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The Money View Rediscovered

by ARGeezer Sun Sep 8th, 2013 at 12:15:58 AM EST

This diary was prompted by the ongoing discussion in Chris Cook's Credit, Currency and Other Animals and specifically, by Drew Jones' comment below:

How are the outcomes any different from other fixed currency regimes?  You're still fixing the currency to a "commodity" whose value is disconnected from your country's macroeconomic needs in the name of achieving some imaginary "true" value.

We got away from fixed currencies for a reason.  The Eurozone is currently engaged in a fine display of why we did so.

The problem is that so few people understand money, banking or 'money and banking'. Early 20th century monetary economists such as Irving Fisher, John Maynard Keynes and Allyn Young clearly understood the problems of the gold standard. The UK only really came out of the Long Depression when large quantities of gold started coming out of South African mines. Then prices started rising again. It was the financial collapse of 1873 which led Walter Bagehot to write Lombard Street, describing how the banking system of the day worked to assure that cash flows were available to meet cash demands.

Part of the problem we have in understanding the current ongoing crisis is that we have taken our eyes off the money. Another perhaps related part is that we have no generally acknowledged set of rules for managing the money supply of individual currencies, let alone rules for managing a global financial system. Still another part is that this lack of rules is loved by some very wealthy individuals and organizations and they have learned to exploit it to their advantage. This all makes solving this problem more difficult and can render even discussions of the subject fraught.

In The New Lombard Street Perry Mehrling describes his view as being based on 'the money view' and notes:

...a fundamental premise of this book is that a "money view" provides the intellectual lens necessary to see clearly the central features of this multidimensional crisis. The reason is simple. It is in the daily operation of the money market that the coherence of the credit system, that vast web of promises to pay, is tested and resolved as cash flows meet cash commitments. The web of interlocking debt commitments, each one a more or less rash promise about an uncertain future, is like a bridge that we collectively spin out into the unknown future toward shores not yet visible. As a banker's bank, the Fed watches over the construction of that bridge at the point where it is most vulnerable, right at the leading edge between present and future. Here failure to make a promised payment can undermine any number of other promised payments, causing the entire web to unravel. (p.2-4)

Mehrling goes on to describe how 'the money view', which was what Walter Bagehot described in the late 19th century in Lombard Street, has come to be eclipsed over the last six decades, first by 'the economics view' and then by 'the financial view'. These terms are Mehrling's analytical constructions:
On the one hand we have the view of economics, which resolutely looks through the veil of money to see how the prospects for the present generation depend on the investments in real capital goods that were made by generations past. On the other hand we have the view of finance, which focuses on the present valuations of capital assets, seeing them as dependent entirely on imagined future cash flows projected back into the present.

The Institute for New Economic Thinking has sponsored a course in Money and Banking,  offered by Perry Mehrling through Barnard College, Columbia University, and online through Coursea in which I have enrolled. The first reading assignment are three topics on the history of banking by Allyn Young, available in PDF through the online course.

When England and the USA were both on the gold standard in the 19th century economists complained of the problem that the money supply depended on mining discoveries. But, none-the-less, gold remained the best reference for value they could identify. And it was one of those commodities, unlike grain, that the wealthy would keep acquiring regardless of how much they already had. The gold standard had limitations but using it made monetary economics and international trade settlement pretty much mechanical applications of known laws. Countries stayed on the gold standard when they could.

Allyn Young described the workings of the monetary system under the gold standard in a series of anonymous sections in The Book of Popular Science by Grolier Society in the 1920s: The Mystery of Money - how modern methods of making payments economize the use of money. the role of checks and bank notes - The enormous edifice of credit; Mobilizing Banking Credits - the drastic reform of the banking system of the United States - Possibilities of the Federal Reserve; and Dear and Cheap Money -  The Bank of England and the mechanism of the London Money Market - How the foreign exchanges operate. Together they offer an excellent brief history of money in the US and the world as of 1929, (57 pages total). Allyn Young was a low profile heavyweight in monetary economics in his prime at the time of his premature death in 1929 in London of pneumonia.

Young described how the US banking system developed the capability to expand and contract the money supply in order to deal with large seasonal requirements for credit at harvest time and how any but trade imbalances persisting over several years were dealt with by the London Money Market - on the gold standard. While all combatants during The Great War but the USA abandoned the gold standard they felt compelled to return to gold when possible. This again failed in the 1930s.

My view is that the limits of the gold standard increasingly bit as the market system spread into all aspects of various societies and as subsistence agriculture ceased to be a reliable fall back for all but a tiny portion of the population. The problems with the gold standard emerged during downturns. Subsistence agriculture played a significant role in the US during the Great Depression of the '30s. It fed people who could not otherwise have afforded to buy food and allowed them to use what money they could earn to pay the rent. But, even so, it became necessary for all countries to abandon the gold standard during the 1930s in order to have the flexibility to deal with the pressing needs of their citizens by expanding the money supply without respect to the supply of gold available. This consideration became even more pressing as WW II approached and, with it, the need for rearmament.

The gold standard was finally abandoned because it became unsustainable and because a minimally acceptable alternative emerged. At Bretton Woods Keynes proposed a technically workable system of international settlement that was based not on gold but on a mechanism to enforce balanced trade, but the USA shot that system down for reasons of power politics. The USA had financed the successful prosecution of WW II and wanted to continue to dominate the world economically. The USA had the largest gold reserves in the world and so a gold based settlement system was adopted for international trade, with the gold price being US$35 per ounce, other currencies were denominated with respect to the US$ and trade balances continued to be 'netted out' where possible.

This worked acceptably into the 1960s, in large part, as Yanis Varoufakis has noted, because the USA recycled its surplus through aid and foreign investment. International trade balances turned against the USA, in no small part due to US expenditures both on the Vietnam War and Great Society social welfare programs - LBJ's 'guns and butter' policy, and, in 1971 President George Pompidou, seeing that soon the USA would not be able to settle trade deficits in gold, sent a French warship to New York to retrieve French gold. This led Nixon to close the gold window, or end gold convertibility, on August 15, 1971. Other countries didn't like this, but world trade did not collapse. And the US dollar went from being the gold backed reference standard of monetary value to being the de facto world currency even though it was a US fiat currency. Needless to say this was acceptable to the USA. The communist 'Second World' had their own arrangements and some 'non-alligned' countries, notably India, dealt with the situation by minimizing their involvement with the USA.

Fortunately for the USA oil was priced in dollars and was the single most important item of international trade. In addition European countries had accumulated large quantities of US Dollars or Eurodollars and Japan Europe were starting to export significant amounts of manufactures to the USA a trade that was denominated in dollars. This hasn't 'solved'  the problem in any fundamental sense and the world economy has been in a prolonged 'muddle through' ever since.

We have developed a practical framework for international settlements through the Bank of International Settlements but we have not developed any widely acceptable means of controlling the world money supply or verifying the integrity of 'systemically important' banks and other financial establishments, let alone resolving 'systemically important' insolvent banks and financial establishment in the face of an international monetary crisis.

Our money supply is no longer bound by the limits of the gold standard and the amount of available gold yet we continue, in many important ways to act as though we were still on the gold standard. And we have disaggregated monetary inflation into consumer price inflation, however defined, on which governments focus compulsively, especially when it involves 'wage push' inflation, and asset price inflation, variously defined but typically including real estate, stocks,  bonds and other financial instruments, especially derivatives, most of which are studiously ignored by governments and left largely unregulated or 'self regulated' as a playground for the enrichment of the already wealthy and the despoliation of the rest.

The current global system of finance is poorly understood and much abused by those who do understand it. Keynes' system of settlements by forcing individual nations to have balanced trade over time retains its practicality and appeal but adoption is and will be opposed by a wealthy few who benefit from the existing mostly unregulated global system of finance and by countries such as the USA, Germany and China who are current beneficiaries, though for different reasons. Transcending this impasse remains our biggest challenge.

Update [2013-9-8 11:11:20 by ARGeezer]:Changed De Gaulle to Pompidou    

European Tribune - The Money View Rediscovered

we have not developed any widely acceptable means of controlling the world money supply or verifying the integrity of 'systemically important' banks and other financial establishments, let alone resolving 'systemically important' insolvent banks and financial establishment in the face of an international monetary crisis.

it increasingly appears that the tools of 'high' finance are similar to our acquisition of nuclear tech. both might well work, supposing a higher level of honesty and responsibility than our checkered species has been able to manifest.

meanwhile back at the ranch, these weapons of mass destruction are being tooled and the level of moral awareness needed to competently manage their use is ever more lacking.

with all tools before, we had some slack, in that the general adage "first you use them badly, to learn to use them well" worked well in the steam age, (and all points further back in history) will not be useful when the tools have become so powerful.

you either get it right from the git-go, or kaboom.

whole counties decimated so brown and toot can accumulate uber-profits, economies laid to waste so coldman sux can make bank, ecologies turned into dead zones so wastinghouse can thrive, oceans getting fuku'd up by tech designed for saints being run by mendacious, fumbling monkeys.

modern media has removed any lingering doubt that the development of intelligence is mankind's great goal, and the very word has come to be a synonym for anally retentive panty-sniffing on your neighbours so you can be prewarned when they start to rattle their chains or grumble at the injustice meted out to all but the favored few.

before we could dream there would be a 'somewhere' where these dramas wouldn't hold sway, and one could have a peaceful life tending one's hearth and enjoying one's community, now our all-seeing panopticon cauterises even that cherished illusion, as it documents how the mental aberration of greedy powerlust has reached everywhere with its foul stink of 'gotcha' exploitation, 'sell your mother to feed your kids' mentality, while it mockingly dares you to care.

every day to dig a little deeper into why we have no choice but to...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Sun Sep 8th, 2013 at 04:08:28 AM EST
Sadly, Polanyi was quite right about the effects of a market economy on the average members of a society.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Sep 8th, 2013 at 10:18:02 AM EST
[ Parent ]
in 1971 Charles De Gaulle, seeing that soon the USA would not be able to settle trade deficits in gold, sent a French warship to New York to retrieve French gold.

Like de Gaulle (d. 1970) this story seems to enjoy eternal life. :) It has already been discussed on ET

by Katrin on Sun Sep 8th, 2013 at 04:42:31 AM EST
At least I didn't write 'battleship'! Had I just checked Wiki for De Gaulle I might have avoided the blunder. Perhaps the prior discussion, very dimly remembered, warded me off of 'battleship'. Were this to be the worst error in this diary I would be quite satisfied. :-)

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Sep 8th, 2013 at 10:14:12 AM EST
[ Parent ]
On the other hand we have the view of finance, which focuses on the present valuations of capital assets, seeing them as dependent entirely on imagined future cash flows projected back into the present. Perry Mehrling The New Lombard Street

Finance is famously forward looking. So the prolonged current US Zero Interest Rate Program indicates that there is NOTHING in the way of business prospects in the near term - the next year or two at least. The average citizen can only get access to zero rate finance for durable consumer goods and automobiles are being financed by the manufacturers for six years at low or zero interest, but these are vendor finance schemes. 30 year fixed rate loans are being offered at 3.38% APR. Successful businesses are sitting on hoards of cash, partly courtesy of favorable tax policies, but they see little opportunity for profitable investment.

This situation was discussed on ET three years ago in my diary  Systemic Fear, Modern Finance and the Future of Capitalism. In their article of the same title Bichler and Nitzan noted that in times of crisis, such as The Great Depression of the '30s the forward looking nature of finance breaks down and valuations revert to current performance. Capitalists currently appear to have lost confidence in the future and motivation has shifted from greed to fear. Little has changed in that regard since 2010. In the '30s this situation persisted until it became obvious that there was going to be another world war.

What will end the current eclipse of finance? Investors have shifted from financing industry and real estate to financial schemes involving 'hot money' flows to the BRICs, leveraging asymmetries in information for moves that are corrosive of the long term stability of the current world system. Much of their activity could be characterized as looting of societies via organizations such as the IMF in third world countries. And then there is the agony of the periphery in the Eurozone. What is the future of finance - Generalization of the Somali pirate model of finance for exercises in looting? The world financial system is an ongoing train wreck and the response seems to be for the well off to loot as much as possible from each succeeding wreck and not worry about fixing the problems that lead to the wrecks.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Sep 8th, 2013 at 04:08:57 PM EST
He wrote a very nice book called "Making Money". Below, a quote from a dialoge (with a jump in between) showing, again, why I love Terry Pratchett's books, his uncanny ability to observe the real world and integrate his observation into the Discworld:

You took our joke of a post office, Mr. Lipwig, and made it a solemn undertaking. But the banks of Ankh-Morpork, sir, are very serious indeed. They are serious donkeys, Mr. Lipwig. There have been too many failures. They're stuck in the mud, they live in the past, they are hypnotized by class and wealth, they think gold is important."

"Er . . . isn't it?"

"No. And thief and swindler that you are--pardon me, once were--you know it, deep down. For you, it was just a way of keeping score," said Vetinari. "What does gold know of true worth? Look out of the window and tell me what you see."

"Um . . . a small, scruffy dog watching a man taking a piss in an alley," said Moist. "Sorry, but you chose the wrong time."

"Had I been taken less literally," said Lord Vetinari, giving him a Look, "you would have seen a large, bustling city, full of ingenious people spinning wealth out of the common clay of the world. They construct, build, carve, bake, cast, mold, forge, and devise strange and inventive crimes. But they keep their money in old socks. They trust their socks better than they trust banks. Coinage is in artificially short supply, which is why your postage stamps are now a de facto currency. Our serious banking system is a mess. A joke, in fact


"Ah, the inventor of the revolutionary unsecured one-penny note?" said Bent, extending a thin hand. "Such audacity! I'm very pleased to meet you, Mr. Lipwig."

"One-penny note?" said Moist, mystified. Mr. Bent, despite his protestation, did not look pleased at all.

"Did you not listen to what I was saying?" said Vetinari. "Your stamps, Mr. Lipwig."

"A de facto currency," said Bent, and light dawned on Moist. Well, it was true, he knew it. He'd meant stamps to be stuck to letters, but people had decided, in their untutored way, that a penny stamp was nothing more than a very light, government-guaranteed penny and, moreover, one that you could put on an envelope. The advertising pages were full of businesses that had sprouted on the back of the beguilingly transferable postage stamps: "Learn The Uttermost Secrets Of The Cosmos! Send 8 penny stamps for booklet!" A lot of stamps wore out as currency without ever seeing the inside of a posting box.

Something in Bent's smile annoyed Moist, though. It was not quite as kind when seen close. "What do you mean by `unsecured'?" he said.

"How do you validate its claim to be worth a penny?"

"Er, if you stick it on a letter you get a penny's worth of travel?" said Moist. "I don't see what you're getting at--"

by crankykarsten (cranky (where?) gmx dot organisation) on Thu Sep 12th, 2013 at 04:33:17 PM EST
I once spent four hours on a train sitting next to an English undergrad who insisted that Pratchett wasn't proper literature.

There were awkward silences.

I hope she knows better now.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Sep 12th, 2013 at 04:45:03 PM EST
[ Parent ]
And of course, Mr. Ponzi made his name on purported arbitrage in return mailing stamps.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Sep 12th, 2013 at 07:21:19 PM EST
[ Parent ]

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