Money is someone’s debt | Print edition

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Not all have international value.

A man walking in front of me suddenly stopped and leaned down impatiently to see something at his feet. He was a few meters ahead of me – we were both walking down the same street in Amsterdam.

Although he bent down to pick something up, he didn’t take it. Then he kicked it with his boots and kept walking. Since I was behind him, I was curious to know what and why he threw it. It was a banknote with a face value of 1,000 from a Southeast Asian country. For him, it was nothing more than a useless piece of paper with pictures. If it was a 1,000 euro note or a US dollar note, he would definitely have picked it up.

“Design flaw”

Last week, I had to chair a seminar, organized by the Economic Association of Sri Lanka. It was an online video seminar through which we now have the technology to connect people from anywhere in the world. The presentation was made by Dr. Kaoru Yamaguchi, Director of Japan Futures Research Center, who came from Japan. It was 10:00 p.m. for him, as we started the short one and a half hour seminar at 6:30 p.m. Sri Lankan time. The speaker was Hema Senanayake, who came from the United States where he lives, early in the morning for him.

Incidentally, the topic of Dr. Yamaguchi, who had about 40 years of teaching and research experience in the fields of money and monetary economics, seemed controversial to many who would watch him at through conventional wisdom. It was “Debt Money as a Design Failure and Japan’s Loss of 30 Years”. The presentation was about how “money” has caused Japan’s long economic recession since the 1900s!

His example was catchy: if a plane crashed through the fault of the pilot, such incidents could be minimized by recruiting a skilled pilot. But if this was due to a “design flaw” in the aircraft, then changing the pilot is not the solution.

I don’t expect to talk about this seminar presentation. However, this seminar inspired me to talk about the basics of money and debt, which sounds like an interesting economics lesson today.

What is money?

If we ask someone the question “what is money?” he would pull coins and bills out of his pocket or wallet and show them as “change”. For you and me, this answer is fair enough. But “what is money for a country?” Should it be the value of all coins and banknotes in the country?

As the legitimate issuer of currency in a country, the Central Bank knows the value of all the coins and notes it has issued. But it is a wrong answer to say that money is all coins and notes! This is wrong because “although coins and bills are money, money (alone) is not coins and bills”.

In order to count the amount of money in a country, we need to know that money is a medium of exchange. There can be other purposes as well, but it’s mainly the money that people use to buy whatever they want.

When you get a 1000 rupee note in your hand, it is different from a piece of paper or a picture because it is legally accepted in Sri Lanka as a banknote with that exact value. But if you drop it on a street in a foreign country, no one will dare to pick it up.

banking magic craft

Now here is the main problem: in a situation where there is a modern banking system, the “medium of exchange” is not only coins and notes – the notion that it is not money (alone) . If you deposit this 1000 rupee note in a bank account, the bank will use it to give a loan to someone else. The person who has obtained a bank loan will spend it because for him it is a means of exchange – debt money!

When the borrower, who can be a household, a business or the government, spends the money, whoever got it can spend it again or credit it to their bank account. And the bank can loan it out again to someone else who would also do the same as the previous borrower. It all started with the single deposit of 1,000 rupees that you made initially, which was used for a series of debts one after another and multiplied by the banks.

The Central Bank can intervene in the creation of debt-money by imposing what is called the legal reserve ratio (SRR) on bank deposits. Accordingly, banks must deduct reserve requirements in accordance with the SRR and credit their reserve accounts at the Central Bank. Of course, if banks find it more profitable or less risky to maintain excess reserves above the required reserve level without lending, they can do so.

In addition to coins and notes issued by the Central Bank, its liabilities now also include reserves. These two components constitute the stock of “reserve currency” of the country which can be controlled by the Central Bank using its monetary policy tools.

Too much debt money?

All bank borrowers use their “debt money” as a medium of exchange. Therefore, it is now necessary to also add the debt money to the amount of coins and notes. Thus, the quantity of money available in a country is made up of these two components, represented by the monetary aggregates.

The money supply over the reserve currency (MS/RM) is a ratio that gives the money multiplier; if this ratio has increased over the years, it means debt money is on the rise. If it goes too far, it is not the amount of coins and notes, but the amount of the country’s debt that goes too far.

Let us see what happened in Sri Lanka: in 2005, the value of this ratio was 5.16, which indicates that each rupee of reserve money stock is multiplied by Rs. 5.16 to the money of the country. The ratio has increased over the years due to the increase in debt money. Twenty years later, in 2020, it was 9.75, indicating that each rupee of reserve money is multiplied into rupees. 9.75 adding to the country’s money supply. And the increase is due to an increase in debt money, which indicates that a lot of the country’s money is debt money – somebody’s money is debt of another !

Whose debt? Household consumption debt, corporate investment and operating debt and, above all, public debt. When they borrow more, the money supply increases, while the Central Bank can encourage them to borrow more by lowering the SRR and reducing interest rates.

US Debt and Our Debt

If someone finds a 100 dollar bill on the street, no matter where it is, they will pick it up, because everywhere in the world it is much more than a piece of paper. This is because the US dollar as well as other international banknotes around the world have gained this international value. One day, if the Sri Lankan rupee can also gain this international value, anyone would like to take a 100 rupee note too.

The United States is also a highly indebted country; public debt alone represents 137% of GDP, compared to 105% in
Sri Lanka. But the difference is that the United States can “print” US dollar notes and pay off its foreign and domestic debt. Countries like Sri Lanka must “earn” dollars to pay their foreign debt; even to repay their internal debt, they have limits to even print their national currency. It is a problem of weak currency which has no international value.

(The author is a professor of economics at the University of Colombo and can be reached at [email protected] and follow @SirimalAshoka on Twitter).

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