Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

Socratic Economics II: What is Money?

by Migeru Thu Sep 28th, 2006 at 06:49:13 PM EST

The elephant in the living room of our economic discussions is monetary theory. Not the monetary theory that ChrisCook says is complete bollocks due to the faulty assumptions that underpin it but, in a broader sense, "[any and all] theories of money".

So, in the Socratic spirit of asking naive questions to expose hidden assumptions:

  • What is money?
  • How is money created?
  • What determines the value of money?
  • Why do we pay interest?

Below the fold, some quotations by ChrisCook to get the discussion going...
In short, our current [monetary] system is akin to the Emperor's Clothes, and sites like ET are well placed to point the finger of fun to point it out.
Previous instalments of the Socratic Economics series:
* Colman: Socratic Economics I: Why GDP growth above all else? (June 29th, 2006)


ChrisCook:

Any energy policy which sits upon a deficit-based monetary infrastructure is doomed to failure.

...

The solution IMHO can only lie in "reversing the polarity"  to create firstly "asset-based" investment mechanisms particularly in renewable energy, and secondly, generic clearing, along the lines advocated by Keynes at Bretton Woods, but with a global monetary "Value Unit" based upon energy.

To me the problem lies with the nature of the assumptions that underpin Economics, and with the treatment of both Money and Property as "Objects" when in fact both are "Relationships".

...

The Money that we use is a toxic interest-bearing Object issued by credit institutions for the most part not based upon "Value" or "Money's Worth".

This "Deficit Money" is a "claim over Value" and represents "anti-Value" rather than "Value"

...

In my opinion any rate of interest charged in excess of the cost of administration and the costs of defaults is de facto inflationary. If it is not, could someone explain to me why not?

Growing inequality is an inevitable consequence of two factors:
(a)a deficit-based monetary system; coupled with
(b)absolute property rights in respect of "Commons" such as Land and Knowledge.

A deficit-based economy is unsustainable mathematically, and the only solution is, in due course, that proposed by Keynes (and now Stiglitz) of an International Clearing Union and (the view of others like Lietaer) an asset-based Value Unit - eg a "Petrodollar" based upon energy.

The second factor was addressed over 100 years ago by Henry George's idea of a "Single Tax" ie Land Value taxation, a policy which is once again receiving much attention, and is looked upon with approval by Martin Wolf, among others.

And if you need more [money], why should not the Treasury issue credits interest-free?

Who actually needs a Central Bank as an intermediary anyway? We no longer need banks as credit intermediaries, although there is a requirement for the MANAGEMENT of credits created bilaterally.

Ah, you say: to allow a Treasury to create credit would be INFLATIONARY.

And yet when Banks create it - adding an interest burden on top - then that is OK.

We take for granted the current "Deficit-based" monetary system which is based upon credit issued by "Credit Institutions" as a multiple of their capital base.

Unfortunately conventional economics is based upon the assumption that the IOU's / "claims over Value" issued by Banks represent Value as opposed to its complete opposite.  The fact is that the Economic Growth we are told is desirable is an imperative of such a deficit-based system, because when Money is created as an interest-bearing loan, it is necessary for the Economy to grow to create the Value against which further IOU's may be issued and so on.

We are now running up against the unavoidable fact that resources - particularly oil - simply do not exist at a level necessary to accommodate the level of economic activity required to service the global interest requirement on the Money supply.

We must "Reverse the Polarity" of the money supply so that it becomes "asset-based" rather than "deficit-based".

Display:
by Metatone (metatone [a|t] gmail (dot) com) on Thu Sep 28th, 2006 at 06:59:24 PM EST
held on to the DC electrical energy distribution system, long after every one else had discovered that AC was safer and more efficient.

Reversing polarity is not something I would easily equate with the dollar.

But you missed one of the more important CC quotes, that money only has value when it is in motion. In this sense, reversing polarity would be a singular event comparable to the reversed polarity of the Earth (an event that no human generations have yet experienced as far as I know)

Now if this reversing polarity was more like AC - happening so fast that it is not humanly detectable without instruments ie that it was both asset AND deficit based.....alternately

hmmmmm

You can't be me, I'm taken

by Sven Triloqvist on Thu Sep 28th, 2006 at 07:11:01 PM EST
I've already suggested that money is at least in part a way of quantifying faith in both the present and the future. This is most obviously true of speculative transactions. But it's true in a more immediate way too.

Even when people engage in a supposedly simple barter transaction, they're really attempting to quantify for themselves the future use-value of the item they're haggling for.  

The use-value can be symbolic, aesthetic, emotional or just plain sentimental - it doesn't have to be practical. This doesn't change the fact that they're trying to work out exactly what an item will add to their experience in the future.

This isn't quite the same as money only having value when it's in motion. Transactions are the points at which estimates of faith in the future are made. Being able to imagine how much something might be worth if you could buy it or sell it gives money a persistence of value outside of actual transactions.

One of the bizarre feudal remnants of modern economics is that banks own money. People don't - they're merely allowed to use it. Banks (and to a lesser extent, national governments) define its actual value. This is why only banks are allowed to control interest rates and other key indicators of value.

The more money you're allowed to borrow and use - literally and metaphorically - the more influence you have on your local environment, and also your future.

Very big players are allowed to try to define international environments and futures - again these are both literal and metaphorical.

So money does two things. The first is to formalise faith and confidence. And the second is to define social and political relationships between the feudal overclass that owns the resource and the underclass that is allowed access to it on sufferance.

This is a neat twist on fedualism, where land was limited. Money is symbolic, which means it's not a finite resource. If you're in the overclass you can hand out as much, or as little, of it as you want, to offer as much of a future - or not - as you feel like offering.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Sep 28th, 2006 at 08:30:32 PM EST
One of the bizarre feudal remnants of modern economics is that banks own money.

Actually, in the US, the Fed owns the notes, but the Treasury owns the coins.  (No reason for pointing that out.  Just popped into my head.)  The truth is that it wouldn't matter, whether people owned the actual money or not, because the value of money is based on what it can buy.

Money is made to be a limited resource for the sake of price stability.  You could print all the money you'd like to, but, in the end, you would simply be jacking up inflation -- which, as you know, can lead to pictures that are not at all pretty (Germany and others after WWI, Argentina on numerous occasions, and so on).  We have interest rates as a means to leading supply and demand roughly to equilibrium in the money market.  In feudalism, sure, you could've handed out land until you were blue in the face.  Everybody could have had an equal chunk, and this could also be made to be in the at the beginning of a period with money -- everybody being given (say) £18,000, which is, I think, roughly the average income in the UK ($30-35,000).

Would this end the debt-based financial system?  No.  Some would save, leaving a base to loan; others would borrow from that base for investment (or apparently consumer goods in the current American picture); just as we have today.  Loans are what allow people to invest in themselves to raise their incomes, whether a college loan or a small-business loan or or or.  (In the end, you can only loan as much as people save.)

Some would be successful, and pay off the loan, while others would not.  That's a fact of life, -- and not simply one of capitalism -- and it is the reason we have (and are right to have) the welfare state and various other protections.  Most economists, myself included, will tell you that bankruptcy protections, for example, interfere with market forces, but they will also tell you, I think, that they are, on the whole, a good thing.  You'll, of course, inevitably be encouraging people to take on too risky a project, but, without those protections, -- and I fear America may learn this the hard way if the Republicans don't cut the shit -- most people, being risk-averse, will be much less likely to take on loans for projects that are fairly low-risk, because of their fear of being practically owned by the credit companies.  And that will, in my opinion, inevitably make for a far less dynamic economy -- less competition (and, therefore, higher prices), less innovation, etc.

So the point is that the current system is not perfect, but it exists this way for a reason beyond politicians and "economic elites".

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Fri Sep 29th, 2006 at 04:19:05 AM EST
[ Parent ]
Why do we pay interest?

Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Fri Sep 29th, 2006 at 06:42:32 AM EST
[ Parent ]
CC has come up with a very good explanation as to why it is not necessary ;-)

You can't be me, I'm taken
by Sven Triloqvist on Fri Sep 29th, 2006 at 08:07:24 AM EST
[ Parent ]
All the more reason to ask our resident orthodox economist why we do it.

Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Fri Sep 29th, 2006 at 08:10:47 AM EST
[ Parent ]
quite rightly too..

You can't be me, I'm taken
by Sven Triloqvist on Fri Sep 29th, 2006 at 08:28:03 AM EST
[ Parent ]
Lending money at interest was universally considered antisocial before the rise of Capitalism in Europe
Usury was defined originally as charging a fee for the use of money. This usually meant interest on loans, although charging a fee for changing money (as at a bureau de change) is included in the original meaning. After moderate-interest loans became an accepted part of the business world in the early modern age, the word has come to refer to the charging of unreasonable or relatively high rates of interest.

Usury (in the original sense of any interest) is scripturally and doctrinally forbidden in many religions. Usury was denounced by countless spiritual leaders and philosophers of ancient times, including Plato, Aristotle, Cato, Cicero, Seneca, Plutarch, Aquinas, Muhammad, Moses, and Gautama Buddha.

...

Indeed, the historical rendition of usury as a vile enterprise stems not only from a spiritual view that charging exorbitant interest is a flagrant manifestation of unchecked greed, but carries with it social connotations of perceived "unjust" or "discriminatory" money-lending practices.



Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Fri Sep 29th, 2006 at 08:37:55 AM EST
[ Parent ]
Turn it around: Why shouldn't we?

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Fri Sep 29th, 2006 at 10:29:27 AM EST
[ Parent ]
We could decide it has bad macroeconomic consequences and is antisocial, as it was considered before the current bout of financial capitalism started in Europe a few hundred years ago.

Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Fri Sep 29th, 2006 at 10:35:16 AM EST
[ Parent ]
and is antisocial

"Antisocial" is a bullshit term.  Homosexuality was also considered antisocial for much of history.  (In fact, it, unfortunately, still is in too many parts of the world.)  Drug use is considered antisocial behavior in most countries.  If I wanted to legislate morality, I would've registered as a Republican.  The fact that Mohammed and Moses opposed it doesn't make interest payments immoral, in my view.  It just says to me that a couple of famous schizophrenics opposed interest payments.

Let's stick to the economics of it: What bad macroeconomic consequences are you speaking of?

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Fri Sep 29th, 2006 at 11:58:10 AM EST
[ Parent ]
The first consequence is that lending money at interest is inflationary.

The second consequence is that it acts as a damper on investment.

I'll develop these and come up with more later.

Then I have to ask you whether you think that economic regulations [including property rights] are independent of social mores, and whether economic activity fulfills a social purpose, whether "social" is a bullshit word.

I don't think drug consumption or prostitution are good, but making them illegal causes more problems than regulating them. Similarly, outlawing the lending of money at an interest would just create a black market of loan sharks, but that doesn't mean that just because it should be allowed it is a good thing.

So, back to my original question, why do we pay interest?

What is interest?

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Migeru (migeru at eurotrib dot com) on Fri Sep 29th, 2006 at 12:13:08 PM EST
[ Parent ]
it's a rental payment for the ultimate capital good: capital itself. It pays for

  • capital acquisition cost. Buying (earning) or renting (borrowing) the capital
  • opportunity cost: not having the money for any other purpose for the given period
  • default risk: not being repaid
  • admin and profits.

You lend money because presumably someone else can put your capital to better use than yourself.

Interest and principal are two totally different things, and it's pointless to compare them (as in 'poor African countries, paying so much more in interest than they borrowed'). One is a payment for a service, and the other is a good.

Borrowing X for 1 year and borrowing it for 20 years is not the same, and it's natural that the rental price of that money is different, both in absolute and per unit of time.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Sep 29th, 2006 at 05:17:18 PM EST
[ Parent ]
And conventional economics is based upon bullshit assumptions. A House of (Credit)Cards.

When Banks create Money as a multiple of their Capital base they do so as in the form of interest-bearing loans.

So when you borrow $200k to buy your apartment, you pay back another (say) $200k in interest over the period of the loan.

Unfortunately the money to pay the interest on bank loans does not exist at the time of creation, and cannot exist across the system, unless economic growth takes place to create the "money's worth" against which more money can be created.

Economic Growth is not a "good thing" - it is devouring the planet (a bad "macroeconomic consequence, I submit) - but it IS a consequence of a deficit-based money supply which grows inexorably in the exponential curve with which all economists are only too familar.

Any interest charged in excess of the cost of running the clearing/risk management system and the cost of defaults is, I submit inflationary, and if not I would be interested in an explanation as to why not.

Credit is founded in the sovereign individual's undertaking to provide something of Value (ie "Money's worth") at a future point in time. Banks provide nothing of Value other than a further promise to pay, backed only in small part by real Value (ie their regulatory Capital).

Their function is therefore actually only that of a Guarantor, but they are hugely over-rewarded in respect of it and to the extent that credit is created by Banks in excess of their Capital it is a direct cause of asset price inflation, which in turn leaks into retail inflation.

The other source of inflation is fiscal ie when national Treasuries manufacture credit (through the agency of the banking system) in excess of the "Value" being collected in taxes.

Return on investment - which is legitimate - has become conflated with a charge for "time to pay" in respect of credit created.

The problem with "usury" is not really "interest" per se but the inequitable nature of the debt contract, where the lender is entitled to the return of his Principal no matter whether or not the borrower is able to pay.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Sep 29th, 2006 at 12:26:55 PM EST
[ Parent ]
The problem with "usury" is not really "interest" per se but the inequitable nature of the debt contract, where the lender is entitled to the return of his Principal no matter whether or not the borrower is able to pay.
The one with the economic power is the lender, not the borrower. The lender does not need to lend the money out and make a return on it in order to survive, the lended money could just as well have been used by the lender for its own consumption. The borrower needs the lender, the lender could embark in other investments if so incluned. Hence the inequitable nature of the debt contract. The borrower has no bargaining power.

Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Sun Oct 1st, 2006 at 03:20:40 PM EST
[ Parent ]
As ChrisCook said the "natural" sources of positive interest are the default risk, administrative costs and profits.

In theory, perfect competition should reduce profits to zero, and current information technology reduce a good part administrative costs to zero, the rest is peopleware to assert default risk.

Now, in the current world there is a another term to add : the government intervention in the market to set short term interest rates to some value (nowadays through central banks, but that's the government anyway).

Just like China central bank manipulate its dollar exchange rate, central banks do manipulate short term interest rates, and by doing so central bank are influencing long term interest rates, by arbitrage.

Example:

You're a lender and you've managed to be good enough to have an average default rate that translates into a 1% interest rate for 10 year loans. Without central bank gaming the system, well the 10 year interest rate is 1% period. Now that central bank are setting the short term rate to 5% and says it will maintain it for as long as whatever random condition is true and people think it will be true for the next 10 years. By arbitrage, the 10 year interest rate you have to offer is 5+1=6%.

Now why are central banks currently messing with short term interest rates?

Because somewhere current money is fiat money, just paper and has near zero commodity value. Money is a great technological invention, way more pratical than barter for everyone.

But there's a problem: how much money should be printed for a given economy and how is decided the initial repartition?

I've never found anything about how the initial repartition of fiat money was made.

The current system for deciding how much money should be printed is the fractional-reserve banking system : private banks are given both the priviledge of creating money and the priviledge of having access to someone always willing to loan you more money : the central bank. In other words: it's privatized, with the priviledged having the guarantee of the state.

Commodity money is an alternative system where the money can still be paper but representing a certificate that you own a certain amount of commodity (gold, silver, oil, whatever, ...).

With commodity money, the initial repartition is by ownership of the land where commodities are found, and the amount is what's around. Of course discoveries and technological improvement ("hey I can make gold from garbage") can change the amount and thus the value of commodity money brutally.

Note: I suspect the initial repartition of fiat money followed commodity money.

I've always been surprised of the religious belief in the current fractional-reserve bankind as being the best possible fiat money system. May be I haven't found yet the right papers, but I've seen about zero alternative even discussed.

Help welcomed :).

by Laurent GUERBY on Fri Sep 29th, 2006 at 02:57:48 PM EST
[ Parent ]
Credit is "time to pay" ie the time between the two halves of a "split barter" transaction.

If any buyer's IOU can be "wrapped" in a credible Guarantee then other people will accept it.  That is all Banks are doing as "credit intermediaries".

I am working on introducing, in two countries initially (leaving Iran to one side, which I have given up on after the Iran Oil Bourse now hijacked by the Oil Minsitry) the "Guarantee Society" concept.

Simply put: a Guarantee Society is a grouping of businesses and individuals with a "common bond". Within the GS bilateral "peer to peer" trade credit is extended interest-free, backed by a mutual guarantee, but with the option to settle in "Money's worth" ie in barter as well as in fiat money.

Dead simple.  A banking function as service provider is implicit in it. ie management of credit creation and maintenance of a secure accounting & clearing system. These accounting systems quite straightforward in practice.

But addressing trade credit is only addressing a small part of a modern economy. A large amount of credit is that of a Government operating as a "Public Enterprise" ie providing services in return for taxes.

One of the sources of inflation is fiscal - ie when Treasuries create (via the banking system as agent)more credit than their tax base warrants.

However, most of the "Value" in circulation is "Money's worth" arising from productive assets - particularly the rental value of property (Land & buildings and Intellectual property make up most of it). Over 70% of UK money supply is deficit-based and asset-backed, ie it is credit backed by mortgages.

The relatively value-less nature of bank credit leads to asset-price inflation, which may leak via equity release into retail inflation

The problem is that the institution of private property in Commons such as land and knowledge leads, via credit and gearing, to the concentration of ownership of these Commons in fewer and fewer hands and hence in the revenue streams to which they give rise also becoming concentrated.

In addition to addressing the unsustainable credit mechanism we use, we must also provide a mechanism to address the inequitable distribution of Commons.

Here I advocate that those who have exclusive private use of a Commons should compensate those they exclude ie the principle behind Henry George's "single tax" but extended to other "Commons", and reconfigured as a "Rental" perhaps incorporating a tithing or pooling arrangement.

I believe, wiith Keynes, that an International Clearing Union is the solution, upon which "money's worth" in energy, property rentals, and of course individuals' labour in time units, will be exchanged with reference to a "Value Unit".

When "wrapped" in a collective guarantee, interest-free credit will be available (albeit not cost-free, since both the service provision and default cost must be shared) and the result is an asset-based monetary system.


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Sep 29th, 2006 at 04:12:14 PM EST
[ Parent ]
You have reinvented the "bank"

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Sep 29th, 2006 at 05:10:23 PM EST
[ Parent ]
I must admit I don't see a clear new proposal either :).
by Laurent GUERBY on Fri Sep 29th, 2006 at 05:42:55 PM EST
[ Parent ]
Albeit a bank that only recoups cost, not interest

You can't be me, I'm taken
by Sven Triloqvist on Fri Sep 29th, 2006 at 05:44:34 PM EST
[ Parent ]
what's in interest.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Sep 29th, 2006 at 05:52:13 PM EST
[ Parent ]
I think you are right: the Internet was always going to disintermediate Banks (www.zopa.com disintermediates Credit Unions) but what was lacking was the "Enterprise Model".

Japanese and other "Trust Banks" came close to this model in terms of outcome, but are still intermediaries. It is the concept of the  "Open Corporate" (inadvertently created by HMG for the wromg reasons) which enables the total disintermediation of Banking. .

However, I regard Banking as an honourable profession which can and should continue to exist, and thrive. Banks can reconfigure (ie reinvent themselves as you rightly say) in a transparent disintermediated system to add value, rather than extract it through smoke and mirrors as now.

NB The worst offenders, by the way, are so-called "Islamic" Banks, which are an Islamic veneer on an unIslamic reality.

Firtly, re Credit, Banks servicing a future "service provider" GS model can risk manage the bilateral creation of credit, operate the necessary default fund in accordance with GS policies, and also manage a secure clearing platform. Not a million miles from LCH is it?

The involvement of local government in backing youngsters and start-ups is a key element in developing the model, and hopefully they will lead the formation of a key element of the "Hanseatic Microfinance Initiative" involving a Scottish Council, and a regional Norwegian Council.

The GS is already official policy of one Scottish political party, and well on the way for another.

Secondly, re Investment using "Capital Partnerships" Banks may fulfil functions in:
(a) bringing together Investors with Investment;
(b) liquidity provision as market-makers;
(c) possibly the provision of bolt-on guarantees, for those who need them.

Banks' position as credit intermediaries is simply no longer defensible in a "Napsterised" or "Peer to Peer" society, and deficit-based banking based upon credit creation is in any case mathematically unsustainable - I give the current system two to five years irrespective of anything I'm working on.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Sep 29th, 2006 at 05:56:04 PM EST
[ Parent ]
But there's a problem: how much money should be printed for a given economy and how is decided the initial repartition?

I've never found anything about how the initial repartition of fiat money was made.

The current system for deciding how much money should be printed is the fractional-reserve banking system : private banks are given both the priviledge of creating money and the priviledge of having access to someone always willing to loan you more money : the central bank. In other words: it's privatized, with the priviledged having the guarantee of the state.

First of all, let's stress the distinction between printed money and fiat money. Printed money is a measure of how much cash people feel they need to have on them in order to make small payments in day-to-day life. For instance, suppose I have an average balance of €1,000 in my account, and that I like to have between €0 and €100 on me at any given time. To satisfy my needs, there need only be 1/10 of the total money in the form of printed/minted currency. If I use cheques/plastic for large transactions, or get used to carrying less than €10 on me and using plastic for small purchases, there is only need for 1/100 of the money to be in the form of currency to satisfy my needs.

As for initial repartition of fiat money, let's just take the case of the US dollar. Once upon a time, the US dollar was made of gold or silver. Then paper money was introduced, which was backed by gold or silver in the banks' vaults. Then fractional reserve banking came about, and only a fraction of the paper money needed to be backed by actually existing gold or silver in the bank vaults (see my previous example regarding the difference between money and currency). Then the gold standard was abandoned, by removing the redeemability of money for gold or silver. At that point, the initial repartition of fiat money was identical with the final repartition of gold-standard money. Or, to put it differently, fiat money wasn't created in a vacuum, but just took over from a previous state of the conomy with an existing repartition of wealth. The repartition of fiat money reflected the existing repartition.

Those whom the Gods wish to destroy They first make mad. -- Euripides

by Migeru (migeru at eurotrib dot com) on Sun Oct 1st, 2006 at 03:32:54 PM EST
[ Parent ]
I do fiat amount = paper amount since the difference is irrelevant to the discussion of what is the quantity of money that is appropriate for a given economy and how this quantity is achieved.

From wikipedia:


Silver and gold standards

From 1792, when the Mint Act was passed, the dollar was pegged to silver and gold at 371.25 grains of silver, 24.75 grains of gold (15:1 ratio). 1834 saw a shift in the gold standard to 23.2 grains, followed by a slight adjustment to 23.22 grains in 1838 (16:1 ratio).

In 1862, paper money was issued without the backing of precious metals, due to the Civil War. Silver and gold coins continued to be issued and in 1878 the link between paper money and coins was reinstated.

In 1900, the bimetallic standard was abandoned and the dollar was defined as 23.22 grains of gold. Silver coins continued to be issued for circulation until 1964, when all silver was removed from dimes and quarters, and the half dollar was reduced to 40% silver. Silver half dollars were last issued for circulation in 1969.

Gold coins were withdrawn in 1933 and the gold standard was changed to 13.71 grains, equivalent to setting the price of 1 troy ounce of gold at $35. This standard persisted until 1968. Between 1968 and 1975, a variety of pegs to gold were put in place. 1975 saw the U.S. dollar freely float on currency markets.

by Laurent GUERBY on Tue Oct 3rd, 2006 at 01:57:09 PM EST
[ Parent ]
Money is made to be a limited resource for the sake of price stability.  You could print all the money you'd like to, but, in the end, you would simply be jacking up inflation -- which, as you know, can lead to pictures that are not at all pretty (Germany and others after WWI, Argentina on numerous occasions, and so on).
The Central Bank could print/mint currency, or not, but that would have a minimal impact on money, as currency in circulation is only a few percent of all money. Money is created by private banks when they loan money to people. In order to do this, fractional reserve banking [could someone please rewrite the appalling Wikipedia article on the topic?] is allowed (banks have to be allowed to have assets to back only a fraction of their deposits). The monetary authorities can indirectly control money creation by setting reserve requirements and the base interest rate, but that is rather indirect and even then
In practice, the connection between reserve requirements and money supply is not nearly as strong as the exercise above would suggest. Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money. Deposits that are components of M2 and M3 (but not M1), such as savings accounts and time deposits such as CDs, have no reserve requirements and therefore can expand without regard to reserve levels. Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States.
so money creation is almost entirely in the hands of private banks, has little to do with printin/minting cash, and is based on debt.
We have interest rates as a means to leading supply and demand roughly to equilibrium in the money market.
If you say so...

Those whom the Gods wish to destroy They first make mad. -- Euripides
by Migeru (migeru at eurotrib dot com) on Sun Oct 1st, 2006 at 03:16:47 PM EST
[ Parent ]
Money is something that has evolved spontaneously and repeatedly from barter in societies all over the world, starting at the neolithic level of development (or perhaps earlier). Any theory of money that seeks to describe the baffling complexities of modern monetary systems must first be able to explain the monetary function of tobacco, shell money, big cylinders of limestone, gold, and so on, and the role of lending and debt in barter economies.

I don't see anything special about energy as a basis -- in fact, because different forms of energy differ not only in quantity but quality, it seems to me to be no more suitable than other bundles of assets. If the idea is to back money with diverse assets, I can think of no reason to limit these to materials that are commonly burned.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Thu Sep 28th, 2006 at 11:43:47 PM EST
Firstly, let me insert here a section from a recent paper of mine which touches on the subject of Money.

>>
Money as Dynamic Value

Few people understand Money: John Law:was perhaps the first, in 1705:

"Money is the Measure by which Goods are Valued, the Value by which goods are Exchanged, and in which Contracts are made payable".

"Every thing receives a Value from its use, and the Value is raised, according to its Quality, Quantity and Demand".

"Money is not the Value for which Goods are exchanged, but the Value by which they are Exchanged":

The following quote,by E C Riegel, is a good summary.

"The purpose of Money is to facilitate barter by splitting the transaction into two parts, the acceptor of Money reserving the power to requisition Value from any trader at any time. The method of Money is to employ a concept of Value in terms of a Value Unit dissociated from any object. The monetary unit is any adopted value, which value is the basis relative to which other values may be expressed."

The monetary process is a dynamic one involving the creation and recording of debt/credit obligations between individuals and the later fulfilment of these obligations.

Riegel speculated that Money exists only in the transitory instant of Exchange of Value: in other words that Money exists only in motion.  

This transitory monetary "Value Event"/ Transaction involves the creation of "Credit": so in exchange for something of Value to me (of whatever type) I will assume an obligation to provide something of equivalent Value at a future point in time.

These obligations may be recorded on transferable documents, electronically or even merely retained mentally. The sum total of all obligations as recorded in the accounting universe of all sets of accounting records essentially comprises a "ledger of ledgers" or "Master Ledger" as Riegel put it.  Another way of viewing it is as a "Cloud" of "Accounts Receivable" and "Accounts Payable".

This massive database of "Credit"obligations is not Money, but temporary "Capital" (often known as "Working Capital"). It is Static Value - which only becomes "Money" Dynamic Value when exchanged in the transitory Monetary process. Rather than the "clearing" of these obligations by a mutually owned and operated exchange and offset system we utilise Banks as intermediaries to carry out the "Clearing" function for us.

In this electronic age what we think of as Money is in fact not tangible "cash" but rather for the most part (97% of Money in circulation) the flow of data between databases of obligations maintained by Credit Institutions (ie Banks and Building Societies).

The role of Credit Institutions such as Banks in current Money creation is little understood. Banks literally "loan" Money into existence. In exchange for an obligation by an Individual to provide to Banks something of Value in the future (ie an IOU or claim upon Value) as described above Banks merely issue a reciprocal IOU.

These Bank-issued IOU's which we are accustomed to use as our Money are therefore not a claim upon Value, but rather a claim upon a claim upon Value. A "double negative" giving rise to what is essentially a "false positive".  

The true source of Credit is the Individual, not the intermediary Bank, and Banks therefore levy upon Borrowers a return - in the form of Interest - upon Money they create arbitrarily and which is for the most part not based upon Value at all.

In summary, Money need not be- as it currently is - an "Object" circulating in the form of a Bank-created IOU but should instead be a relationship involving a dynamic process of Value creation and exchange by reference to a "Value Unit".
>>

The question then is, what would be the principal forms of "Value" or "Money's Worth" customarily being used as Money within the necessary generic Clearing Union?

Firstly, I believe that energy is uniquely placed as a "Cross border" currency which would be available for global exchange. But it would of course be a Common currency, rather than a Single currency.

However, the vast bulk of Money in circulation in most "developed" countries came into existence as bank and building society loans. eg over 70% of UK money supply is "Asset-backed" but "Deficit-based".

I believe that it is possible - through the use of "Co-ownership" investment in property using "Land/Property Partnerships" to produce a stream of property rentals arising from direct ownership ie an "asset-based" stream of "money's worth".

This will likely come about from the simple fact that this partnership mechanism is the best Equity Release mechanism there is on the one hand, and a REIT on the other.

In other words, following John Law's reasoning some 300 years ago (although he did rather bugger up the implementation) the majority of money in  circulation NATIONALLY would be Property-BASED. as opposed to property-BACKED.

In this way we cure the problem identified by Marx in his later work of "Fictitious Capital".


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Sep 29th, 2006 at 04:31:11 AM EST
[ Parent ]
I like the definition of Jerry Gillies:

The basic reality of money is that it's unreal. Money is a myth. It has no value in and of itself. It is a medium of exchange for goods, services and ideas. It's a beautiful human invention that most people haven't figured out how to use yet. Myths are wonderful things, made to be enjoyed, but if you try to embrace them, you'll just end up hugging air. So it is with money.

Sorry no link, this is from a book I received over 20 years ago.

by Fran (fran at eurotrib dot com) on Fri Sep 29th, 2006 at 11:03:10 AM EST
I do not pretend to be an economist. But if I might take a shot at stirring the pot:

There has been a great deal of discussion about how money is created, but it seems to me that money economies also allow for the spontaneous occurrence of events that destroy money (or, as a climatologist might say, "sequester excess money from the monetosphere"). The collapse of the equities bubble at the start of the millenium was one such, the impending housing bubble will likely prove another. And then there were the 1930s. (Tulips, anyone?)

Certainly, we can view these events as "accidents" in a system that it is within our power to regulate; indeed, I imagine that this is the implicit assumption of economics.

But it seems to me that stocks of money, if left to themselves, are almost certain to "spontaneously combust" once they exceed a certain level, much like old-growth forests with their high fuel loads are virtually certain to fall to a forest fire if left untended.

So whatever else money is, I suggest that it is also a medium capable of causing a spontaneous restriction of its own supply.

And if I'm mistaken, I'm sure I'll be told so in no uncertain terms. :-)

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman

by dvx (dvx.clt št gmail dotcom) on Fri Sep 29th, 2006 at 12:08:35 PM EST
Good stir. But you assume Money is an Object, which is true of Bank IOU's in a deficit-based system.

Wherever loans are either repaid, or written off after defaults (as with the 30's Equity bubble when so many margin loans on stock went sour) then (Deficit-based or Credit) Money is destroyed.

"Stocks" of Money can only self combust if they exist as "objects".

As discussed elsewhere, Money actually is a Relationship, not an Object, and a monetary system results wherever a barter system incorporates:
(a) credit(extended interest-free by a seller, but with shared costs of admin and defaults);
(b) a "Value Unit".

"Value" or "Money's Worth", such as energy, property rentals or even gold may then be exchanged on such a barter network which may be characterised, with a mutual guarantee, as a "Clearing Union".

So in a true and "asset-based" monetary system there are no "stocks of "Money" - merely static or accumulated "Value" (aka Capital) awaiting exchange in monetary transactions.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Sep 29th, 2006 at 12:42:51 PM EST
[ Parent ]
Hmmm, I still need to get my head around what you mean by an "asset-based" monetary system.

For now, while the 30s bubble was financed essentially on margin, one feature of the millenial asset bubble (at least in the US) was that equities had become an important personal savings vehicle for salarymen and -women (401(k)s!). How would you characterize this in the IOU-vs.-asset-based dialectic?

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman

by dvx (dvx.clt št gmail dotcom) on Fri Sep 29th, 2006 at 01:53:30 PM EST
[ Parent ]
Shares in Joint Stock Companies (the inaptly named "Equity") are a form of "ownership"  of assets and revenues streams within the legal "wrapper" of the Company corporate vehicle.

These shares confer an "absolute" or infinite property right - the "Divine Right of Capital".

This claim conflicts in extremis - eg Eurotunnel - with the temporary (or finite duration)claim of credit secured against the same assets and revenues.

The former is asset-based (upon "ownership"): the latter is "deficit-based" but "asset-backed" (generally using the device of a "mortgage" ,"charge" or "lien").

I am pointing out that there are other legal "wrappers" available to investors to result in "asset-based" finance.  In Canada they use "Trusts" and issue units in them to investors, who thereby get to particpate in the relevant revenues and assets through "ownership". Canadian Income and Royalty Trusts have workable tax treatment (ie transparency), and are very popular with investors, since they may get a piece of revenues BEFORE the user of the finance gets his hands on it.

The (tax transparent) "Open" Corporate UK LLP achieves the same result, but without the cost and complexity of Trust Law, and in a way where the Trust manager can be brought in as a revenue-sharing partner, thereby aligning his interests.

The "Capital Partnership" LLP where revenues (or production) are shared between Capital provider and user FOR AS LONG AS THE CAPITAL IS USED - allows us to transcend the Debt/Equity dialectic through the use of a claim of Indefinite duration - Quantum Capital maybe.

The outcome will be (since those who do not go this route will be at a disadvantage to those who do) to replace much of the Debt in issue with what I call "Open Capital" instead, and this results in streams of "money's worth" produced by productive Capital which has a Value in exchange within a Clearing Union.

NB Conventional and Marxist Economics alike are based upon the assumption that the Sun goes around the Earth and that Capital is not "productive". ie only Labour is productive: what are they smoking?)

eg Refinancing Eurotunnel

Eurotunnel must raise £6bn to repay debt and can afford no more than £240m (or 50% of gross revenues) to service refinancing.

Eurotunnel sells 1 billion Equity Shares @ £6.00 each.  Capital is returned over 50/ (or 100) years, which would be £120m (£60m) per year conventionally.

Instead we calculate that £120m (£60m) constitutes 25% (12.5%) of gross revenues each year and this proportion of gross revenues will thenceforward be repaid to investors each year.

The balance of £120m (£180m) ie 25% (37.5%) of revenues, is available as a Capital Rental, and constitutes a return of 2% (3%) initially to Investors.

The "Capital Rental" declines with Capital so after 25 years (50), it is 12.5% (18.75%) of Revenues.

The outcome is that risks and rewards are shared: if Eurotunnel has a good year, so do Investors.  Existing debt holders must agree how many Equity Shares are to be allocated to each class.


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Sep 29th, 2006 at 02:24:51 PM EST
[ Parent ]
This is an interesting model, but I don't see where it invalidates my original contention:

So whatever else money is, I suggest that it is also a medium capable of causing a spontaneous restriction of its own supply.

To take your Eurotunnel model: If I understand correctly, a 50-year "term equity share" (can I call it that?) sold for 6 arbitrary currency units (ACU) returns 2% capital rental + 2% as the share of anticipated profits.

I assume that your asset-backed model also admits of an aftermarket for term equity shares.

What happens when 5 years into the term it becomes generally anticipated that the profit-sharing component will increase by 50%, i.e. the return from 4 to 5%? The term equity shares will climb to ACU 7.50. (Yes I know: "Well d'oh".;-) For the sake of argument, let's say that these improved expectations cause 200mn term equity shares to change hands, so that an additional ACU 300mn is poured down the Eurotunnel.

At some point the Iron Law of Shit is certain to be invoked: war, oil shock, irrational exuberance, cave-in or a CEO who channels Ken Lay. Profits dry up, the term equity shares return only 2%, the aftermarket price is ACU 3, 300mn shares are liquidated (of which 100mn were purchased at ACU 7.50). These investors originally put in ACU 1.95bn but realize only ACU 0.9bn.

Which brings me back to my humble contention that - whether asset-based or debt-based, money has something of the character of a population of lemmings.

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman

by dvx (dvx.clt št gmail dotcom) on Sat Sep 30th, 2006 at 04:28:51 AM EST
[ Parent ]
Let me try and describe it another way: it is very simple, but it represents a conceptual leap from existing models which is not straightforward.

Revenues come into Eurotunnel LLP and go two ways.

A proportion of gross revenues - NOT profits - goes to Investors in Equity Shares (the "Capital Provider"): the balance goes to Eurotunnel SA (the "Capital User").

These proportional "Equity Shares" have two components:
(a) a Return OF Capital;
(b) a Return ON Capital.

First: Capital repayment.

Each Equity Share is gradually repaid over time (50 or 100 year terms given as examples).  

Instead of receiving a constant repayment of Principal in cash terms (which erodes with inflation) the Investor receives a constant proportion of GROSS Eurotunnel revenues.

So if there are one billion Equity Shares, 2% of each one will be repaid each year(over a 50 year term) or 1% over a 100 year term.  The Capital repayment for each Equity Share will therefore be one Billionth of 25% of Eurotunnel revenues for that year (on a 50 year term) and 12.5% (on a 100 year term).

Secondly: "Capital Rental".

Since Capital is not fixed, and rises or falls with Eurotunnel's gross revenues, we pay no attention to Interest rates, and propose a rate of return ON Capital below that rate.

Which could be zero, in a "high growth" entity, such as the Intellectual Property in (say) software, or a film (which I have done).

Since the precondition was that £240m was available for finance, the balance of the £240m will be dedicated to "Capital Rental" initially.

ie 25% (or 37.5%)of Eurotunnel revenues will available to be divided among "Equity Share" holders as a return on capital.

But unlike the Return OF Capital (which is a constant proportion of gross revenues) this "Capital Rental" is only in respect of the Capital actually being used.

So half way through the term, the Capital Rental proportion of gross Eurotunnel revenues - to be divided into billionths among investors - will have halved, because the Capital oustanding has also halved.

The balance of revenues, initially zero, but rising to 25% (37.5%)during the term, remains with Eurotunnel SA.

You will see that in this model there cannot be a default, since the Investors' return varies with gross revenues as well as the Principal.

However, it is possible that Eurotunnel SA may find that the balance of revenues it receives is insufficient to pay operating costs - which is why it is possible to consider extending the LLP to embrace other stakeholders as well - as follows.

The model may be extended by using it to buy back all of the Equity as well, leading to a situation where a proportion goes to a continuous synthesis of existing Equity and Debt I call "Open Capital".

In which case, our starting point is to agree what proportion of revenues should go to the operating consortium/co-operative, and what balance remains to repay £8bn in Debt AND Equity.

The outcome is then essentially a cooperative consortium of those operating Eurotunnel in a revenue sharing partnership with those who have financed it.

Which IMHO is probably an optimal Enterprise Model (and familar to Muslims as "Musharakah")

This gives a single and homogeneous asset class of what I call "Open Capital" in "Equity Shares" ie proportional shares - quasi units - of gross revenues.

This model has parallels to a Canadian "Income Trust" where a proportion of gross revenues (typically for quasi utilities) is parcelled off into a trust and unitised.

NB Hilton Group did something very similar with a £350m 27 year revenue-sharing LLP about three years ago. But risk was not shared commpletely (there was a minimum return) and neither has the asset pool been unitised into Equity Shares, as far as I know.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Sep 30th, 2006 at 11:26:14 AM EST
[ Parent ]
A proportion of gross revenues - NOT profits I stand corrected (although the one is a subset of the other).

You will see that in this model there cannot be a default

I'll take your word for it (my proposition not depending on default). I am simply interested in what happens when the following occurs:

However, it is possible that Eurotunnel SA may find that the balance of revenues it receives is insufficient to pay operating costs

At that point (or even if revenues stabilize at a point above operating costs), equity shareholders presumably find that their shares are generating less of a return than they expected when they put up their money. A share in revenue being predicated on the uncertainties of actually generating same, this cannot be characterized default. Consequently, their shares are valued accordingly on the market. Those that want or need to cash out are forced to realize the loss.

Bringing me back to my proposition that in a state of nature, money is a medium that periodically reduces its own supply - on an order of magnitude ranging from dramatic to catastrophic.

Tangentially, as I understand it the Islamic prohibition of usury  derives from the circumstance that a debtor is still liable for his debt even should the enterprise fail - it being considered immoral for two persons to profit from an undertaking where only one bears the risk. The risk is shared - not eliminated.

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman

by dvx (dvx.clt št gmail dotcom) on Sat Sep 30th, 2006 at 12:30:57 PM EST
[ Parent ]
Indeed, I think that many lose sight of the fact that it is not so much "interest" that is the problem Islamically but the nature of the debt contract itself.

Some Muslims (like many Victorians when the relevant Company legislation was introduced) have a similar problem with "free" limitation of liability.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Sep 30th, 2006 at 05:41:26 PM EST
[ Parent ]


Display:
Go to: [ European Tribune Homepage : Top of page : Top of comments ]

Top Diaries