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Post by oliver on Oct 26, 2018 7:36:49 GMT
A matter of interest
I recently reread the following papers by Alfred Mitchell-Innes:
What is money
The credit theory of money
I was quite intrigued by their depth and prescience and I can recommend them to anyone. Maybe they can give you, JP, a better idea of where Antti and I are coming from than the things we've written ourselves. They tie in nicely, I find.
There is one critique raised by the host of that website:
So, mustering all my hubris, I thought I'd remedy that shortcoming by whipping up a chapter on the subject myself, illustrating it at times with the language of my previous post, namely that of red and green paper money. A quick recap to begin with: Green money is bank money as we know it. Red money is the corresponding debt held by someone else. Red and green bits of paper are netted against one another if they belong to the same person / institution. There is an individual cap to the amount of net red money any person may hold which is determined by the bank. People receive green money (from the bank; ex nihilo, if you like) when they give away goods but do not receive goods in return. The receivers of goods receive red money (also from the bank; ex nihilo, if you like) along with the goods. To get rid of their obligation (red money), they have to sell goods to someone with access to green money or someone able to receive more red money as per their individual debit limit. If you think of a two person economy, a first sale will produce an equal amount of red and green money. In a second transaction involving goods of the same value, the creation of both red and green money can be reversed, leaving both with a different set of goods as to begin with but with both accounts at zero (no money, no debt). The net effect of such a closed credit circuit is identical to a barter transaction. It is the 'sanctity of the obligation' or 'the law of debt', to quote Mitchell-Innes, i.e. the assumption that the goods given up in the original transaction can and will be returned at some point, that gives the bits of paper their value, whereby red and green values are inverse. Until now, interest rates have not entered the story. I have assumed that all goods given will be returned 1:1 and that neither time, nor risk nor any other 'disturbance' enters the equation. In order to start thinking about interest rates, I think risk is the place to start. Going back to the two person economy from above, one can imagine that, after the first sale, things do not go as planned. The person who received the goods might not come up with the goods of equal value within the agreed timeframe. The timeframe could be the duration of a loan, or, in the case of an overdraft, e.g. the lifetime of the person (death) or corporation (bankruptcy). It is insubstantial whether we think of one transaction being reciprocated or a chain of transactions. There are three sides to each transaction. There is the obligee, the creditor and an institution which transforms an ordinary loan / overdraft (red money) into what we call money (green money). So the input is an imperfect promise to sell goods in the future whereas the output is a paper that promises to be exchangeable for goods in the future but with no risk to the bearer (or let's say: as little as possible). Something, or more like someone, has to give. In this case, it is the obligees who agree to give more goods than they have received. They collectively make up for those obligees who fail to make good on their promises in order to make money a 'riskless asset'. i.e. to make creditors (including themselves) 'whole'. To illustrate that, let's imagine an economy consisting of, say thirteen people, one creditor and twelve debtors. Two in twelve debtors are expected to die before paying back any of their debts, leaving the ten others to come up with 1.2 x the goods they originally received. The creditors thus can recoup all twelve goods they originally gave up, again leaving all accounts at zero. In terms of red and green money, this can be thought of either as a drain of green paper from debtors to compensate for the red papers of the dead debtors so that they can be written off, or, more morbidly, a transfer of red money from the dead to the living. Of course, the projection of how many debtors will 'die' / 'come up short' is just that - a projection - and thus will turn out to be somewhat imprecise. To compensate for that imprecision, creditors are invited to pledge a portion of their green papers, allowing them to partake in the upside but also downside risk involved in making those projections. Those special credits are called bank equity. If a bank 'uses up' its equity cushion, it can either close (break the buck) or find someone to pitch in new equity. In the special case of the state owned bank, see the previous post on central bank equity by Antti. The nominal amount of credits demanded from debtors per year above the amount of the principal loan is an interest rate. In theory, it is the only interest rate necessary to keep the system up and running. Also somewhat theoretically, it is determined separately for each loan or, in the case of an overdraft provision, for each transactor. Competition among banks prevents them from raising rates too far above that necessary rate. We can also compare this to bilateral lending. In that case, there is no separation between holders of 'money' claims and equity holders. The bearer is always both as she directly bears the risk of the lender. Monetary Policy Until now, I have silently assumed that the nominal purchasing power of the green bits is sufficiently stabilised by the system described above. In reality, this may not be the case. For reasons that are beyond the influence of any bank, the value of green and red bits as measured in real goods may deteriorate or improve over time (abruptly or continuously). In the interest of keeping the real value of money claims as stable as possible - I assume this to be a primary goal and in fact the raison d’être of money as such - a policy making bank can use its power to set interest rates to compensate for any such unintended change. If prices are observed to be rising at say 2% annually, banks can debit the accounts of net debtors at the same rate and credit net creditors accordingly, thus keeping real purchasing power constant. And of course, a policy making bank can follow other objectives than just aiming at price stability, and it also has other tools at hand, for example discounting government bills, to target the above or any other goal. Whether such a policy influences the economic behaviour of market participants or whether it itself influences the real value of money claims and thus creates feedback loops is beyond the explanatory power of this simple theory (as far as I understand it) and it's probably best left to empirical researchers and psychologists. They might find that higher lending rates diminish the appetetite for new loans and possibly push some borrowers into insolvency for example. On the other hand, higher interest paid on monetary savings may have the opposite effect. I don't think monetary theory can tell us, which of the two effects is more potent. It may also depend on other circumstances. Fiscal Policy Since I’ve done a quick sketch of monetary policy (setting rates / discounting government bills), I might as well finish off with an equally quick and dirty dip into fiscal policy. When a government spends, it does so in the name of its tax payers. Any debt accumulated by government can only be serviced by the taxpayer. It is often said of ‚fiscal stimulus’ that an increase in spending is identical to a tax cut in terms of the effects it has on the economy. I don’t know about the effect, again that is a matter of empirics (or politics), but in light of the above and also the previous discussions on this board, I think we can be more precise about what it is the is going on in either case. Taking the credit cycle as the basic economic building block, an increase in spending is in effect the opening of a new circuit. Goods are purchased by government (from someone), incurring a new debt on the taxpayer. When taxes are reduced, no goods change hands. Instead, similar as with monetary policy as described above, the terms of existing (and potential new circuits) are changed. In one case, it is the interest rate that changes, in the other it is the payment schedule. In both cases, the ‚burden‘ for producing higher economic activity (measured in new credit circuits), is on the individual taxpayer - unlike when government spends itself. Otherwise, it just remains a new tax burden. |
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Post by oliver on Oct 26, 2018 11:54:45 GMT
@jp
P.S.
What I wrote above may not be of particular interest to you - I don't know - but I think the articles I linked to at the top are directly relevant to your last post on gold regulators (as well as many others you have written). There are lots of accounts about clipping, fineness, muliple standards etc. that should be very familiar to you. But his conslusions are often the opposite of your's, and indeed of many of the other sources he quotes. Iconoclastic, I suppose, and he admits as much, but I'd be interested to hear your thoughts, if you'r interested and find the time. |
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Post by Antti Jokinen on Oct 26, 2018 19:06:35 GMT
A profound post, Oliver!
I agree that risk and inflation are what justify interest rates.
I myself might have started from inflation protection and moved to credit risk, in opposite order from what you did. But I can see why you did it that way; in today's zero/low rate environment, most if not all of the interest on debt is due to risk, not inflation? Why I'd start from inflation is because that is common for debts and all credits. It's kind of the base rate, and on top of that comes 'risk premium' (both on debts and riskier credits). And as you say: "...keeping the real value of money claims as stable as possible - I assume this to be a primary goal and in fact the raison d’être of money as such". Not a big deal, of course. By the way, with "raison d’être", did you mean that the purpose of using money is to trade goods in a fair way, taking one apple and later giving one apple away, and not speculating on price changes? (This takes us to negative interest rates, but I leave that for later -- looking forward to that discussion!)
Could we treat the return on equity as a variable interest rate on credits held by shareholders? I think it has to be RoE, not just dividends, but I might be wrong. Dividends would of course be a more robust measure, but they never need to be paid out and still individual shareholders can claim their "interest" by selling their shares. But this is of course problematic, as RoE doesn't need to show up in the share price, at least not 1:1. In the end it's Mr Market who decides how much "interest" the shareholders take home.
What exactly do you mean with 'credit cycle'? The time between getting into debt by accepting (buying) goods and paying back debt by giving up (selling) goods? Or from a (universal) creditor's perspective, giving up goods and later taking goods in return? Or both? I find the term 'credit cycle' misleading, as it brings to my mind a 'debt cycle' (the ones Ray Dalio, for instance, talks about).
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Post by oliver on Oct 27, 2018 12:50:55 GMT
A profound post, Oliver! I agree that risk and inflation are what justify interest rates. I myself might have started from inflation protection and moved to credit risk, in opposite order from what you did. But I can see why you did it that way; in today's zero/low rate environment, most if not all of the interest on debt is due to risk, not inflation? Why I'd start from inflation is because that is common for debts and all credits. It's kind of the base rate, and on top of that comes 'risk premium' (both on debts and riskier credits). And as you say: "...keeping the real value of money claims as stable as possible - I assume this to be a primary goal and in fact the raison d’être of money as such". Not a big deal, of course. By the way, with "raison d’être", did you mean that the purpose of using money is to trade goods in a fair way, taking one apple and later giving one apple away, and not speculating on price changes? (This takes us to negative interest rates, but I leave that for later -- looking forward to that discussion!) Could we treat the return on equity as a variable interest rate on credits held by shareholders? I think it has to be RoE, not just dividends, but I might be wrong. Dividends would of course be a more robust measure, but they never need to be paid out and still individual shareholders can claim their "interest" by selling their shares. But this is of course problematic, as RoE doesn't need to show up in the share price, at least not 1:1. In the end it's Mr Market who decides how much "interest" the shareholders take home. What exactly do you mean with 'credit cycle'? The time between getting into debt by accepting (buying) goods and paying back debt by giving up (selling) goods? Or from a (universal) creditor's perspective, giving up goods and later taking goods in return? Or both? I find the term 'credit cycle' misleading, as it brings to my mind a 'debt cycle' (the ones Ray Dalio, for instance, talks about). Going over this again, I think I'll have to be a little more precise. The reason I started with credit risk is because I believe that eliminating it as best as possible is what distinguishes money from other assets. So when you say 'money is a owed by no one' I believe it is the elimination of credit risk that 'severs' the debtors from the creditors, making being 'owed by no one' possible in the first place. Inflation comes in second because that is a phenomenon that applies to all types of assets. It comes from without, it is a change in the UofA. All assets reference the UofA, but money 'merges' with it because it is as close to it as one can get. The UofA itself may not be stable in terms of real goods, though. You can think of an economy with high inflation. In such an economy there will be assets that perform much more stably in real terms than the official currency. Nevertheless they will not take over as monetary asset. That function will be left to that asset that, on the one hand is reflective of debtors of all sorts within an economy but, on the other hand, has had their credit risk 'extracted'. If that makes sense? As for my cute French term, I should have said raison d'être of monetary institutions (or left it altogether - it just sounds so nice...). That's what they're there for. But maybe I'm contradicting myself by saying that. My base assumption was that eliminating credit risk is mostly sufficient for stabilising a currency. Maybe that's wrong. I use the term credit cycle circuit in both ways. It's just a device that in my mind captures both the constant flows of goods between people as well as the stock of obligations / assets at any one time. I find it illustrative to think of an economy as a myriad of opening and closing credit and debt relations, both on an individual but also at an aggregate level, kept together by 'the law of debt' / 'the sanctity of the obligation'. That, as opposed to a stock of money floating around which facilitates trade. That's the picture I am trying to eradicate. |
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Post by oliver on Oct 29, 2018 7:06:33 GMT
What exactly do you mean with 'credit cycle'? I meant credit circuit, not credit cycle. Corrected it in my post above. |
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Post by JP (admin) on Oct 29, 2018 17:26:30 GMT
@jp
P.S.
What I wrote above may not be of particular interest to you - I don't know - but I think the articles I linked to at the top are directly relevant to your last post on gold regulators (as well as many others you have written). There are lots of accounts about clipping, fineness, muliple standards etc. that should be very familiar to you. But his conslusions are often the opposite of your's, and indeed of many of the other sources he quotes. Iconoclastic, I suppose, and he admits as much, but I'd be interested to hear your thoughts, if you'r interested and find the time. Oliver, thanks for the links. I will do my best to read one of them. I don't claim to know very much about the credit theory. But it seems to me that the biggest test of the theory is with coinage and not paper money or digital IOUs. Recording a debt on a full bodied coin seems like a very odd thing to do. But if Mitchell-Innes can make a good case for the credit theory using coins, I'm all ears. |
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Post by Antti Jokinen on Oct 31, 2018 10:18:56 GMT
Oliver, I'll get back to you a bit later with a longer reply. Probably tomorrow.
JP: When it comes to your concern about coinage, I think Innes might be able to answer that, at least partly.
I agree that more or less full-bodied coins are confusing. I say "more or less", because usually their intrinsic value was somewhere between, say, 80-97 % of their nominal value. Correct?
My current understanding of the phenomena goes something like this:
Had the coins traded strictly at intrinsic/bullion value, then we could conclude that they were commodities, and traded as such -- in barter transactions -- also when the government was involved. Some could still call these coins "money", but credit theorists would not. For them, as for me, the monetary system is about credits and debts. So explaining 100 % full-bodied coins is not problematic from the credit theory viewpoint. Ignorant people might call them money, but they are wrong.
Once the coins trade even a fraction above their bullion value, then we are talking about credit. They are not different in kind from today's coinage. The bullion value is collateral value, related to a Plan B which hopefully doesn't need to be adopted.
Let's go back to times before Adam Smith. I'll simplify, but I hope you get the point. The wealth, and strength, of a nation was to a large extent measured by its gold reserves. If the government needed to buy something, it could do it by trading its gold for that something. But that would mean a decline in its wealth, especially when viewed in an international context. So the government had plenty of what many viewed as "money", but it didn't want to use it (not that useful "money", is it?). It could have issued gold certificates, as the US did later (we've discussed this). But there was no central bank to sell the certificates to, and paper money wasn't yet well-trusted.
If the government wanted to use its gold as collateral, it had to let it go. The creditor had to possess it. But only for a while, of course. A creditor wants always to get repaid, and not take permanent possession of the collateral. Right? So the gold was in circulation, but only as collateral. It belonged still to the nation (represented by the government), and not to its individual holders.
How does this sound?
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Post by Antti Jokinen on Nov 1, 2018 20:25:43 GMT
Oliver said: OK, I see. Debtors have to pay interest so that the holders of various risky credits can get paid, in form of dividends and interest, for bearing the credit risk. Only in this way can we have credits we are used to call 'money' -- credits that should be nominally risk-free. Makes sense. Here we differ slightly, at least in language. I like to keep the UoA very abstract. To me it is much easier to say that nominal prices of goods, which are expressed in the UoA, rise and fall, than to say that the UoA is not stable in terms of goods. There's no change in the UoA; it is not something that can change. Prices of goods change. And I consider it fundamental that the interest rate on risk-free credits, money, more or less matches any inflation there is, so that I can give 50 apples out of my 100 this autumn to you and expect to get (at least) 50 apples from you next year. And vice versa: if I take 50 apples from you this autumn, I consider it fair that I have to give you at least 50 apples next year, even if there's deflation. An optimal monetary system should aim to make trade as fair as possible in real terms. You see from the above that I'm not happy with the historical system in this particular case. A lot of this has to do with cash paying zero interest, so we just have to see how higher inflation plays out in a post-cash society. But this doesn't put me at odds with you, I think. Other than that I don't agree that cash is used during high inflation because it is credit-risk-free. It is used because there's no alternative, and inflation accelerates to a large extent because people must use cash if they are to trade goods and at the same time they must try to minimize the real loss that comes with holding it; ie. they rush to buy goods, further bidding up their prices. As I said above, an optimal monetary system should aim to make trade as fair as possible in real terms. So I more or less agree with your use of the cute French term. If by stable currency you mean low inflation, then eliminating credit risk doesn't have much to do with it, does it? Circuit reminds me of the Monetary Circuit. You and I don't fully agree with that theory, do we? There's no money floating around or circulating. I find it hard to see the credit circuit you're talking about. What makes it a circuit? |
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Post by Antti Jokinen on Nov 2, 2018 12:43:32 GMT
Oliver said:
On a second thought, I don't agree with you here. Even if there was a haircut to your checking account balance due to some large credit losses, your credit balance would still be 'owed by no one'. By 'owed by no one' I mean there is no direct debt relationship. As a creditor (to the society, if you will) you can't walk to a debtor and ask for repayment.
'Owed by no one' in this sense applies to all credits. Time deposits*, bonds, and equity, too. Even in non-banks. I know, it's a stretch. But the idea is that all these are part of bookkeeping of goods owed, and owed to. What a bond issuer owes its holder is eventually an amendment of these records, so that the holder can hold 'money-credits' again, after holding bond-credits.
It's an alternative economic worldview.
* Time deposits should be easier to understand as 'owed by no one'. Not that different from checking account balance. If we accept that, then, by way of reasoning, we must accept that all credits are 'owed by no one (in particular)'.
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Post by Roger Sparks on Nov 3, 2018 17:15:30 GMT
I believe that mainstream economic thinking will not find a comprehensive theory until green money is thought of as being a gift certificate. Red money is nothing more than a promise to repay green money. Interest is nothing more than a green money payment for the use of loaned green money.
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Post by JP (admin) on Nov 5, 2018 14:35:54 GMT
I wrote a blog post on Mitchell-Innes. Antti, on twitter someone tells me that the gold collateral theory can also be found in Felix Martin's book.  |
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Post by Antti Jokinen on Nov 6, 2018 20:00:53 GMT
JP, as I said on Twitter, I've thought this collateral aspect is quite commonly recognized among credit theorists. For example, here's Eric Tymoigne in his 'A financial analysis of monetary systems' (2014, p. 91) (which I've got from him and have just started to read): I think you're probably right in questioning anyone who suggests that all gold coins throughout history have been credit instruments / IOUs. Gold in bullion form, for example as a kilobar in Oliver's basement in Switzerland, is clearly a commodity, not a credit instrument, and very few would consider it money. Those gold bars have been closely inspected and they bear official markings as a proof of their purity and weight. That is not too far from certain gold coins you have mentioned? If so, then I'd conclude that those gold coins, despite of their appearance, cannot be money, just like a gold bar is not money. Both gold bars and these coins have been and are sometimes still traded. One might have even considered them "media of exchange", but then again, many people consider Bitcoin a medium of exchange. (It's actually funny that news articles on Bitcoin are often accompanied by this picture or similar, as if just the coin form made something money.) I would like to suggest, partly following Eric Tymoigne's comment in your blog, that we could consider gold bullion as a 'commodity medium of settlement'. There's no doubt that central banks among themselves used it as such long into the 20th century, and such practices have been common among private banks earlier. Likewise, in societies spanning from the ancient world to Europe in the middle ages, debts that weren't in due course cleared during regular trading, could be settled by delivering some agreed commodity. It could be precious metals or it could be staples, and neither needed to be considered 'money' by the participants nor lend its name to a unit of account. If I'm right, it would be no wonder if people have often mixed these two concepts, and considered this 'commodity medium of settlement' money, especially as it no doubt has been circulating alongside credit instruments, ie. tokens, which in my opinion can rightly be called 'money'. What is not a matter of opinion is that these two things are different in kind, and so we should not call both 'money' and try to come up with a theory of money that encompasses both. |
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Post by oliver on Nov 7, 2018 7:50:01 GMT
OK, I see. Debtors have to pay interest so that the holders of various risky credits can get paid, in form of dividends and interest, for bearing the credit risk. Only in this way can we have credits we are used to call 'money' -- credits that should be nominally risk-free. Makes sense. On a second thought, I don't agree with you here. Even if there was a haircut to your checking account balance due to some large credit losses, your credit balance would still be 'owed by no one'. By 'owed by no one' I mean there is no direct debt relationship. As a creditor (to the society, if you will) you can't walk to a debtor and ask for repayment. 'Owed by no one' in this sense applies to all credits. Time deposits*, bonds, and equity, too. Even in non-banks. I know, it's a stretch. But the idea is that all these are part of bookkeeping of goods owed, and owed to. What a bond issuer owes its holder is eventually an amendment of these records, so that the holder can hold 'money-credits' again, after holding bond-credits. It's an alternative economic worldview. I see where you're coming from. Being 'owed by no one' is the result of a general balance sheet operation and applies to all credits on a bank's balance sheet, not just those in a checking account. I'm on the look out for the distinguishing feature of those credits that are used in trade and those that require determination of their value in terms of the first before they can be used for buying goods and services. Credit risk felt like the most logical place to look. I may be wrong, but I don't know where else to look. Well, inflation is a difficult creature to capture, anyway. Prices of apples may go up while those of pears go down. And since few people trade apples now for apples later, the whole concept is rather murky. Also, just because the UoA is abstract, doesn't mean it can't change. In fact, I think it has to change. There was no concept of the price of an iphone at the time the UoA was conceived. Yet it must have evolved to encompass iphones, otherwise we wouldn't be able to price them. Why must people use cash, though? Why don't they revert to other 'things' if cash is so bad? They do revert to foreign cash, I suppose. But what is it that distinguishes cash from other types of credit? Why don't MBSs suddenly become the new cash when cash loses its value? You're right, money circulating is not the picture I'm trying to paint. I suppose decrease and increase in synchronisation or gifting and reciprocating will do the trick or that we are all sellers and buyers. You know what I mean but you're right to call me out on language. |
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Post by JP (admin) on Nov 7, 2018 15:13:09 GMT
Antti: "If so, then I'd conclude that those gold coins, despite of their appearance, cannot be money, just like a gold bar is not money."
As I've said before, I don't want to get drawn into semantic debates about what is money and what isn't. I'd prefer if most debates didn't even include the term money.
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Post by Antti Jokinen on Nov 7, 2018 20:44:57 GMT
I'm fine with that, JP.
Referring to my comment in your blog, a gold bar or a gold coin, if neither has a face value higher than its bullion value, is a commodity and not a credit instrument. Credit instruments are what most people nowadays refer to when they talk about 'money', and that was what I had in mind when I talked about money above.
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