The money induced inequalities in income (more accurately, output) distribution

In our modern capitalist society, a major inequality results from the very nature of production for monetary profit and the hiring of workers. Marx distinguished production for exchange from production for monetary profit using the equations M-C-M' and C-M-C. Workers ( or in proto/non/precapitalist money using societies, peasants) first and foremost are looking to acquire the basic necessities of life. Generally, this means selling the only reproducible asset they have, their labor power. Workers are paid a wage that is denominated in money. Then they use that same money to purchase what they need from firms.

Here, production is fundamentally broken from consumption. Workers only acquire the output they produce by purchasing it at the market and capitalists are producing, not to satisfy consumption but to accumulate money that will partially be used to consume on the market later. Under capitalism, people spend much of their time either producing or consuming, but these activities are never directly connected.

Normally at this point, Marxists go into explanations of how this leads to the exploitation of workers and how all profit comes from surplus value produced by workers. This may or may not be a valid argument, but it is not the focus of this post. Rather, I would like to direct this post towards the analysis of Michal Kalecki, a polish (Marxian trained) economist and widely seen as an independent (conemporary) developer of John Maynard Keynes's analysis. As is noted above, workers are paid a monetary wage. This means they aren't guaranteed any set standard of living (for the moment I will ignore inflation adjusted contracts, since those are no where near the norm). It also means that the pricing and production decisions of firms as a whole determine the output workers receive, no matter how high or low their nominal wages are.

If worker's for example, form a union and push for higher and higher wages (assuming their productivity stays constant), capitalists as a whole could grant them their wage increases but then raise prices to preserve their profit margin. This is quite a dangerous result for many reasons, not least of which it shows that firms have vast control over the living standards and power of workers, but workers (even when they push back) are only able to achieve limited gains for themselves. For Neoclassical economists, this is unacceptable. It is partially why the concept of competition (specifically “perfect” competition) is so central for them. The process of competition between firms helps them strip firms of their agency and social control. It also leads to the easy defense that any undue power corporations have over our lives is a result of a “lack of competition” that is often attributed to state intervention. Even when they spend their time modeling the economy more realistically (using “imperfect” competition) competition is supposed to exert massive control over firms and if it doesn't, the solution suggests itself (deregulate and break up firms). Interestingly Marxists also rely on competition reducing capitalist agency, but for different effects. Rather then equalizing the power dynamic, it is supposed to make it more brutal since any capitalist which didn't try to expand production, invest and squeeze workers would be destroyed.

Mankiw, Nicholas Gregory. Principles of Economics. Mason, OH: Thomson South-Western, 2011. Print.

Marx, Karl. Capital: A Critique of Political Economy. London: Penguin in Association with New Left Review, 1981. Print.

Lopez, G. , Julio., and Michael Assous. Michal Kalecki. Basingstoke, England: Palgrave Macmillan, 2010. Print.

How do banks create money?

This is one of those questions that make me squirm when I have to answer it on the spot, for a lot of reasons. First, money is an intimate topic to people’s lives. They owe people and institutions money, their savings are in money; money is just an integral part of everyday experience. Explaining the nature of money to someone can be a difficult experience, especially when they understand the answer.

Second, there’s the fact that multiple explanations of how banks create money exist. Not only that but neoclassical economics proposes one view that dominates the academic and political discourse (neoclassical economics is broadly the economic point of view that has dominated economics for the last 140 years, with perhaps a brief interlude during the “Keynesian” revolution). In the neoclassical view banks are only able to lend money after depositors have put their cash into a bank. Since governments sometimes require banks to hold a certain amount of money aside (in the U.S it’s 10%), the idea is that the rest of their “excess” reserves are available for lending. This theory plus the US’s 10% reserve requirement has led to one of neoclassical economics’s most appealing teaching example. I think it is valuable to quote N. Gregory Mankiw's principles of economics textbook at length here because he's a very clear writer and his book dominates the textbook market (not to mention it gives me a chance to remind people that his students walked out of his class in protest of it's content last semester here: www.thecrimson.harvard.edu/article/2011/11/2/mankiw-walkout-economics-10 )

"Let's suppose that First National has a reserve ratio of 1/10, or 10 percent. This just means that it keeps 10 percent of its deposits in reserve and loans out the rest... First National still has $100 in liabilities because making the loans did not alter the bank's obligation to it's depositors. But now the bank has two kinds of assets: It has $10 of reserves in its vault, and it has loans of $90. (These loans are liabilities of the people taking out the loans, but they are assets of the bank making the loans because the borrowers will later repay the bank.)

...Once again consider the supply of money in the economy. Before First National makes any loans, the money supply is the $100 of deposits in the bank. Yet when the First National makes these loans, the money supply increases. The depositors still have demand deposits totaling $100, but now the borrowers hold $90 in currency. The money supply (which equals currency plus demand deposits) equals $190. Thus, when banks hold only a fraction of deposits in reserve, banks create money.

The amount of money the banking system generates with each dollar of reserves is called the money multiplier. In this imaginary economy, where the $100 of reserves generates $1000 of money, the money multiplier is 10. What determines the size of the money multiplier? It turns out that the answer is simple: The money multiplier is the reciprocal of the reserve ratio. If R is the reserve ratio for all banks in the economy, then each dollar of reserves generates 1/r dollars of money. In our example, R=1/10 so the money multiplier is 10."

sector	Government		Banks		Debtors (to the bank)		Creditors (to the bank)
Parts of balance sheet	assets	liabilities	assets	liabilities	assets	liabilities	assets	liabilities
Balance sheet	0	$10 (currently held as bank reserves)	$10 reserves. $90 loans	$100 in bank checking account	0	$90 loans	$100 in bank checking account	0

I should add that although this is what Mainstream economics puts in their undergraduate textbooks their is a lot academic literature written and published by Neoclassical economists that qualify or even contradict this story. Indeed the most common defense of neoclassical economics is that the critics either don't understand it or are criticizing a "caricature" (aka what appears in the textbooks). The table above is a much more detailed (with the implicit sectors made explicit) exposition of the model Mankiw is presenting. If you learn accounting, you find out very quickly that any financial asset is someone/something else's liability so that they should all sum to zero (The real world contains physical objects that don't have corresponding liabilities so real world balance sheets should sum to positive values).

Notice that in this conception of money creation by banks, the government directly controls the money creation process. If it lowers reserve requirements, excess reserves will appear in the banking system that, according to these theorists, will be lent out, redeposited and lent out again in the “money multiplier” process Mankiw described. If it raises reserve requirements, banks will have to attract more deposits or reduce the amount of loans they are making.

This is a very orthodox theory but it is used in more unorthodox circles to defend various policies. Many liberal critics of big banks have criticized them on the grounds of “not lending” even after the bailouts (this being based on the idea that their holdings of excess reserves are and should be available for “funding investment”). The “move your money” campaign is largely predicated on the idea that moving your deposit limits the ability of big banks to lend money and increases the ability of small banks to. The NEED act (HR 2990) introduced by Dennis Kucinich is largely based on the American Monetary Institute's ideas.

They subscribe to the Neoclassical view of money creation, with the crucial difference that they don't see the “loanable funds” (the deposit and loan concept described by Mankiw) market as an equilibrating system that balances savings and investment in a way beneficial to all. They see it as a system that allows a privileged few to function as a usurious middle man between government, industry and the public (see: monetary.org). For them returning money creation back to the government simply involves raising reserve requirements to 100% .Recall what Mankiw said above:“If R is the reserve ratio for all banks in the economy, then each dollar of reserves generates 1/r dollars of money.” In this case R=1 so each dollar of reserves is just 1 dollar. To AMI, this means that money is only created when governments spend it into existence.

Another view is presented (usually) by the Post-Keynesian school . They look at the correlation between reserves and broader money creation but think that Neoclassical economics has the causation reversed. Rather then banks needing deposits (and thus reserves) to make loans, they see banks making loans which create deposits and then seeking out reserves later. In Neoclassical economics (as alluded to above) savings and investment is balanced through the loanable funds market. The variable that adjusts to balance these two things is the interest rate. If there are more (less) savings being offered as loans then borrowers willing to borrow them, the interest rate is supposed to fall (rise) until equilibrium is reached. Post-Keynesians in contrast envision a central bank with a target interest rate that will intervene to inject reserves when demand for reserves rises to prevent (unplanned) rises in interest rates and withdraw reserves to prevent (unplanned) falls in interest rates. For them the money supply expands and contracts to accommodate the (profitable) financing needs (and desires) of (credit worthy) economic actors including corporations, other financial institutions and households.

I personally subscribe to the Post-Keynesian view. For some Theoretical and empirical defenses of the Post-Keynesian position see Schumpeter's book, Basil Moore's empirical work and definitive book, and a sampling of federal reserve publications cited below. This is enormously relevant to social inequalities. If one accepts the neoclassical view, banks don't have very much agency. they are simply the (well paid) intermediary between savers and borrowers. It is ultimately their actions and reactions that make major changes in the global economy. Rather then the housing bubble being led by madly inventive, criminal bankers, it is supposedly let by investors in search for higher returns and borrowers desire for more and bigger houses. The neoclassical view also leads to the idea that the level of debt doesn't really matter. It also leads to the idea that less radical forms of activism, like moving your money, will bring banking under control, rather then protest, confrontations or even revolution. Social inequality created by finance is ultimately our own fault. If we just became more active and conscious, these ills would shrink enormously. It's not a class conflict, it's a conflict with ourselves.

Works Cited

Delreal, Jose A. "Students Walk Out of Ec 10 in Solidarity with 'Occupy'" The Harvard Crimson. Harvard University. Web. 23 Mar. 2012.

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Kydland, Finn E.; Prescott, Edward C., "Business Cycles: Real Facts and a Monetary Myth", Federal Reserve Bank of Minneapolis Quarterly Review 14 (2): 3–18

Holmes, A. R. Operational Constraints on the Stabilization of Money Supply Growth. Controlling Monetary Aggregates. F. E. Morris. Nantucket Island, The Federal Reserve Bank of Boston: (1969) 65-77 .

Mankiw, Nicholas Gregory. Principles of Economics. Mason, OH: Thomson South-Western, 2011. Print.

Moore, Basil J. Horizontalists and Verticalists: The Macroeconomics of Credit Money. Cambridge [England: Cambridge UP, 1988. Print.

Moore, Basil J. "The Endogenous Money Stock." Journal of Post Keynesian Economics 2.1 (1979): 49- 70. Print.

Schumpeter, J. A. The theory of economic development : an inquiry into profits, capital, credit, interest and the business cycle. Cambridge, Massachusetts, Harvard University Press. 1934. Print

Rent and social inequalities

“THE PROBLEM OF RENTS IS EASY FOR A NONECONOMIST, EVEN A sparsely educated low-wage worker, to grasp: it's the market, stupid. When the rich and the poor compete for housing on the open market, the poor don't stand a chance. The rich can always outbid them, buy up their tenements or trailer parks, and replace them with condos, McMansions, golf courses, or whatever they like. Since the rich have become more numerous, thanks largely to rising stock prices and executive salaries, the poor have necessarily been forced into housing that is more expensive, more dilapidated, or more distant from their places of work. ...Insofar as the poor have to work near the dwellings of the rich-as in the case of so many service and retail jobs-they are stuck with lengthy commutes or dauntingly expensive housing.”

In popular discourses, social inequalities are often discussed in income terms. However, as Ehrenreich comments here The lot of the working poor can't be discussed without discussing the major costs they incur. You have to look at both sides of the ledger: the revenue and the costs. One of the most crucial costs, especially in the past three decades, is housing. The increase in rents tend to have marginal effects on the very rich but are the difference between surviving and not surviving for the working poor. In the late 19^th century, a social reformer Named Henry George was intently focused on rent. What he observed was the benefits of nature were accruing to a select few, through the institution of land ownership.

By simply owning land, a person could collect an income that didn't derive from the products of their labor (in seeming violation of Locke's justification of private property). To George, this meant “we must ... substitute for the individual ownership of land a common ownership ... We must make land common property”. This did not require public ownership of the means of production ala Marx : “Let the individuals who now hold it retain, if they want to, possession of what they are pleased to call their land. Let them continue to call it their land. Let them buy and sell, and bequeath and devise it. We may safely leave them the shell, if we take the kernel. It is not necessary to confiscate land; it is only necessary to confiscate rent”. How did he propose to “confiscate rent”?

His suggestion was a land value tax. This is a tax on the value of the “unimproved land”. It is different from normal real estate taxes because it does not tax improvement of the land's quality or property on top of the land. This would prevent property owners from profiting off of a market increase in the land price (that wasn't a result of improvements they made) because increase in it's worth (called site value) would accrue to the government rather then the private individual. Consequently, the incentive for land speculation (which can create self-fulfilling price bubbles) would be removed because they don't profit off of market rates rising.

Henry George provides a comprehensive analysis of the other side of the ledger, the cost of living that only rarely enters popular discourse even after the recent hyperinflated housing bubble. Housing (and George's analysis) provides a concrete case of a relatively few extracting unearned income from the large majority of people that fall especially hard on the working poor. In addition, because it costs nothing for an owner to leave a property idle, the lack of land value taxation allows undermines the quality of neighborhoods and undermines the quality of community services.A close examination of his analysis and his proposals would be useful so that the comprehensive qualities of social inequalities could be pushed out . Also, he's one of those rare social analysts who proposes cut and dry solutions which can also be analyzed and criticized in it's ability to relieve social inequality.

Ehrenreich, Barbara. Nickel and Dimed: On (not) Getting by in America. New York: Holt Paperbacks, 2008. Print.

George, Henry. Progress and Poverty. Levin, N.Z.: W.M.F. Williams, 1969. Print.

Unemployment and social inequalities

Above is the unemployment rate since 1948. As one can see, the unemployment rate ticked up around 1970 and only a few brief periods turned back down to 1941-1968 levels. (notably, once during the dot com bubble). The numbers are even more striking when we look at those who have been unemployed longer then 27 weeks. These figures are easy to stare at, but what do they mean for actual people? What does it mean for the unemployment rate to be 3 as opposed to 6 percent (let alone 10 or 12)? What does it mean for the number of people unemployed for over 27 weeks to approach zero in parts of the “golden era” and to secularly increase ever since?

The Center for Disease Control provided a chilling Glimpse last April when they sent out a press release about suicide rates and the “business cycle” (basically the cycles where unemployment and the amount society produces goes up and down). According to their study the suicide rate usually rose during recessions and fell during expansions. “The largest increase in the overall suicide rate occurred in the Great Depression (1929-1933)—it surged from 18.0 in 1928 to 22.1 (all-time high) in 1932 (the last full year in the Great Depression)—a record increase of 22.8% in any four-year period in history. It fell to the lowest point in 2000”.

The ability to pursue a happy and fulfilling life is paramount to a socially harmonious society. As Martin Luther King stated “if a man doesn't have a job or an income, he has neither life nor liberty nor the possibility for the pursuit of happiness. He merely exists”. When inequalities prevent that, and even drive people to suicide, they are inflicting damage of the highest order. Unfortunately, this is only a small sample of the damage caused by Unemployment on social inequality. Unemployment affects crime rates, family cohesion and all other elements of (and inequalities within) social life. How preventable is Unemployment? If it is preventable, why isn't it prevented? To what extent is social inequality responsible for unemployment and to what extent is unemployment responsible for inequality?

King, Martin Luther. "Remaining Awake through a Great Revolution." King Institute Home. Web. 14 Feb. 2012. .

"Press Release:CDC Study Finds Suicide Rates Rise and Fall with Economy." Centers for Disease Control and Prevention. 14 Apr. 2011. Web. 15 Feb. 2012. .

"Unemployment Rate Data." Bureau of Labor Statistics. Web. 19 Feb. 2012. .

Derivatives and social inequalities

What is a Derivative?

The term Derivative is used everywhere. Boring calculus books make you derive derivatives. English teachers tell you that a body of work is “merely Derivative”. If the word couldn't get any more boring, you hear the term in the financial context. Most financial articles can't go a paragraph or two without name dropping a type of Derivative. It might be helpful then to know what a derivative is. Below is a definition of derviatives taken from the “Dictionary of Financial Engineering ” by John F. Marshall . Don't worry if you don't understand the definition on the first reading. I will break it down as best as I can.

“A generic term to describe a wide variety of financial instruments ranging from standardized, exchange-listed products to custom-made, over-the-counter instruments whose values depend on, or are derived from, the price or value of one or more underlying assets, including indexes, exchange rates, interest rates, or commodity prices. “

Wow. That had a lot of words. They seemed to logically follow one another in a sentence, but at this point some of you are taking my word for it that that meant something. Let's take the first part. What is an “exchange-listed product”? This just means that there's some trading floor (or some place online), similar to the New York Stock Exchange, where people will buy and sell financial products that do the same thing. In other words, the products are fungible. Just like one dollar bill does exactly the same thing as another dollar bill, one of these financial products does (or is supposed to do) the same thing.

From this, it's easy to figure out what a “custom-made, over-the-counter instrument” is. It's simply the opposite! Rather then being “listed” on some exchange somewhere and buying it on an exchange, people buy the products on their own. More specifically, there's a person named a “dealer” (also called a “market maker”) who both buys and sells the same product and makes money on the price difference between the price he/she pays for products and the price he/she is paid when selling them (or at least that's the ideal, more on this in later posts). You can think of a market maker as similar to your local corner or grocery store. They buy products from suppliers, sell those same products to you and make money on the difference.

Now how about that second part? “Instruments whose values depend on, or are derived from, the price or value of one or more underlying assets, including indexes, exchange rates, interest rates, or commodity prices”. This is much simpler then it sounds. All that's being said is a derivative doesn't have some inherent value tied to it, it's worth is based on the value of something else. I'll give a simple example. Let's say that I go to my local farmer and tell him “hey, if you sign right here, I'll pay you 2 dollars every week for a year for the right to buy a bushel of apples for 10 dollars at any point during that year”.

That's called an “option” because I'm paying for the option of buying apples at a certain price. When the price of apples goes down (up), the value of this option goes down (up) because the privilege to buy a bushel of apples at 10 bucks is less (more) appealing the lower (higher) the price. If I can go out and buy a a bushel for 5 dollars that option won't be worth very much to me but if the spot (immediate) price is 30 dollars the option becomes more valuable. This principal of basing the value of an asset on another asset can and has been extended to nearly every conceivable thing from those listed above to the weather and movie earnings. In the same way your bet on Jeremy Lin is based on Jeremy Lin's performance, you can design a custom contract to be valued based on the performance of nearly any measurable thing on the planet just as long as you can find someone to take the other side of the bet.

What does this have to do with social inequalities?

Everything. Derivatives exemplify everything about the fact of social inequality and its media discussion. While electoral politicians go back and forth endlessly on tax cuts (the supposed marker of “evil” inequality loving republicans and “equalizing” democrats is their position on marginal tax rates for high income earners), products such as derivatives escaped their traditional place in agricultural markets to infest nearly every part of finance. Large sectors of the American economy and social structure have been able to use products with complex (but longer term) risks and uncertainties to squeeze out millions (if not billions) in the short term while blowing up their companies in the long term and then putting them on the publc's doorstep.

As James Galbraith and his co-author Jing Chen said in a relatively recent paper:“When a part of an organism escapes regulation and turns into a free market, that part of the organism will grow rapidly. This is called cancer. In the end, the unregulated growth, if it is not stopped, will drain all the resources of the organism and destroy the organism. In human society, if an economic sector gains control of large amount of resources and escapes regulation, it will grow rapidly and generate huge profit for the insiders. But the process will drain resources from the whole society. This is what we have witnessed in the current financial crisis”.

In this context, who really cares whether the top marginal tax rate is 35 percent or 39.6 percent? No one tries to deal with cancer simply by putting in place marginal measures to prevent it's growth. People first try everything they can to kill cancer or have it removed. Derivatives are at the center of this process of cancerous growth but because they are complex and (almost deliberately) confusing, they have stayed out of the public eye . More or less the only people who comment on their nuances in legislative fights and public arenas are those who benefit the most from keeping them opaque, unregulated and off-balance sheet. Next time you're at a casino, try a game that you don't know the rules to. That's the game the public is forced into in many areas, but especially in finance.


Chen, Jing and Galbraith, James K., A Biophysical Approach to Production Theory (December 8, 2008). Available at SSRN: http://ssrn.com/abstract=1313366
Marshall, John F. Dictionary of Financial Engineering. New York: Wiley, 2000. Print.