Theories of credit money in Japanese Marxian economics: 2 Credit creation and endogenous money supply theory in Uno theory

B. Credit money in Uno school and controversy

 

B.1 Kozo Uno’s criticism of Marx’s credit theory

Logically, Marx starts credit theory by dividing one capital into ownership of capital and function of capital. Each becomes a money capitalist and a functioning capitalist as their personalization. In other words, money capitalists exist apart from functioning capitals. Credit is the lending and borrowing of capital between the two parties. The relationship between the two determines the level of interest rate. Note that the interest rate does not follow the same law as the production price of commodities. Marx mainly treats the money supply as exogenous, although he also refers to elastic money supply as fictitious capital (ex. Marx[1981] p.589). Marx asserts that money is gold and the source of loan capital is outside the functioning capital. If the money supply is inelastic, it would be easier to explain the catastrophic crisis.

However, Uno criticized Marx for separating money capitalist from functioning capitalist (Uno [1977] p.120). The principle of political economy assumes that each capital tries to maximize its profit. Therefore, it cannot suppose the money capitalists who are satisfied with a lower rate of interest although they could earn a higher rate of profits with their capital.

 

 Instead, Uno argued that parts of the money capital are temporarily idle for various reasons in the capital reproduction and are sources of funds to lend(ibid., p.110). They lose the use-value  for the owner but will be needed soon. Thus, such money capital temporarily becomes a commodity as use-value for others. When the funds (money capital) are lent, its rent is the interest rate. In short, interest is the price for the use of funds for a definite period of time. (ibid., pp.121-122) Uno, as well as Marx, assumed that the supply and demand of money (fund) determines the interest rate level. However, unlike Marx, Uno emphasized that the loan funds are from temporarily inactive funds in the capital reproduction process and increase or decrease in the business cycle.

Uno further utilizes his theory of interest rate to explain the crisis. When the profit rate declines at the end of the boom due to wage increase, idle money capital will decrease, and the interest rate will rise rapidly. Then, when the interest rate increases above the profit rate, a crisis happens.

Thus, Uno inherits Marx’s way of the exogenous money supply, although he refers to issuing banknotes depending on the bank’s reserve money (ibid., p.111).

However, when credit money can increase elastically by lending, money holders need not be supposed as sources of funds. In addition, the interest rate cannot be determined by the supply and demand of the money. Instead, it should be determined by the competition among capitals and the general rate of profit in the capitalist economy.

 

B.2 Development of the theory of credit creation: Yamaguchi

Yamaguchi, a theorist of Uno school, explains that credit creation is creating current purchasing power in anticipation of future return. He theoretically argued that credit creation takes place at commercial credit before bank credit.

He indirectly criticizes the concept of fictitious capital of Marx. The debt of a bank beyond the reserve money of the bank is not fictitious, but the whole debt is backed by the claim of banks.

Let us illustrate to make the following explanation easier to understand.

Fig. B-1

Yamaguchi explains the credit creation as follows:

Recently, even among Marxian economics, credit creation is often used more than just as a popular word. Its contents are still variously understood by theorists, and its theoretical provisions have yet remained ambiguous. It generally means creating unreserved liability that functions as the purchasing power. In other words, traditionally, it means the banks increase lending by creating the debt (banknotes or deposits) beyond their cash reserves (sometimes called primary deposits). In addition, it has been thought to be unique to bank credit, and its internal relationship with commercial credit has been largely unquestioned.

Such a conventional view of the bank’s credit creation emphasizes that it creates money beyond its reserve. … However, even if the created banknotes and deposits exceed its reserves, they are made by loans such as bill discounts and backed by the loan receivables, not cash reserves. In other words, bank liabilities are the purchasing power based on the fact that loan receivables are repaid after a certain period of time. Therefore, the essence of what is referred to by the term “credit creation” is not the money creation beyond the reserve, which is superficial and less meaningful. Instead, it should be a substantive function of creating current funds by anticipating future acquisition of funds.

Thus, credit creation has already emerged in commercial credit before bank credit, and the internal relationship between credit creation by banks and commercial credit becomes clear. In other words, the bank credit only lifts the restrictions on the credit creation in the commercial credit and substitutes for the commercial credit. Commercial credit is the basis of credit creation by banks. The credit creation through commercial credit is more direct than bank credit in anticipating future fund reflux. The bank credit also stands on the anticipation of the future money return, but the anticipation is indirect. Therefore, the bank reserve seems to support the bank credit. For that reason, the conventional view may have emphasized the creation of money beyond reserve money (Yamaguchi [1984] pp. 44-46).

 

Note that the difference between commercial credit and bank credit. The debtors’ money acquisition backs both commercial credit and bank credit. Nevertheless, bank credit seems to be backed by the bank’s reserve.

Let us consider the substitution of a bank for commercial credit. At first, suppose that capital A is short of money reserve due to temporary stagnant sales of its commodities. To continue production, capital A can buy raw materials from capital B in postpaid credit. The assets of capital A increase by the price of raw materials, and its debt increases by the same price simultaneously. On the other hand, capital B (seller, creditor) receives claims (commercial bills) on A instead of cash.

Fig. B-2

after credit trading

Fig. B-3

The creditor anticipates that the debtor’s commodity will be sold and monetized in the future and allows the postpaid dales. The creditor does not lend money directly to the debtor.

Subsequently, suppose the banking capital buys the claim from the creditor and pays with self-addressed liabilities at sight, such as deposits or banknotes.

Fig. B-4

The deposit currency in the creditor’s asset is backed by the claim in the bank’s asset. Finally, it is backed by the future money from the future sale of the commodity in the debtor’s asset. Subsequently, the creditor can buy commodities with the deposits. Thus, credit money emerges from commercial credit and circulates without the proper money.

Consequently, Yamaguchi argues that the circulation of convertible banknotes mainly stands on the smooth repayment of the claims held by the issuer’s bank.

Yamaguchi explains the conversion and the credit money:

 

Firstly, let us consider promissory notes and convertible banknotes. Although the bill is materially a piece of paper, it is received by the commodity seller and acts as a de facto means of purchasing. The rationale is that the receiver trusts the debtor will pay in the future. The basis of the trust is the debtor’s smooth reproduction process. The convertible banknotes are received, for the moment, because they are liabilities at sight (money claim), and their payment is trusted.

Nevertheless, the basis of trust is that the bank or the banking organization would smoothly receive repayment from their financial assets. More generally, the convertible banknotes can circulate as de facto money, based on the smooth process of social reproduction (Yamaguchi [2000] pp.194-195).

 

B.3 Self-contained Credit theory of money: Yoshida

Satoru Yoshida had worked for the Japanese Bankers Association for a long time and then became a university professor. He was a practitioner economist rather than a theorist but exchanged with economics scholars, including the Uno school.

Uniquely, he asserts that all the existing money is credit money endogenously issued by bank lending. In addition, he denies other exogenous money such as gold and fiat money. Usually, the theorists of endogenous money supply assume fiat money supplied exogenously by central banks or governments, apart from credit money by commercial banks. However, not just commercial banks, Yoshida argued that the money issued by the central bank is also credit money, not fiat money. Yoshida summarizes as follows::

In modern times, all money (central banknotes, deposit currency) is credit money. (Auxiliary money is not a problem here, although legally referred to as “money”). “Credit” of credit money is “credit,” not “trust.” Credit money is money that occurs and disappears in a credit relationship. However, this definition of credit money is subject to many objections.

Banks provide financial intermediation while creating money as deposits through credit creation. Then, banks must replenish their reserves. The reserve is supplied by the central bank as a bank of banks. (Reserve is needed after, rather than pre-existing reserve enables credit creation. The Phillips-style theory of multiplier credit creation is reverse causality. )

For deposits to function as money, systems such as bill clearing and exchange trade are formed. (These are deposit transfer systems.)

The essence of a central bank is a “bank of banks.” Banknotes and central bank deposits are only issued through financial transactions. Even inconvertible banknotes are not fiat money.

People get banknotes through the withdrawal of deposits. Deposits are promises to pay banknotes, but deposits must exist first to increase banknotes.

The Central bank accommodates to demand for banknotes and central bank deposits. However, how it accommodates (financial adjustment) can determine short-term market interest rates and affect general rates of interest. This is the basis of monetary policy (Yoshida [2008] p.15).

 

Interestingly, Yoshida uniquely uses the term “credit.” Usually, “credit” of credit money means “to trust the promise of the bank issuing credit money to pay the proper money.” That is, the holder of credit money trusts the bank. However, Yoshida uses the term “credit” to mean “to trust the debtor receiving the credit money to pay off the debt.” That is, the bank trusts the debtor. By interpreting in this way, Yoshida can discuss credit money without any proper money.

The commercial banks are obliged to hold the central bank money preparing for payment of deposits. Then, can the central bank money circulate by becoming fiat money by the legal tender provision? Yoshida goes back to the convertible banknotes and explains the basis of circulation of central bank money regardless of conversion.

 

Were the convertible banknotes able to circulate due to convertibility? If so, inconvertible banknotes could circulate only by the provision of legal tender. However, even if a currency is forced to circulate as legal tender, it could not spread, or even dollarization could occur when suffering from severe inflation. When even inconvertible banknotes are managed well, they can circulate without any problems. Certainly, convertibility was necessary to enhance the credibility of banknotes, but was not the actual basis for circulation the ways to issue banknotes? In short, at first, there are credit relationships in economic transactions. Then, as the substitute of the relation, the credit money is issued, whether a banknote or a deposit currency. In other words, does the valid rationale of circulation exist in the issuance and return of money grounded on reproduction?  (Yoshida [2002] p.78)

 

“The ways to issue” means that fiat money is issued by government spending while credit money is issued by lending. Fiat money has no backing assets, whereas banknote as credit money holds a backing asset such as financial claims and bonds. As long as the backing asset is sound, the banknote can circulate.

Even inconvertible banknotes do not lose their debt nature. Here, Yoshida appreciates the well-known explanation of the debt nature of inconvertible banknotes in Nishikawa[1984]. Nishikawa says that the bank’s debt is paid off by banknote holders buying commodities in the market rather than directly requesting the central bank to pay off (Nishikawa [1984] p.47). Nishikawa assumes the debt nature of the inconvertible banknote is not a direct relationship between debtor and creditor but the central bank’s debt to the entire commodity society. Based on this explanation by Nishikawa, Yoshida explains as follows:

Price stability (maintenance of currency value) is essential for the issuer of inconvertible banknotes to guarantee their ability to pay off. It is an obligation of private law for the issuer of inconvertible banknotes to maintain the trust of banknote holders rather than a public obligation. Financial textbooks say the goals of monetary policy are stabilizing prices, balancing international payments, and maintaining full employment. Nevertheless, it is said that the final destination should be stabilizing prices because of maintaining the debt nature of banknotes, including other debts of the central bank (Yoshida [2002] p.128).

Just as the commodity producer should guarantee the quality of his commodity, the bank should maintain the magnitude of the value of the credit money it issues. The magnitude of the value of the money is the reciprocal of prices.

However, Yoshida’s theory has the problem of discussing credit money without explaining the money. In short, it is “a theory of credit money without any theory of money.

 

B.4 Yoshida-Yamaguchi Controversy

Yamaguchi criticized Yoshida’s theory of credit money as follows:

“The endogenous money supply theory,” which Yoshida seems to support, denies that the pre-existing money is lent and maintains that, conversely, money arises by the lending. Indeed, money arises from the loan relationship, and similarly, the modern inconvertible central banknote also comes into existence through the credit mechanism. However, since lending is a lending of money, we should first assume the concept of money before the lending. If we consider that money arises from money lending, we will fall into eternal circular reasoning. After the circular reasoning is cut off, the theory of endogenous money supply can hold. In other words, theoretically, “the cash money is the premise.” Nevertheless, this does not mean agreement with the Phillips-style theory of credit creation. (Yamaguchi［2008］pp.84-85)

 

In response, Yoshida wrote:

It shows the theorist’s way of thinking, but actually, such cash money never exists. Nevertheless, “theory” resting on such cash money seems to diffuse. It would ground credit theory on inconvertible banknotes (fiat money) with mandatory circulating power. Not to say, Yamaguchi would agree with the “theory.” Hopefully, an approach “breaking the circular reasoning” will emerge. (Yoshida [2008] p.24 )

 

B.5 How to break the circular reasoning of credit money

As criticized by Yamaguchi, Yoshida’s theory of credit money is circular reasoning that “a promise to pay money is money.” If credit money is a promise to pay something, what is this “something”? If we present something, we can cut off the circular reasoning.

(1) The first way is to “cut off with legal tender.” The government stipulates what can pay off the debt between private agents, and the government provides it as legal tender. Because all the agents owe the monetary debt by buying commodities in the commodity society, the legal tender can circulate even with no value. The government does not necessarily issue it. The promise to pay it is credit money.

(2) The second is to “cut off by tax collection.” The government stipulates what can pay off tax. Because all the agents owe tax obligations to the government, The means to pay tax can circulate even with no value or with no mandatory circulating power. The government does not necessarily issue it. The promise to pay it is credit money. This way is often used by Chartalists.

(3) The third is to“cut off with gold money.” As the theory of value-form shows, gold is selected as a money commodity among all commodities that have value in themselves. Because gold has its value and all agents can exchange all commodities with it, it can circulate. The promise to pay it is credit money. However, as Yoshida says, gold is no longer money.

(4) The fourth is to ​​“cut off with commodity money.” The way emphasizes that the issuer of credit money has financial assets backed by commodity value. We explain it in the next section.