Money capital: New monetary principles for a more prosperous society By PatrickBolton and HaizhouHuang. Princeton University Press. 2024. pp. 312. £30.00 (hbk). ISBN: 978‐0691232225. £21.00 (ebk). ISBN: 978‐0691232379

This book by Patrick Bolton, Professor of Finance at Imperial College London, and Haizhou Huang, Special-Term Professor of Finance at Shanghai Jiaotong University, builds a theoretical model of an economy and monetary system which claims to provide a better framework for understanding and managing a macroeconomy than monetary, Keynesian, or modern monetary theory (MMT) models have so far provided. Most of the book is an exposition of their model, not about the real world. In their attack on other models of how economies work, Bolton and Huang (hereafter BH) mainly take aim at the Friedman–Schwartz version of monetary analysis (featured in ‘Money and Business Cycles’, a chapter in The State of Monetary Economics, NBER, 1965) as viewed through BH's particular perspective on the experiences of the US, China, Japan and Switzerland, leaving Keynesian and MMT models generally on one side. They have high praise for Hyman Minsky's view that credit cycles are more important than money in driving the overall business cycle, though they quote only the success of Minsky's theory in explaining the Great Depression of 1931–33 and the Global Financial Crisis (GFC) of 2008–10. The authors' two pillars are (a) their analogy between equity capital in corporate finance and money in the nation's capital structure, and (b) a proposition that policy is either monetary-dominated or fiscal-dominated, displayed in graphs (pp.161–5), which is elaborated in three uncalibrated and unquantified diagrams (pp. 196–8) showing when it is appropriate to switch from a monetary-dominated style of macro management to a fiscal style of management. First, the authors claim that whereas companies finance themselves with a mixture of debt and equity, sovereign nations finance themselves with debt and fiat money. In their analysis, “a nation's equity is the sum of central bank-issued domestic currency and Treasury-issued domestic currency debt” (p. 18). Debt in this context means foreign currency debt (p. 17). But are fiat money and Treasury debt in the macro world really analogous to equity in the world of corporate finance? BH acknowledge that excess equity issuance by corporate entities leads to dilution, and argue that the macro equivalent is inflation. But they also claim that new money acts like equity provided it adds to capacity or produces positive net present values. This is essentially a version of the real bills doctrine, which was shown long ago, by Henry Thornton and others, to be false. Several times BH make the argument that it matters how money enters the economy, whereas recent years have shown decisively that this is not correct. Most of the time in a fiat system money is created by commercial banks making loans. However, following the GFC, bank balance sheets were so impaired that banks stopped lending, and it required central banks to step in and create money (via asset purchases or quantitative easing, QE), otherwise money growth would have been too low. Consequently, post-GFC QE did not create inflation because overall money growth remained subdued (something BH refer to as a ‘big puzzle’). By contrast, during the Covid crisis, banks' balance sheets were in good shape and the injection of money via central bank purchases produced excess money growth and inflation. In other words, as far as inflation was concerned, it did not matter whether the money was being sourced from commercial bank lending or from central bank asset purchases; what mattered was the rate of growth of broad money. On their second proposition, it is highly dubious that macroeconomic policy can be characterised as either monetary-dominated or fiscal-dominated. A budget deficit can be financed only by taxation, by borrowing, or by the printing of money (i.e. creating enough money to finance the deficit via commercial banks or the central bank). Since taxing and borrowing are both transfers, this means, as Friedman maintained, that fiscal policy determines only the division of national income between different groups, whereas it is monetary policy in the sense of broad money growth that determines the growth of nominal national income. In Chapter 1 BH critique the Friedman–Schwartz proposition that broad money growth is the dominant driver of nominal GDP, using mostly graphical data from the US, China, Japan and Switzerland to illustrate successive periods of annual changes in M2, real GDP and the CPI. The analysis and comparisons are, to say the least, naïve and simplistic. They begin by quoting the Friedman–Schwartz proposition that “Appreciable changes in the rate of growth of the stock of money are the necessary and sufficient condition for appreciable changes in the rate of growth of money income” (p. 4) and then proceed to apply that as if Friedman and Schwartz never acknowledged any other sources of change in real GDP or inflation. For example, in one graph BH ignore the role of price controls during World War II, stating that, because there was “a relatively small increase in the price level” between 1938 and 1946, monetary theory therefore failed “most spectacularly during World War II” (p. 8). In a graph covering 1955–75 they fail to deal adequately with the long lags in effect between changes in M2 growth and price changes. “During the 1960s”, they write, “there was surprisingly little inflation” despite “quite substantial growth in [M2] and … sustained high growth in GDP” (p. 9), in effect failing to acknowledge the role of lagged M2 growth in the inflations of 1965–66 or 1968–69. Similarly, in a graph covering1965–87 they assert there was a negative relation between M2 growth and annual inflation based on an absurd one-month lag between money and prices. Again, for the period 1975–95 they denigrate the monetarist framework on the grounds that while M2 growth remained mostly above 8 per cent, inflation fell “from 14% to less than 4% and economic activity was subdued” in 1980–83 (p. 11). They ignore widely discussed regulatory changes that affected money growth during this period. BH also fail to comment on the success of slow money growth in taming inflation through the 1990s and 2000s (the Great Moderation). Finally, in the period after the GFC they again seek to trash monetary propositions by saying that there was “a sharp increase in the growth of M2 – of the order of 6% p.a.” accompanied by GDP growth and inflation “at around (if not less than) 2% p.a.” (pp. 11–12) as if this was not explicable by the Friedman–Schwartz account of the relation between money, income, and prices. Yet a simple application of quantity theory using 2 per cent annual real GDP growth, 2 per cent annual inflation and minus 1.7 per cent per annum change in income velocity (the norm since 1997) produces an equilibrium growth for M2 of 5.7 per cent – very much in line with the 6 per cent that BH quote for 2010–19. In sum, the BH critique of monetarism as applied to the US, on which they base much of the rest of their book, builds a grotesque version of monetarist thinking and then applies it naïvely and inaccurately. In the case of China, Japan, and Switzerland BH also misapply quantity theory. China's money growth after 1996 “grew between 20% and 10% per year” but produced “no inflation” (p. 12). The BH narrative is that “very high growth in economic activity accompanied high growth in M2 … so the price level remained more or less stable”. In turn, they say, the high GDP growth is explained by “very large investment in fixed assets”. They conclude: “Instead of increasing the price level, the growth in the stock of money helped finance investment, which in turn increased output. If you increase the stock of money and also increase output, it is no longer obvious what will happen to the price level” (p. 13). Their story is a travesty of what actually happened. Like Japan in the 1950s and 1960s (when Japanese M2 growth averaged nearly 20 per cent per annum, real GDP growth was 9.5 per cent and inflation was low), the economy was in a rapid catch-up phase of growth. In both economies, real factors determined the rapid growth of consumption and investment. Under largely fixed exchange rates in both cases, money growth accommodated (a) high real GDP growth and (b) relatively rapid additions to money balances each year (about 4–5 per cent per annum), resulting in low inflation rates comparable with those in the US to whose currency both were pegged. The implicit claim that more rapid money growth, if invested in fixed assets, somehow avoids creating inflation is simply wrong.