dollars for a certain amount of time.
A Treasury is a one-year, or two-year, or ten-year security, or whatever. If you swapped your dollars for a Treasury security, you couldn’t get the dollars again to get the gold for one year, two years, or ten years.
This kept people’s hands off the government’s gold supply. And it stabilized the gold in Fort Knox. The purpose of borrowing was to keep that money from being able to convert itself into gold right away. You had to wait until your Treasury security matured first.
Since 1934, that reason is gone. But the government keeps borrowing anyway. It had the appearance at the time that you were borrowing to be able to spend. That’s an easy stance to perpetuate. So, they perpetuated it.
CL: Under the gold standard, government borrowing competed with private sector investment. Money was a scarce commodity. It could either go into government borrowing or into private sector investment. People worried that government borrowing ‘crowded out’ private investment. Is that still a worry?
WM: So, you have government spending first. When the government spends dollars, it puts them in a bank’s reserve account at the Fed. If the government decides to borrow back those dollars, it just shifts them from its reserve account to another account it has at the Fed called a securities account. They give them fancy names. They call them reserve accounts and securities accounts. But they’re really just checking and savings accounts.
The government creates new dollar balances. It puts them in one type of account. Then it shifts those dollar balances to another type of account. We call that ‘government debt.’
CL: You say governments need to run budget deficits and that budget surpluses can be disastrous for the economy. Can you explain what you mean by that?
WM: Sure. Let’s say the government runs a budget surplus, which means it taxes more than it spends. That means it’s draining money out of people’s bank accounts. Eventually, this would empty people’s accounts.
The U.S. has had seven depressions. All seven followed the only seven budget surpluses in history. I don’t think that’s a coincidence.
A government deficit, on the other hand, happens because the government spends more than it taxes. This net spending adds money into people’s bank accounts. This may cause inflation. But nobody is going to run out of money because of it.
CL: Again, most people see it differently. For instance, at the end of the 1990s, President Clinton took the U.S. into a budget surplus. Why did he do that, if it was so bad for the economy?
WM: The way Robert Eisner, a professor of economics at Northwestern University, used to tell the story was that he was at the Clinton White House explaining to the president that running a budget surplus was draining money out of the economy… and that it was going to cause a crash. And Clinton said, ‘Yeah, you’re right, Bob. But this is not about economics. It’s about politics.’
Some people understand it. Some people don’t. In 2003, I was in the White House having a conversation with President Bush’s chief of staff, Andrew Card. The economy was bad. Low interest rates weren’t working. And I told him more or less the same thing I’m telling you – that we needed a much larger deficit. In other words, we needed to either lower taxes or increased public spending.
Card was a quick study. He’s an engineer. He got it. And he asked, ‘By how much?’
I said, ‘About $700 billion.’ Which, back then, was a large number.
‘We don’t have much time, do we?’ he asked.
I said, ‘No.’
I wasn’t a Bush supporter or anything. But he was the president, and the economy wasn’t doing so well. A week later, Bush made an interesting statement. When he was asked about the deficit, he said, ‘I don’t look at numbers. I look at jobs.’
He passed every spending bill he possibly could. He also got through every possible tax cut. Six months later, the deficit was about $200 billion for the quarter, which was about $800 billion for the year. The economy had turned around. And it didn’t cost Bush his second term.
From time to time, there are people who understand how the system works enough to make intelligent comments about it and, in the case of Andrew Card, to do something about it. But then it kind of fades away.
CL: One important thing that MMT predicted was that quantitative easing (QE) would not lead to runaway consumer price inflation, as many people feared. The idea you heard – and you still hear – a lot was that central banks were ‘printing money.’ And that this money was going to flood the economy and cause inflation… or even hyperinflation. But we’ve had seven years of global QE. And this still hasn’t happened. Why hasn’t QE led to consumer price inflation?
WM: It depends how you define ‘money.’ The government is ‘printing money’ only under a very narrow definition of money supply.
If you have your money in a checking account, and I have my money in a savings account, it’s not like you have money and I don’t. But when the government looks at the money supply, it counts the dollars in checking accounts – reserve accounts – as ‘money.’ But it doesn’t count the dollars in savings accounts – Treasury securities – as ‘money.’
All central banks do under QE is buy somebody’s savings account and pay for it by putting money in their checking account. People say, ‘We’re adding to the money supply. We’ve added $4 trillion to the money supply.’
But if you count the dollars in both accounts as money – like you’d count the dollars in your checking and savings accounts as money – nothing has changed. All that’s happened is people decided they’d rather the extra liquidity of a checking account instead of having a savings account, because the interest rate on their savings account was so low.
QE just moved money from savings accounts to checking accounts. Somehow, central banks thought that was going to cause spending, and inflation, to rise. But it didn’t.
CL: You refer to them as ‘checking accounts,’ but what exactly are bank reserves?
WM: Reserves are just investments banks have at the Fed. They give the Fed money and earn a quarter of a percentage point [0.25%] in interest. Reserves are a liability of the Fed… and they’re a bank’s asset. It’s just like when a bank loans you money – the loan is your liability and the bank’s asset.
CL: Why won’t banks ever lend their reserves to their customers?
WM: Reserves are just assets that banks own. They’re loans to the Fed. People have that backward. You don’t loan out assets. There is no such thing.
CL: So, how do banks make loans in the modern monetary system? I think there’s a lot of confusion over this point…
WM: It’s simple. Banks make loans anytime they can find somebody to pay them more interest than their cost of funds. If a bank’s cost of funds is 0.25%… and it can lend to a big corporation at 1%… it’ll do it. It’ll make what’s called a ‘spread.’ Banks just try to make a spread against their cost of funds. It’s not about having money or not having money.
Let’s say you go into your bank and borrow $100,000. You sign for the loan. The bank creates $100,000 that didn’t exist before and puts it in your account. But it’s not the bank’s money. It’s your money.
The new money doesn’t belong to the bank that loaned it into existence. People act as though the banks are creating money for themselves. They’re not. Whoever borrows the money is the one who gets it, not the bank.
CL: Andy Haldane, the chief economist at the Bank of England, recently gave a speech in which he talked about banning physical cash and then imposing negative interest rates on bank deposits to stimulate growth. Cash would allow you to escape the negative interest rates on bank deposits because you could always just put it under the mattress or whatever. So, Haldane also proposed banning cash to make negative interest rates more effective. Is that a good way to stimulate economic growth, in your view?
WM: First, central bankers have got the interest rate thing backward. They think lowering rates will somehow stimulate the economy. But negative interest rates are just a tax. You start off with a certain amount of money – say, $100. If the rate is negative 1%, then you have $99 at the end of a year.
How is taking money away from me supposed to stimulate the economy?
CL: Aren’t central bankers channeling Keynes? As I understand it, they believe that seeing your money disappear like that will make you rush out and spend.
WM: Right. But if you’re trying to save for retirement, all of a sudden you’ve got to save a lot more money because you’ve got a lot less income. Isn’t there some theory that says when people’s money goes away, and they have less, they spend less?
CL: At what point do central bankers admit that lower interest rates aren’t working? Or do they just keep doubling down on something that’s clearly not working?
WM: Somebody once said that economic theory changes one funeral at a time. Nobody really changes their minds. You’ve got to have somebody new coming in.
This interview was conducted in 2014.
[i] Peter Coy , Katia Dmitrieva and Matthew Boesler ‘Warren Buffett Hates It. AOC Is for It. A Beginner’s Guide to Modern Monetary Theory,’ Bloomberg, 21st of March, 2019, https://www.bloomberg.com/news/features/2019-03-21/modern-monetary-theory-beginner-s-guide