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John Harvey’s article, Why You Should Love Government Deficits is correct. But since it is focused on government deficits, it ignores other major economic elements, thus opening to critique. It is more or less true, presuming that all expenditure investments by government are equal in terms of ROI (return on investment), which they are not. The ROI varies.

Giving money to hoboes to buy bread is generally low ROI. (Feeding hoboes isn’t always low ROI. Think of refugee children who might go on to become physicists, or those unemployed through no fault of their own.) Spending money to build new infrastructure generally is high ROI. (But not always. Think of a road that doesn’t need resurfacing but is anyway. No net increase in utility value occurs.)

The article also could be interpreted to imply that government deficits are how money is created, which it is not. But it is part of the mechanism. I’ll explain.

Most business people are quite clear that money and wealth (or value) are not the same thing. Mark Twain got this concept across 123 years ago in “A Connecticut Yankee in King Arthur’s Court”. Money is the abstract symbol we use to represent value. There is a long history of success by religious communism and community (e.g. Hutterites, Shakers, Amanites, Oneida, Mennonites, etc) which generated great wealth without internal money. Such communities are generally so successful that as an example, in the Hutterite’s case, Canadian law barred them from buying property until quite recently.

The primacy of social capital is ignored by most mainstream economists, who presume all social/government systems are equally capable of generating wealth. And yet, differences in social capital explain why just pouring money into a place doesn’t necessarily work. For an economy to work also requires some form of regulation of behavior. In secular society that regulation is through the system of law, with social and cultural norms the foundation for observing the law.

The second primary way money is created is banking and stocks. In both banking and the stock market money is created by the private sector. In banking this occurs through loans. The maximum multiplier available is 1/r where r is the reserve ratio to capital. Usually it’s about 20, which means that 20 times the amount of money originally deposited is created in the system by loans. But since loans are demand driven by creditworthy borrowers, without borrowers, the multiplier collapses. It is an extremely common fallacy to attempt to drive loan activity by providing more capital, or lowering interest rates. Without borrowers there are no loans, and thus no follow-on activity, no matter what you do.

And that is where something like large government investment or spending comes into play. If the government spends $1 billion in seed money on projects that create a high level of new value, that creates huge amounts of money. Employees get paid and spend on many things. Prime contractors buy from subcontractors. There are jobs for highly educated people. In theory, spending $1 billion could result in nearly $21 billion ($20 billion + the original $1 billion spent – cash outside the banking system) in the economy when there is a 5% reserve ratio. In practice, based on empirical evidence it gets stuck at about 5 for long periods although some banks do max out their ratio. As everyone who deals with a bank knows, loan qualification takes time. Things take time to build up. But still, that extra $5 billion is how we can pay off those treasury notes with money left over.

The stock market is the other place that money is created. But stock market money creation occurs out of apparent nothing. What stock value measures is the market’s pricing of the probable utility value (e.g. goods and services) that the company provides. Definitely, those can get out of whack and Facebook is a current case in point. But, nevertheless, it is the market’s slapdash measurement of the utility value creation of companies that underlies our acceptance that the value of all stock certificates is approximately the price of the last trade.

Without these engines of money creation in the private sector, the only way money could appear is by fiat declaration of the government. The government does this to a limited degree. The system of treasuries that we use is a brake on that mechanism, our method of linkage of government fiat creation to the utilty value creation economy.

I have little doubt that Professor Harvey understands this. When writing an article though, one necessarily focuses on one aspect. In this case, I think that focus makes some readers cautious. They read and although it makes sense, something feels like it’s missing. So I thought I would attempt to touch on basics of the rest of the mechanism. (Admittedly, incompletely.)

The presentation of MMT tends to ignore these mechanisms of money creation. MMT also tends to ignore social capital and the underlying value economy. I think this makes many people uneasy when they read things like Professor Harvey’s article.