Creationism versus Redemptionism: How a Money-Issuer Really Lends and Spends

ECONOMICS, 3 Jun 2019

L. Randall Wray | New Economic Perspectives – TRANSCEND Media Service

Modern Money Theory has emphasized that there is a close relation between sovereign power to issue a currency and its power to impose tax liabilities. For shorthand, we say “Taxes Drive Money”. Sovereign governments do not “need” tax revenue in order to spend. As Beardsley Ruml put it, once we abandoned gold, federal taxes became “obsolete” for revenue purposes.  I’ll have more to say about good old Beardsley in the next installment.

I want to step back a bit to ask a more fundamental question: does the issuer of a money-denominated liability need to obtain some of those liabilities before spending or lending them?

I will examine three analogous questions (each of which has the same answer):

  1. Does the government need to receive tax revenue before it can spend?
  2. Does the central bank need to receive reserve deposits before it can lend?
  3. Do private banks need to receive demand deposits before they can lend?

If you’ve already answered “Of course not!”, you are probably up to speed on this topic. If you answered yes (to one or more), or if you haven’t a clue what the questions means, read on.

As we’ll see, these are reducible to the question: which comes first, Creation or Redemption?

An apology for the somewhat theoretical, academic–even esoteric?—exposition that follows. I’m going to assume that at least some readers are not familiar with the MMT literature on what we might call “the nature of money”. So let me begin with the familiar ground of orthodoxy.

The Nature of Money

What I’ve been trying to do in my own work on money (and interest rates) is to provide an alternative to the orthodox money supply and money demand approach. Recall that orthodoxy has a money supply that is fixed by the authorities and a money demand function that is determined by three presumed motives for holding money (Keynes’s transactions, precautionary, and speculative demands), with the intersection determining “the” interest rate, if you are a Keynesian-type, or “the” price level if you are a Monetarist-type.

Post Keynesians turned this on its head, making the money supply “horizontal” at “the” interest rate determined by the central bank. The central bank accommodates the bank demand for reserves, and banks accommodate the demand for loans. The money supply is “endogenous”, interest rates are “exogenous”.

While this is an improvement, it is not very satisfying. I won’t go into my critique of Horizontalism.[i] Instead, I want begin with the Institutionalist view that money is an institution; Dudley Dillard argued that it might be the most important institution in the capitalist economy. (See also my post some weeks ago on Fagg Foster’s views, which I will draw upon for a few paragraphs here.)

What is the nature of the institution that we call money? What do the things that many people call money have in common? Most economists identify money as something we use in exchange. That, too, might move our understanding forward a bit, but it simply tells us “money is what money does”. (Sort of like defining a human as something that watches TV, with occasional trips to the fridge.)

In The Treatise, Keynes began with the money of account, the unit in which we denominate debts and credits, and, yes, prices. He also says something about the nature of the money of account: following Knapp he argues that for the past 4000 years, at least, the money of account has been chosen by the state authorities. Units of measurement are necessarily social constructions. I can choose my own idiosyncratic measuring units for time, space, and value, but they must be socially sanctioned to become widely adopted.

So, one commonality is that all monies are measured in a money of account. All those things economists declare to be money are denominated in the money of account. But the nature of money must amount to more than that if money is an institution.

As mentioned, many economists identify money as that which is used to intermediate market exchange. But that seems to reduce money to a thing we agree to use to intermediate exchange in the institution that we call a market—rather than an institution in its own right.

What is the institutional nature of those money things? The most obvious shared characteristic of some of them is that they are evidence of debt: coins and treasury or central bank notes are government debts; bank notes or deposits are bank debts; and we can expand our definition of money things to include shares of money market mutual funds, and so on, which are also debts of their issuers.

If we go back through time, we find wooden tally sticks issued by European monarchs and others as evidence of debt (notches recorded money amounts). Clearly it does not matter what material substance is used to record the debt–the tally sticks are just tokens, records of the relation between creditor and debtor. The monarch promises to redeem his tally IOU, following prescriptions that govern redemption. A taxpayer cannot bring any notched hazelwood stick—the stock and stub must match exactly, tested by the exchequer or his representative.

Modern Money[ii]

What we have, then, is a socially created and generally accepted money of account, with debts that are denominated in that money of account. Within a modern nation, socially sanctioned money-denominated debts are typically denominated in the nation’s money of account. In the US it is the dollar. Some kinds of money-denominated debts “circulate”, used in exchange and other payments (ie paying down one’s own debts).

The best examples are currency (debt of treasury and central bank) and demand deposits (debt of banks). Why do we accept these in payment?

It has long been believed that we accept currency because it is either made of precious metal or redeemable for same—we accept it for its “thing-ness”. In truth, coined precious metal almost always circulated well beyond the value of embodied metal (at least domestically); and redeemability of currency for gold at a fixed rate has been the exception not the rule. Hence, most economists recognize that currency is today (and often was in the past) “fiat”.

Further, and importantly, law going back to Roman times has typically adopted a “nominalist” perspective: the legal value of coins was determined by nominal value. For example, if one deposited coins with a bank one could expect only to receive on withdrawal currency of the same nominal value.[iii] In other words, even if the currency consisted of stamped gold coins, they were still “fiat” in the sense that their legal value would be set nominally.[iv]

The argument of Adam Smith, Knapp, Innes, Keynes, Grierson, and Lerner is that currency will be accepted if there is an enforceable obligation to make payments to its issuer in that same currency.[v] Hence, MMT has adopted the phrase “taxes drive money” in the sense that the state can impose tax liabilities and issue the means of paying those liabilities in the form of its own liabilities.

Here there is an institution, or a set of institutions, that we can identify as “sovereignty”.[vi] As Keynes said, the sovereign has the power to declare what will be the unit of account—the Dollar, the Lira, the Pound, the Yen. The sovereign also has the power to impose fees, fines, and taxes, and to name what it will accept in payment. When the fees, fines, and taxes are paid, the currency is “redeemed”—accepted by the sovereign.

While sovereigns also sometimes agree to “redeem” their currency for precious metal or for foreign currency, that is not necessary. The agreement to “redeem” currency in payment of taxes, fees, tithes and fines is sufficient to “drive” the currency—that is to create a demand for it.[vii]

Note we also do not need an infinite regress argument. While it could be true that I am more willing to accept the state’s IOUs if I know I can dupe some dope, I will definitely accept it if I have a tax liability and know I must pay that liability with the state’s currency. This is the sense in which MMT claims “taxes are sufficient to create a demand for the currency”. It is not necessary for everyone to have such an obligation—so long as the tax base is broad, the currency will be widely accepted.

There are other reasons to accept a currency—maybe I can exchange it for gold or foreign currency, maybe I can hold it as a store of value. These supplement taxes—or, better, derive from the obligations that need to be settled using currency (such as taxes, fees, tithes, and fines).

The Fundamental “Law” of Credit: Redeemability

Innes posed a fundamental “law” of credit: the issuer of an IOU must accept it back for payment.

We can call this the principle of redeemability: the holder of an IOU can present it to the issuer for payment. Note that the holder need not be the person who originally received the IOU—it can be a third party. If that third party owes the issuer, the IOU can be returned to cancel the third party’s debt; indeed, the clearing cancels both debts (the issuer’s debt and the third party’s debt).

If one reasonably expects that she will need to make payments to some entity, she will want to obtain the IOUs of that entity. This goes part way to explaining why the IOUs of nonsovereign issuers can be widely accepted: as Minsky said, part of the reason that bank demand deposits are accepted is because we—at least, a lot of us—have liabilities to the banks, payable in bank deposits.

In modern banking systems that have a central bank to clear accounts among banks at par, one can deliver any bank’s deposit IOU to cancel a debt with any other bank.

Acceptability can be increased by promising to convert on demand one’s IOUs to more widely accepted IOUs. The most widely accepted IOUs within a society are those issued by the sovereign (or, at least, by some sovereign—perhaps by a foreign sovereign of a more economically important nation). In that case, the issuer must either hold or have easy access to the sovereign’s IOUs to ensure conversion. In the financial literature, this is called leveraging and while it sounds similar to the notion of a deposit multiplier there is no simple, fixed ratio of leverage.

Stephanie Bell/Kelton, Duncan Foley, and Minsky have all used the metaphor of a pyramid of liabilities, with those lower in the pyramid leveraging those higher in the pyramid, and with the sovereign’s liabilities at the apex. Monetary contracts for future delivery of “money” typically designate whose liabilities are acceptable, usually either commercial bank demand deposits or the sovereign’s liabilities. As the government’s backstop of chartered banks has increased, the need to use sovereign liabilities for settlement has been reduced to clearing among banks, to foreign exchanges, and to illegal activities.

In any event, whatever final payment courts of law enforce can be used as final payment. From Roman times, courts have interpreted money contracts in nominal terms requiring payment in “lawful money” which is always in the form of designated liabilities denominated in an identified money of account. That is to say, the contracts are not enforceable in terms of things if they are written in money terms.

Redemptionism or Creationism?

In the introduction we raised three analogous questions:

  1. Does the government need to receive tax revenue before it can spend?
  2. Does the central bank need to receive reserve deposits before it can lend?
  3. Do private banks need to receive demand deposits before they can lend?

It should be clear that the answer to each is “No!”. Indeed, the logic must run from CREATION to REDEMPTION. One cannot redeem oneself from sin or debt unless that sin or debt has been created.

The King issues his tally stick or his stamped coin in payment. That puts him in the position of a sinful debtor. He redeems himself when he accepts back his own IOU.

The central bank issues its reserve deposit as its sinful debt—normally when it makes a loan to private banks, or when it purchases treasury debts in the open market. (These reserve deposits can always be exchange on demand for central bank notes—which keeps the central bank indebted.) The central bank redeems itself when it accepts its notes and reserve deposits in payment.

The private bank issues its demand deposit as its sinful debt—normally when it makes a loan to a private firm or household. The bank redeems itself when it accepts a check written on its demand deposit in payment.

Note that we’ve looked at two sides of one balance sheet (the “money issuer”) in each of these cases, but there is another sinful debtor in every case.

Before the sovereign can issue tallies or coins, he must put taxpayers in sinful debt by imposing a tax obligation payable in his tally stick or coin. This creates a demand for his tally or coin.

When the central bank lends reserves to a private bank, it puts that bank in sinful debt, crediting its account at the central bank with reserves, but the bank simultaneously issues a liability to the central bank.

When the private bank lends demand deposits to the borrower, it credits the deposit account but the borrower records a liability to the bank.

So each “redemption” simultaneously wipes out the sinful debt of both parties. The slate is wiped clean. Hallelujah!

You see, folks, it’s all debits and credits. Keystrokes. That record bonds of indebtedness, with both parties united in the awful sinfulness.

Until Redemption Day, when the IOUs find their ways back to the issuers.

Those who think a sovereign must first get tax revenue before spending;

Those who believe a central bank must first obtain reserves before lending them;

And those who believe a private bank must first obtain deposits before lending them

Have all confused Redemption with Creation.

Receipt of taxes, receipt of reserve deposits, and receipt of demand deposits are all Acts of Redemption.

Creation must precede Redemption.


[i] This began with a review of Moore’s Horizontalists and Verticalists (1988)as well as my own book, Money and Credit (1990).

[ii] The term “modern money” comes from a quote of Keynes, who argued that the Chartalist or State Money approach—that provides the foundation for MMT—applies to the last 4000 years, “at least”. So, in short, MMT applies to the use of money since the rise of civilization.

[iii] In Roman law, an exception was made if one deposited coins for safe-keeping in a sealed sack; in that case, the bank must return the sack still sealed.

[iv] However, Gresham’s Law dynamics would not allow nominal value to fall much below the bullion value since coins would be taken out of circulation.

[v] See Wray 1998, 2004, and 2012.

[vi] Note that different forms of government have different forms of sovereignty, and sovereign power goes well beyond ability to choose a money of account and to impose and enforce obligations. While some critics have scapegoated MMT as applying only to dictatorships, it is obvious that all modern democracies have representative governments with vast sovereign powers, including these specific powers. In the case of the US, the Constitution specifically gives these powers to Congress.

[vii] MMT does not claim that taxes and other obligations are necessary to drive a currency. It is difficult to find exceptions—that is, cases in which currency (defined here as government-issued “current” IOUs) circulated without taxes, fees, fines, tithes, or tribute requiring its use in payment. If we broaden the definition of currency to include nongovernment-issued current means of payment, then Bitcoins might qualify as a counter-example.


L. Randall Wray is a professor of economics and research director of the Center for Full Employment and Price Stability at the University of Missouri-Kansas City. His current research focuses on providing a critique of orthodox monetary policy, and the development of an alternative approach. Wray is the author of Money and Credit in Capitalist Economies, 1990, and Understanding Modern Money: The Key to Full Employment and Price Stability, 1998. He is also coeditor of, and a contributor to, Money, Financial Instability, and Stabilization Policy, 2006, and Keynes for the 21st Century: The Continuing Relevance of The General Theory, 2008. He taught for more than a decade at the University of Denver and has been a visiting professor at Bard College, the University of Bologna, and the University of Rome (La Sapienza).

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