...a blog by Richard Flowers

Tuesday, March 29, 2011

Day 3739: Money


I suppose we all like to THINK that we could take a one pound coin to the Bank of England and swap it for one pound coin's worth of gold. But if you take your pound coin to the Bank of England, all they will give you in exchange is… ANOTHER pound coin.

Of course, a moment's thought will explain why. If Great Britain, a trillion pounds in debt, were, like a dragon at Gringotts, sitting on a great big hoard of gold, wouldn't we, um, sell it to pay off the debt?

Oh wait, Mr Frown already did that.

There is a theory that money exists just because the Government SAYS that it does.

This is what is known as "Modern Monetary Theory" or "MMT", and I have recently been reading a small tome (pdf) by one of its proponents, a Mr Warren Mosler.

It's a bit like discovering a SITH HOLOCRON.

You can see how the ideas of the "other side" are put together – there is a LOT in there that clearly informs the what I call "thinking" of Mr Bully Balls, for example – but you can't quite help but feel oddly REPULSED because there's clearly SOMETHING not quite right, even if you can't put your fluffy foot on what it is!

(And I thought that MMT was a kind of TANK for BATTLE DROIDS in STAR WARS, but it turns out that's an "MTT" or "Multi-Troop Transport". Though as it happens, the Wackypedia disambiguation for "MMT" offers up both "Modern Monetary Theory" AND "Magical Mystery Tour". You can make your own jokes up, really.)

Now you SHOULD bear in mind that Mr Mosler is a RESPECTED and WORLD-RENOWN economist with YEARS of study and thought behind his works. Also he's a candidate for the US Senate. And I am a stuffed elephant. Admittedly an AWARD-WINNING stuffed elephant, but even so.

And what he has to say READS very PLAUSIBLY.

But my rule of thumb is if it sounds too good to be true it almost certainly IS too good to be true. And this doesn't half sound like the MAGIC MONEY TREE.

Money does NOT grow on trees. Unless you are the survivors of the Golgafrinchian "B Ark" that crash-landed on prehistoric Earth in Mr Douglas Adams' "Hitchhikers' Guide to the Galaxy". They adopted the LEAF as their currency and all became instant millionaires. Although there was a small problem with inflation. As we will see, this is a not untypical outcome of creating money from nothing.

Anyway, I'm going to try to explain some of the things in his theory and why I think they must be wrong. But you may prefer to read him in his own words and decide for yourself.

In this theory, since money exists because the government says it does, then taxation is just the government saying that some of the money – your money – does NOT exist any more. Similarly, government spending is just the government creating new money, as and when it needs it. And there is NO CONNECTION between the two.

Thus the government can never go bankrupt. Do you see the attraction for Hard Labour?

When the government taxes you, claims Mr Mosler, all it does is change the numbers on your bank account. When the government spends, all it does is change the numbers on the bank account of whoever it is paying.

Mr Mosler likens this to the scoreboard in a football game. (I suspect he means an AMERICAN football game, but it still counts.) When one team scores, the ground staff change the numbers on the scoreboard. They don't need to have a supply of "goals" beforehand; they just "create" the score at the point when it is needed.

This leads to the BACKWARDS-SEEMING notion that the government does NOT raise taxes in order to have money which it can spend, but instead SPENDS so that people will have money which it then collects again in taxes.

Oh dear; Daddy says his head has just turned inside out!

let me try and give you Mr Mosler's explanation:

The government demands tax from people (under threat of punishment) and only accepts payment in its own special tokens (what we call "the currency" which is "pounds and pence" to you and me or "dollars" to Mr Mosler).

This means that people have to OBTAIN currency, which they can only get from the people who create the currency, i.e. the government themselves.

Which, in turn, means that people EITHER have to work for the government directly OR produce something which they can trade with government employees in order to get the required tokens to settle their tax bill.

So, the government "creates" all the money and "puts it into the economy" (spot the Bully Balls phrase). Private business just "re-circulates" the money inside the economy like a big tumble-drier full of notes. And then the government destroys some of the money by taxation.

The illogical logical consequence of this is that if you want to GROW the economy… the government should almost always run a deficit.

(Further counter-factual arguments that follow include: "running a trade deficit is good because imports are a real benefit and exports are a real cost(!)"; and "leaving our debts for our kids is fine – they'll still enjoy all the benefits of the goods they produce because they can't send those goods back via time travel to settle our debts now(!)" – to which I have to reply: "no, but they CAN send them to CHINA to settle the debt. You IDIOT.")

Now, this is all rather like that optical illusion of those monks walking up the endless stairway. It LOOKS like it makes sense, but surely there's something WRONG somewhere.

And I think that, actually, it has the same PROBLEM as the monks' stairwell: it's a system with NO INPUT. Or, as Daddy Alex puts it: a perpetual stagnation machine!

Suppose EVERYONE goes to work for the government. The government can create the money to pay everyone and everyone can pay their taxes, and what happens? Everyone starves to death.

Look, let's just step back a second and ask the IMPORTANT question: what IS this thing called "the economy" anyway?

Well, it seems to me that "the economy" is basically a machine for turning WORK into GOODIES.

Most people have some basic needs: food, shelter, James Bond DVDs and so on.

At the most basic level: you COULD go out and fix all of these things for yourself: you could catch your own food; you could build your own shelter; you could make your own cine-camera and film yourself performing your own James Bond script… or is that just me?

This is called a SUBSISTENCE economy, or TOO MUCH EFFORT.

A step up from that is that YOU could go and gather food while YOUR FRIEND could stay behind and build shelter. This is a (slightly) more efficient use of both your time. AND it is the most basic form of ECONOMY: you put in your labour getting food and get out BOTH food AND shelter; your mate puts in labour building shelter and gets out BOTH shelter AND food.

You've both turned your work into more goodies.

It should be pretty obvious how you extend this to a BARTER economy: you and your friend might have EXTRA food left over – suppose you're especially good at gathering apples, you might have more apples than you need or want. So you can take off with some of your EXTRA apples and see if you can't find someone with something they might be willing to SWAP. Perhaps you find someone who's really good at growing potatoes.

So now, you've put in your work gathering apples and you've got apples AND shelter AND potatoes.

BARTER allows for more complicated economies to develop. If you aren't spending all your time gathering your own food and finding your own shelter then you can SPECIALISE: for example you can become an expert in making TOOLS. The tools themselves might not feed or shelter you, but they enable someone else to be BETTER at getting food or making shelter. So you make them a tool, and they use it to increase the stuff they get from their labour, and in return give some of the excess back to you.

[Even today, this is why trade is GOOD – and why exports are NOT a cost; you've converted your labour into goodies which you swap for other goodies and everyone benefits.]

So you can see how this is a BETTER sort of economy, but it's still a bit CUMBERSOME. Carrying, say, a flock of sheep around with you to exchange for stuff is a bit of a chore, not to mention fiddling with the small change.

Eventually, it occurred to people that carrying around small chunks of VALUABLE stuff – mainly lumps of gold – was more convenient.

Now, a chap called King Croesus of Lydia came up with the idea of making regular sized lumps of gold so that you could easily count out different amounts depending on how much things were worth. And he decided to have his face stamped onto each one – well, he was king, after all. This was the invention of COINS, and also why we still talk about being "as rich as Croesus" – because for a while at least he did literally own all of the money in the world.

Of course it helped that his kingdom of Lydia – in modern day Turkey – was sat on a great big deposit of gold to make coins out of. Well, electrum, actually, which is a naturally occurring alloy or what we call gold mixed with silver, though HE called it gold, and so invented debasing the currency at the same time that he invented a currency to debase!

Unfortunately for King Croesus, Lydia was also slap-bang in between Greece and Persia and – with all that gold – a very tasty target for invasion; Croesus made the SLIGHT strategic error of pre-emptively attacking the vast Persian Empire who promptly obliterated him. Still, they quite liked this "coins" notion.

So, once the idea had caught on, money in those Ye Olden Dayes was worth its weight in gold mainly because, Croesus electrum aside, it WAS gold. Or silver. Or copper. Or sometimes shiny shells. Or even leather belts. I'm drifting…

This was called COMMODITY money, because the money itself was an exchangeable commodity or what experts call "useful stuff". The economy was now basically "BARTER PLUS": that is, LIKE barter but with a sort of agreed exchange rate based on the value of the stuff you made your coins from.

This was quite a lot of FUSS, though. The coins were HEAVY and cumbersome and even if people DIDN'T try to cheat you by mixing their gold with silver (or some copper or tin or lead or whatever), it wasn't always easy to be sure you were getting the weight of gold you thought you were. Different kings issued coins in different weights so they ought to be worth less or more than each other, but some traders were a bit crafty about that too.

So, to get around all this, someone came up with the idea of PAPER money. And as most people probably know, it was the CHINESE who thought of it first.

There is a famous episode of Doctor Who where Mighty Kublai Khan gives Dr Woo some of his new paper money. And this was worth real stuff: these notes were basically written I.O.U's, which could be exchanged for the stated amount of gold, silver or silk and wily old Kublai was as good as his (printed) word when it came to his money.

Unfortunately, his descendents were less trustworthy: running short of resources, they just PRINTED extra currency and carried on spending, resulting in nasty case of HYPERINFLATION – a situation that brought down their dynasty and that the subsequent Ming Dynasty only got out of by abolishing the currency all together!

Nevertheless, Kublai Khan's cash was an early example of what we call FIAT MONEY. Now, that's NOT currency that you can exchange for a small Italian car. It is money where the VALUE does not depend on what it is MADE of, but on the PROMISE that it is worth what it says it is worth. Fiat comes from the Latin for "let it be" as in "let it be worth THIS".

Ultimately – or at least as ultimately as the 21st Century – this evolves into our system where we don't even need the paper, and the promises are recorded as electronic scores inside banking machines.

Now, I think I can see how this FIAT system LOOKS like it's the government just wishing money into existence with a "let it be"; even more, I can see how the electronic recording of money makes it LOOK even more like Mr Mosler's football scoreboard.

But I think that those resemblances are SUPERFICIAL.

You can't ACTUALLY exchange your goals on the scoreboard for anything else.

Or, on a deeper level, the rewards of the players ARE determined (in the long run) by those numbers of goals scored, so in a way they DO exchange goals for exchangeable currency… BUT, that currency is paid for from the receipts that the club got at the gates (and from television rights) so in a way the ground staff DO have a supply of "goals" before they put the scores up on the board. Money goes in – the money is "turned into goals" for which the players labour – and then the scores are turned back into money which goes out again. There's just not a simple linear relationship between these flows.

Money is essentially a DEBT: it represents the VALUE that we are OWED for the labour and resources that we have put in (or maybe that someone else, our Daddies perhaps, put in and then gifted to us); and/or it represents the VALUE of goodies we expect to get OUT in return. And that is why we are able to swap money for goodies. Or for that matter vice versa if, for example, you produce James Bond DVDs and want my pocket money.

Suppose *I* choose to create a currency. It WOULDN'T have any VALUE because no one else would BELIEVE in it.

I could call it the CURRANT. It'll be a decimal currency: ten currants equals one BUN. Actually, currants are delicious and nutritious and that's in danger of being a COMMODITY CURRENCY that MIGHT have actual value. I'm drifting again…

Mr Mosler suggests another example of a family where the parents issue the children with coupons for doing chores under the rule that the children have to pay a "tax" of ten coupons or face punishment. But again, that's another system without input. Not to mention sadistic! The parents obviously have to go out to work to support themselves and their kids, even if they just go hunter-gathering. So that's NOT like a government "creating" currency. The kids get food protection, shelter "for free" from their parents. Probably not James Bond DVDs from THESE parents, though, the swine! Again, that's not ANYTHING like the way that real governments or real economies work.

"But," says Dr Freud, "literally infantilizing everyone EXCEPT ze government – zat IZ, how you say, revealing."

No government just sits down and CREATES an entire currency from scratch just by issuing it. Even when introducing a NEW currency – like when the Euro arrived in 1 January 1999 (yes, the single currency is two years older than ME!); or when pounds and pence replaced pounds shillings and pence on 15 February 1971 (yes, our "grand historic traditional pound" is two weeks YOUNGER than Daddy Richard!) – the new currency is swapped for old currency. So in theory (if not always in practice) the VALUE – or if you prefer the DEBT for LABOUR put in – gets carried forwards intact.

So if governments DON'T create all the money, where DOES the money come from?

Well, there's a bit of a CHICKEN and EGG thing going on: because there IS money in circulation, we BELIEVE people (governments or banks) when they gives us more money.

Look, there is more money IN CIRCULATION than is just the spending of the government.

If I was a farmer with a corn field, I could EAT some of my corn, TRADE some of my corn and KEEP some to PLANT next year. I don't need ANY input of "money" government.

Suppose that the person that I want to trade my corn with DOES want to pay me with money. Must they have got that money from the government? No, they could BORROW it from a bank. The BANK (not the government) creates the money. It also creates a DEBT that will have to be paid off with some WORK sooner or later. I ACCEPT the money because I BELIEVE the bank's promise to back up the money with assets, that is that the bank will get hold of the promised labour or goodies for me either directly from my trader or indirectly from someone else who has created a similar debt.

So we've added some VALUE to the economy (my corn) and added MONEY to the economy (as a debt my trader – or someone – will have to repay, backed up by the bank's promise to make them) and the government had nothing to do with it.

In fact there is a case for saying that the value of money is not created by the government but by the fact that the banks will accept it in settlement of debts. Or ultimately that any of US will accept it in settlement of debts.

And thus, the level of money in circulation has built up over time.

The labour put in by our parents and grand-parents and great-grand-parents and so on has built up some assets that endure. Even if the VALUE of those assets is concentrated into the hands of a very small number of people (starting with the government, formerly the King), the DEBT for that Labour (i.e. the MONEY) has been spread about rather thinly.

Since the first introduction of Fiat Money, what has tended to happen is that currencies have swung between being hard guarantees of convertibility into assets to open ended government promises depending mainly on how much money the government needs in circulation compared to how much people TRUST the government.

For example, after World War Part Two, and particularly remembering the inter-war inflation in Germany, trust in governments was very LOW so governments had to stick to the Gold Standard, essentially promising that they would always swap actual gold for currency if asked.

At the start of the Nineteen Seventies, President Tricky Dickey Nixon BROKE the Gold Standard and said US Dollars would no longer be a straight swap for gold.

He did this because too many people (mainly the Swiss) kept asking him for the metal stuff and it's just a bit AWKWARD for governments to have to hold a great deal of gold in reserve, on the off chance someone happens to ask for it. Just ask Mr Frown. Ahem. It doesn't earn you any interest, just sitting there glittering, and its value can fall relative to other investments (although recently it has performed better as people see it as a long term safe store of value because it's basically indestructible, unlike – as 2008 reminded us – the stock market).

More importantly, gold is in short supply which tends to limit the amount of money backed by gold that any (or even all) government can issue.

And governments have MORE assets than just their gold. Foreign currency reserves; debts; chunks of land. And one way of looking at assets is that they are basically something that you can convert into money later, whether that is gold or land that you can sell or a debt that you will get repaid. So from that point of view, FUTURE TAX REVENUES are "something that you can convert into money later" so sometimes governments look at their future tax revenues as ASSETS too. They issue money as a DEBT, a promise of goodies or labour, and they get the goodies or the labour to clear that debt IN THE FUTURE.

When it came to breaking the Gold Standard, it was a bit dodgy for a while, but basically people ACCEPTED that America had a basically strong economy and would be good for paying the debts. And the perceived value of the Dollar stayed good.

So governments CAN "create" money, but only in the same way that banks can "create" money i.e. because HISTORY means that they have assets and because we BELIEVE them when they promise they will swap the money for a share of those assets.

The government's ability to create money relies on our COLLUSION; money is created by our BELIEF that the debt will be settled, not by the government's say-so.

And we have already seen what happens when people DON'T believe their government when it creates money by its say-so: you get hyperinflation. It brought down the Yuan Dynasty in ancient China. It brought down the Weimar Republic in pre-war Germany. And today you can see the enormous strains being placed on the Euro because the governments of Greece, Ireland and now Portugal have lost credibility.

Money has been described (by Iain M Banks fictional ultra-smug post-scarcity society "The Culture" and/or their dragged-up Doctor Who cousins "The People") as an only-slightly-better-than-the-most-inefficient method of rationing in a society with limited resources. And the hardly-any-less-smug* Federation of Star Trek also claim to have abolished money. To which I say, yes, but you're FICTIONAL.

We have to live in a world where resources ARE limited. And that applies to governments too. So even if a government COULD create infinite MONEY, there is a strictly FINITE amount of resources it could obtain with that cash. So there is a FINITE VALUE to that money.

And, as Mr Dougie Adams would tell you, any finite number divided by infinity is as near to nothing as makes no difference: which is why printing money makes it worthless.


*Daddy Alex couldn't disagree more! He says the Federation are far MORE smug – and with much less to be smug about! Also, they may CLAIM to have abolished money, but that doesn't stop them trading "gold pressed latinum" with the Ferengi when it suits them.

Daddy suggests that when Space Commander Sisko goes to the bar and says "give me a drink", Mr Quark says, "that will be one slip of latinum," rather than "your word and a shower of your imaginary Federation pixie dust? That'll do nicely…"

Obviously, that's NONSENSE. Space Commander Sisko would BULLY Mr Quark into giving him a drink or else the LIGHT and AIR gets TURNED OFF.

Though that DOES raise an interesting point: Mr Quark IS charging his customers for drinks, and for time in his only-to-be-used-for-wholesome-and-morally-uplifting-entertainment holosuites. So is he getting his power for replication and holograms for free from the station? If he is, do the Federation MIND him profiteering off their back? Even when THEY are the ones being charged for DRINKS? And if not, what do the "we don't use money" Federation DO with the rent they charge him?

Mind you, the Federation clearly have both technology ("replicators") that can make literally anything from thin air, or rather energy AND apparently inexhaustible supplies of cheap energy** to power them with. Under their "Prime Directive" they refuse to share this technology with their neighbours. So they have a society with limitless resources surrounded by (relatively) poor neighbours and no immigration problem… which makes you wonder what just what KIND of a society it might be.


**Daddy reckons that the Federation has some sort of perpetual motion machines, and wonders if it might not be the replicators themselves – and you know he might be sort of right: if the replicators can replicate ANTI-MATTER (and why wouldn't they be able to?) then your onto a winner.

You would need to put E=mc2 of energy IN, but you could annihilate the anti-matter with an identical mass of matter to get 2xE=2 mc2 or twice as much energy OUT.

Even allowing for a bit lost to inefficiency, that would be almost limitless free energy so long as you can keep your reactors topped up with matter in the form of any handy planets, stars, or annoying neighbouring civilisations who bug you about sharing the technology…


Gareth Aubrey said...

If the various Star Trek Technical Manuals are to be believed (and there's a hole with no bottom...) the replicators use a specially-produced feed material that the replicator transforms into the type of matter required; this would suggest that you could only make anti-matter with anti-matter feed (and if you've bothered making anti-matter in the first place...)

They also specifically address the energy issue, by asking "If you have replicators, why can't you just replicate a starship?" and answering with the rather pseudo-philosophical, "if you could replicate a whole starship, why would you need to?"

Edis said...

One of the best books on why money works is still J.K.Galbraith's "Money: whench it came, where it went". The great American currency of early years was the tobacco leaf, of course, so Douglas Adams leaf joke had a real-life basis.

Warren Mosler said...

Thanks for the review and not a bad recap of how the currency actually works.

While you have most of the basics, you did miss a few. And the readers can see all for themselves here, where

the (short) book can be read online at no charge here:

Yes, we have a tax driven, fiat currency. And no, you don't have to like it!

Warren Mosler

Alice said...

Give the book another chance. Mosler makes an excellent point with the Scott Pelly/Paulson quote. When the Fed had to make an emergency grant, they just pulled the money out of thin air. If they do that for Banksters, they can do that for any other federal expenditure.