I know it's wrong, or at least deeply problematic, to adopt a teleological view of history: to say that History has an End, or Purpose, and is inexorably driven by deterministic Iron Laws towards that End, with perhaps an occasional hiccough along the way. But I can't stop myself.
What is the End of Finance? Where is it inevitably leading? I think it is leading towards the monetisation of everything.
The First Underlying Driving Force behind the monetisation of everything is that people want their assets to be monetary, other things equal. If two assets had the same expected return, and risk, but one could be used as money and the other couldn't, people would prefer to hold the asset that could be used as money. In equilibrium, assets that cannot be used as money need to yield a premium over assets that can be used as money.
Here's the Second Underlying Driving Force. Cows yield milk. Cows can also be used as money. But using cows as money does not mean they stop yielding milk. In principle, using an asset as money need not detract from its non-monetary yield. It's a bonus, that comes over and above the non-monetary yield. The supply price of this monetary bonus is zero. And it's a bonus that people want, and are prepared to pay for.
Here's the Third Underlying Driving Force. Money is an asset that is used as a medium of exchange; and one of the things that is peculiar about money is that a promise to pay a medium of exchange can itself sometimes serve as a medium of exchange. A coat keeps you warm and dry; but a promise to pay a coat does not keep you warm and dry. A promise to pay a coat is not a coat. A promise to pay money can, however, sometimes be money (Yeager?). That's how paper currency, as promises to pay gold, became money. That's how chequing accounts, as promies to pay currency, became money. And so on.
Cows can work as money, but they have their drawbacks. They can't be easily transported, for one. But a promise to pay a cow can easily be transported. Or a promise to pay something else, with the cow as colateral, can easily be transported. And if the promises to pay cows all cancel out across time and space, no cows need ever actually be transported.
There's a demand for the good (the First Underlying Driving Force). There's a free supply of the resource that can produce the good, since it does not prevent those same resources being used for other purposes simultaneously (the Second Underlying Driving Force). And there's a technology (promising) that can convert the free resource into the good that people want (the Third Underlying Driving Force).
So, it's inevitable, innit? The Iron Laws of Finance mean the eventual monetisation of everything.
The puzzle is not shadow banking. The puzzle is why this Inexorable Progress towards the End of Finance didn't happen instantly, centuries ago. Why is it taking so long?
The answer of course is that the technology of promising is imperfect. It doesn't always work. Will the promiser keep his promise? Will he be able to? What if his ability to keep his promise to you depends on others' keeping their promises to him?
Sometimes we find the technology of promising is not as reliable as we thought it was, and there's a crisis as everyone learns this, and the supply of money contracts. Milton Friedman was right. If we could only keep the money supply growing steadily at k% per year, and the monetisation of everything progressing smoothly, all would be well with the macroeconomy. But we can't.
It's not at all surprising that technologies sometimes turn out not to be as good as we thought they were. Bridges fall down. Rockets explode. But when most technologies fail, the crash usually affects only a small part of the economy. What's different about the monetary technology is that money affects every single market in a monetary exchange economy, because money is always one of the goods traded in every market. So when we learn that the monetary technology is not as good as we thought it was, this affects the whole economy, not just a small sector.
But we learn from crashes in the monetary technology, just as we learn from bridges falling down and rockets exploding. We revert to an older, more familiar technology temporarily. But then History Marches Forward again, and the monetisation of everything progresses further towards its inexorable End.
[I was going to write a post on Treasury Bills as money, and Monetarism, but I lead myself astray.]
Worthwhile Canadian Initiative 
Centralized governments stipulate a universal “medium of exchange” by demanding tax payment in a single “legal tender”, by conducting all government spending using a single “legal tender”, by mandating that all trade and debt payment be made using only a single “legal tender”.
Doesn’t this lower transaction costs for everyone, by assuring a universal market for the legal tender?
I mean, as long as you don’t allow a hyperinflation to upend the apple cart?
Thought experiment. What happens if you eliminate legal tender laws and accept tax payment in all sorts of different securitized baskets of goods?
Is that even possible?
Nick:
“If the monetisation of everything means an increasing supply of money (relative to GDP), doesn’t that mean inflation?”
If there are 100 paper dollars laying claim to 100 square feet of land, or if there are 5000 dollars laying claim to 5000 square feet of land, each dollar must be worth 1 square foot. Meanwhile, the supply of land relative to everything else is unchanged, so the value of land is the same, and the value of dollars, relative to land and everything else, must be the same.
“First, we need to distinguish medium of exchange from medium of account. Inflation is a falling value of the medium of account, which isn’t necessarily the same as the medium of exchange.”
If you start with $100 backed by 100 square feet, and then 50 of those square feet are swallowed by the ocean, each dollar will fall to .5 square feet (inflation) even though the value of the unit of account (a square foot of land) might be unaffected.
“Second, if the monetisation of everything means an increasing supply of money, but also an increasing own rate of return on money, the demand and supply could increase at the same rate, so there needn’t be inflation.”
The more interesting question is what happens if one more square foot is monetized (i.e., 1 more dollar is issued) while everything else (like return on money) is unaffected. The right answer is that one dollar must reflux to its issuer. For example, someone who had borrowed a dollar while offering land as collateral, pays back his dollar. He regains title to his land while the dollar is retired. Thus our hypothetical issue of one new dollar just leads to the retirement of another dollar, and the increase in the money supply that you (and I) spoke of never happens.
Pawn Shops already do this.
Reverend Moon: Yes, there’s really little difference between a pawnshop and a repo. There’s one trouble with pawnshops: if I pawn my watch, I can’t use it to tell the time. It’s like your cows stop giving milk if you lose physical possession. But pawning something shouldn’t necessarily mean it changes location, or stops giving milk.
Mike: think negotiable cows. If half the cows fall off a cliff, half the money stock disappears along with half the assets backing them. But, the whole backing theory won’t work, because the value of the cow is not independent of the fact that it is a monetary cow. Liquid assets have a higher value than non-liquid, even with the same milk yield. The money backs the backing, as much as vice versa.
Greg: if the supply of money increases, it falls in value. If the demand for money increases, it rises in value. When you monetise cows, that increases the supply of money (obviously), but it also increases the demand for money, because money now yields milk. So, the effect on general equilibrium value of money could go either way.
Money can exist even if the government does not demand payment of taxes in that money. If the government struck oil, and decided it could earn enough income from oil so it didn’t need taxes. Would money disappear? Or fall to zero value? Of course not. Chartalism is wrong. The Hippy monies (local monies) cannot be used to pay taxes, and are unbacked, but still have value.
Gotta go to meeting.
Greg, When near monies develop, then the deamnd for fiat money falls. Unless the central bank reduces the supply, the price level rises. But not as much as you’d think, as near monies are actually not very close substitutues for cash.
The key is to see where in the market economy near monies are close substitutes and where they are not.
When the demand and supply ofmonies and near money fluctuate in different directions, this changes relative prices and asset prices and the differential size of of non-identical production streams.
Scott wrote,
“Greg, When near monies develop, then the deamnd for fiat money falls. Unless the central bank reduces the supply, the price level rises. But not as much as you’d think, as near monies are actually not very close substitutues for cash.”
Nick:
Whoa…Hold on there cowboy. First you said:
“How to convert cows into money, while still keeping the cows on the farm:
Randomise the cows. I buy your car, and give you a lottery ticket to a 1% random draw of my cows’ ear tags, so you know you are not getting a lemon cow.
Securitise the cows. You get 1% of the total milk and meat.
Collateralise the cows. Just get a line of credit with chequing privileges with the cows as collateral.”
But then you said:
“If half the cows fall off a cliff, half the money stock disappears along with half the assets backing them. But, the whole backing theory won’t work, because the value of the cow is not independent of the fact that it is a monetary cow. Liquid assets have a higher value than non-liquid, even with the same milk yield. The money backs the backing, as much as vice versa.”
Now, I take your first statement to mean each cow certificate gave its holder the right to claim 1% of the herd of 100 cows. So if 50 cows fall off a cliff, each certificate is now a claim to 1% of 50 cows, or half a cow. Now assuming that the loss of 50 cows had a negligible effect on the world cow population, a cow will still buy the same amount of apples and oranges as it used to, so each cow certificate will now buy half as many apples and oranges as it used to.
Of course the loss of 50 cows means we have still lost half the real value of the money stock, and the resulting tight money condition will be recessionary. No problem. People will simply issue 50 more cow certificates, backed by 50 additional cows.
(By the way, I’m personally more comfortable with land money than with cow money, since we don’t have to worry about milk and such.)
Nick,
IMO, all you’re really talking about when you talk about keeping the milk is about the price of the loan. You bring me a cow I monetize it then i rent the cow to you is the transaction you’re talking about (mortagage, auto loan etc.). Or, I give you more money and you buy your milk from the store.
The cost of recovering the collateral pledged to the pawn shop is prohibitely high relative to the amount owed if you don’t pay. Too much risk, which is why it doesn’t happen like that. Its business, not economic theory. Not trying to be snyde. Just trying to simplify things as much as I can for myself. Like derivatives transactions being selling lottery tickets or buying insurance. Really enjoy your posts and the site in general and am learning a great deal.
Cheers
Nick, I do believe there is a nontrivial minimum positive value for transaction costs that will ultimately limit monetization, even with technological improvement. Transactional costs can be divided into two sources: natural obstacles and human obstacles.
For natural obstacles, we contend against the laws of nature, e.g. communication and data storage costs. As technology improves, these costs will fall to trivially low levels. For example, communication and data storage costs have fallen with modern IT. Gone are the filing rooms, courier boys and computers (people paid to do calculations) of yesteryear.
For human obstacles, we contend against other people, e.g. credit rating and litigation. In these cases, technological improvement cuts both ways. When a credit rating agency discovers a better heuristic to rate securities, securitization firms devise better ways to game it. In the long run, these costs do not fall but fluctuate as the point of technological equilibrium changes. In particular, I believe litigation costs actually rise over time as the volume and complexity of case law inexorably increases.
Over the past decades, the reduction in costs due to IT have swamped any other effects. However, we have reached a point of diminishing returns here. Even if all other costs due to natural obstacles fall to zero, there will still be costs from human obstacles. We will always need to catch cheats and settle differences, and that will never get easier as long as both sides can innovate.
Therefore, I believe transactional costs alone imply a maximum extent of monetization. There are also social and cultural factors that will limit monetization (Where do we stop? Can I monetize my kidneys? Can I monetize the kidneys of my unborn child?). My belief is that we are very close to this ultimate limit already but I am prepared to be wrong. Technological change is impossible to predict, by definition.
David Koo: You might be right. Which would make my thesis here wrong. I like the idea of a technological arms race, between the police and the cheaters, putting a limit on how far the net technology of monetisation can progress.
“In particular, I believe litigation costs actually rise over time as the volume and complexity of case law inexorably increases.”
That’s depressing, if you are right on that point. Technological regress. I hope you are wrong, because if you are right it won’t just harm monetisation.
“Technological change is impossible to predict, by definition.” Popper!?
Reverend Moon and Mike Sproul, on cows milk and land rent: for some assets (all financial assets?) they yield the same return regardless of who has physical possession and who “owns” them (in the sense of being residual claimant). For other assets it matters. My bank manager can’t milk cows. The owner-occupier has less of a principal agent problem than a tenant farmer/landlord. The pawnbroker doesn’t need my watch to tell the time, so the milk runs down the drain. This fact seems to be very important in Finance, and the monetisation of assets. I/we need to think through its implications.
Rev: thanks, and as you can see, I am learning a lot too.
Mike: Damn. You are right on cows and cliffs.
Scott and Greg: Yes, the monetisation of other assets does reduce the demand for central bank base money. And if that money remains the medium of account, the central bank will need to reduce the supply to prevent inflation.
Getting back to the earlier question of demand for collateral money, I just noticed that the FRBNY reckons that treasury fails increased when interest rates fell below 3% – above that level, they think the (negative) cost of carry is sufficient to prevent cynical fails. They interpret the spike in fails to a perverse economic incentive due to a fall in interest rates rather than too much demand chasing too little supply, and they think they have fixed the problem by charging for fails. http://www.ny.frb.org/research/epr/forthcoming/1009garb.pdf.
Hayek pointed out the science could not predict its own advance independently of Popper.
I’m not sure who first stated the point. I think it was Hayek who said it first and most directly.
Hayek made similar points about technology and culture and social institutions more generally.
Processes which select over multitple variations tend to generate novelty and aspects of what can be called “progess” — although there is no objective norm for progress.
The philosophical lit on Darwinian biology and “progress” rehearses the issues here.
Good post & comments.
Nick: “There are degrees of liquidity, and money, as the medium of exchange, is the most liquid of all assets.”
and…
“But I’m talking about all assets becoming money, not about marketisation.”
How can all assets become money if money is – according to your definition – the most liquid of all assets? Not all assets can be the most liquid at the same time.
“using cows as money does not mean they stop yielding milk”
I’ll turn this on its head – yielding milk means that cows cannot be money! Gresham’s Law states that bad money drives out good. Given the opportunity to buy an asset with a low opportunity cost or an asset with high opportunity cost, people will choose the low opportunity cost money. Gold money drives out iron money, and paper drives out gold. People don’t want to use an asset as money if they have better alternate uses of that asset.
Goverment bonds are closer to money than cows ever will be. Their major difference is the interest they pay and their default risk. Bonds are denominated in dollars and they represent no claim on capital. Defaulting on government debt is similar to destroying money in that it does not destroy real assets, only claims on those assets.
azmyth: Gresham’s Law only works when all monies must have the same price. It did work for cows, funnily enough. If all you care about is the number of cows, because all cows are rated AAA, you forget about quality of cows (milk yield). So bad cows drove out good. That’s if i remember the anthropology correctly. Where cows were money, cows were bad quality.
I think Gresham’s Law was operating on AAA securities in exactly the same way. But it only works if all cows have the same nominal value.
JP: “most liquid” can mean “none is more liquid”. So it’s perfectly possible, in logic, for all assets to be equally very liquid and all used as money. If all goods are equally liquid, there are two ways to describe this economy: all goods are money; it’s a barter economy. The two are observationally equivalent. So, that’s a neat point. The monetisation of everything would be a reversion to barter, (but where barter is costless).
Greg: I had always wondered about the interconnections between Popper and Austrian economists. There are parallels. And none I can see for Wittgenstein and Freud, so it can’t have been just the Vienna water.
Phil: you really lost me on that comment. What’s a “treasury fail”?
What’s a “treasury fail”?
Failure to deliver the Treasury for settlement.
Nick,
I think the confusion is in thinking that money is something different from credit. Credit is denominated in currency. Currency is the unit of measurement, that’s all. It makes little sense to have a cow standard as the unit of measurement for pricing credit contracts. So if the question you were really asking is, “why do we not have a cow standard as the unit of account for credit contracts?”, I think that question answers itself. As for my example, it doesn’t have to be a pawn broker. It could be a credit card or line of credit, even a line of credit with another rancher. If I want to spend my cow but keep the milk until I actually settle the debt I’ve incurred, Visa or whoever will charge me for that privilege. The alternative is that you monetize the cow by selling it and forfeit the milk.
Its all just credit, currency included (it just has lower transaction costs because i will have little trouble finding someone who will take it). If you could settle your debt to me in cows I would not do business with you because then i would risk ending up a cow living in my apartment. I want you to bear the transaction cost and all other costs associated with disposing of the cow in return for credit or currency that doesn’t have that liability.
So…I am not in favor of going to a cow standard for money or a gold standard for that matter. I guess I’m saying that all transactions are credit transactions unless you are satisfying a coincidence of wants. I hope that made sense and that i haven’t misunderstood the point made in this thread.
Thanks for the quick response.
“But it only works if all cows have the same nominal value.”
If you were on a cow standard, they would need to have the same value to fulfill their role as a unit of account. Money needs to have three properties: Medium of Exchange, Unit of Account and Store of Value. If possible, it should be widely accepted, be easy to transport, uniform and have low opportunity cost (few alternate uses). I think you picked cows because of the ridiculousness of it. No one would sell loaves of bread and price it in terms of fractions of one particular cow. They couldn’t possibly specify all the information needed to carry out such an exchange. Unlike cows, every dollar is the same. There is no informational cost to determining what kind of a dollar someone is trading you for. The problems of information and transaction costs are a big part of what makes one thing money and another thing not money.
I’d highly recommend this article by interfluidity: http://www.interfluidity.com/posts/1209978923.shtml
Here is a link to Menger’s original article: http://socserv.mcmaster.ca/econ/ugcm/3ll3/menger/money.txt
Nick (and Scott and Greg):
“the monetisation of other assets does reduce the demand for central bank base money. And if that money remains the medium of account, the central bank will need to reduce the supply to prevent inflation.”
In your article “Why do Central Banks Have Assets?” you argued that central bank assets are only necessary to handle normal ups and downs of money demand. For example, if money demand goes up and down 20% in a normal year, the central bank need only hold assets equal to 20% of the money it issued (or 30% for a comfortable margin). That way the central bank can use its assets to buy back its money when money demand is low, and re-issue the money when money demand is high. I argued the other side, that a bank whose assets are less than 100% of its money issue will suffer a run and collapse.
But if you believe that privately-issued money reduces the demand for base money in the way you describe, then a private bank can profit by starting a run on the central bank. For example, the central bank has issued $100, against which it holds only $30 worth of assets. A private bank then issues its own dollars, each of which is a promise to deliver 1 base dollar on demand. If the private bank issues $31, and 31 base dollars reflux to the central bank, then the central bank has no assets to buy back the 31st refluxing dollar, and as you say, the base dollars start to lose value. But every time the private bank issued a dollar, it was taking a short position in the base dollars. Just like if I issued and sold a slip of paper that said “IOU 1 share of GM”, I am short in GM. The private bank has issued dollars that say “IOU 1 base dollar”, so it is short in base dollars and gains as the base dollars fall. So the private bank keeps issuing more dollars until the central bank is dead.
You don’t even need private dollars for the central bank to die. As soon as people realize that the first 30 people will get their money and everyone else gets nothing, they will rush to redeem at the central bank.
The alternative to this scenario is to allow that central banks must have enough assets to buy back all their base money at par. That central bank can always buy back its money at par, even if privately-issued money causes base money to reflux to the central bank.
Reverend Moon: “I think the confusion is in thinking that money is something different from credit. Credit is denominated in currency. Currency is the unit of measurement, that’s all.”
I disagree. I think the confusion is in not distinguishing money from credit. Money is the medium of exchange. Credit may of may not be a medium of exchange. Money usually also serves as a unit of account. Credit is usually denominated in the unit of account, but doesn’t have to be.
Mike: neat argument. But what if the central bank simply refuses to redeem its money? Since the end of the gold standard, there is no promise by the central bank to redeem. It’s the banks that issue redeemable money that face the danger of runs (unless they have 100% reserves).
axmyth: yes, cows don’t seem to work very well as money, for all those reasons you cited. Bur then loans to small businesses don’t work very well as money either, for much the same reason. But a bank that has loans to small businesses on the asset side and demand deposits on the liability side of its balance sheet has just converted loans to small businesses into money. There’s no reason why Finance can’t do the same to cows, and convert them into money.
vjk: thanks.
Nick, re treasury fails.
A “fail” is shorthand for failed trade. Failed trades occur in most (all?) financial markets from time to time; they happen something goes wrong with the actual execution of the trade. This can occur when the terms specified by the buyer and seller do not agree, or when a third party does not receive or misunderstands the trading instructions, or when one party to the trade does not deliver the asset (cash or security) it promised.
As vjk says, the large spikes in failed treasury trades that have occurred over the last decade are mostly due to failures to deliver the promised treasury bond. Gorton implies that this might be due simply to an insufficient supply of bonds, and in fact one remedy that has been proposed is for the Treasury to increase supply by reopening bond issues when trouble arises. This interpretation accords with the monetarist view that you proposed.
The view of the NY FRB, though, is disappointingly prosaic and it takes the wind out of this monetarist idea. They think that failures to deliver bonds are deliberate; they monetize a “free option” created by the market convention for settlement that was in effect until May 2009. The paper I linked explains all this in detail.
Nick:
“neat argument. But what if the central bank simply refuses to redeem its money? Since the end of the gold standard, there is no promise by the central bank to redeem. It’s the banks that issue redeemable money that face the danger of runs (unless they have 100% reserves).”
The central bank can redeem its money for its gold, for its bonds, for its buildings and furniture, etc. When you say “refuses to redeem”, you probably mean for gold. But if people want to reflux $31 to the central bank, and the bank has nothing but $30 worth of bonds, the central bank just sells the bonds for $30 and retires the dollars. The central bank redeems its dollars for bonds, and a bank run can still happen even if the bank won’t redeem in gold.
If the $30 worth of bonds was all the central bank had, then that 31st dollar (and the other $69 still out there) is truly not redeemable, and truly not backed. I say the base dollars will then be worth zero. If those 70 unbacked base dollars were worth anything, then private banks could issue their own dollars, each of which said “IOU 1 base dollar”. As the private dollars were issued, the base dollars would lose value (since the central bank can’t buy them back), and the private banks would profit from their short position in base dollars.
I was talking about 100% assets, not 100% reserves. A bank that has issued $100 might hold reserves of 30 oz. of silver, plus bonds worth $70. That bank is immune to a run, since it can use its $70 worth of bonds to buy back 70 base dollars, then redeem the last $30 with its 30 oz. You’re probably thinking of some crisis where the $70 worth of bonds has to be liquidated for $60, but then the bank’s assets are 30 oz. +$60 bonds, and the bank is insolvent, so of course there will be a run. Runs are caused by insolvency, not illiquidity (unless illiquidity leads to insolvency).
Mike Sproul: I don’t think Nick was talking about refusing to “redeem in gold”. He is saying that the bank doesn’t have to redeem at all. They adjust their balance sheet through open market operations at their discretion, not yours. If they don’t accommodate a loss of demand for money, you might get inflation or devaluation. But you can’t force them to take it back.
What else could Nick have been talking about? Modern paper moneys are always “irredeemable in gold” but still redeemable in bonds (and taxes, buildings, furniture..). If the issuing bank has bonds, they can use them to buy back their money and their money will have value. If the issuing bank has nothing, they can’t buy back their money and the money will be worthless. Whether the buying back happens at the bank’s option or at the public’s option is irrelevant.
But it doesn’t matter whether they (the bank) buy the money back with bonds or they (the treasury) take it back through taxation. Either way they reduce the quantity of the medium of account. If money gets too cheap, someone will buy it up for the purposes of paying taxes. No need for open market operations. To make it really clear you could imagine a proportional money tax which would have much the same effect as interest. So it just doesn’t matter if the BOC has bonds on their balance sheet. They never have to spend them so they could just as well burn them. Like Nick said, it’s just for the accountants. Nick would even claim that there isn’t even a need for taxation. I would think that you would need at least the threat of it to secure the value of money.
Mike: I agree with K @1.49. The central bank can buy back the excess supply of money if it wants to, but is not obligated to do so. It’s irredeemable in that sense, and is totally different from commercial bank money, which is a promise to redeem in central bank notes on demand. The central bank could just say “no”, and let the excess supply of money eliminate itself through a rise in the price level.
K:
You are assuming that the government’s assets are sufficient to buy back all the base money at par, should the central bank fail to do so. But if the government is barely solvent, and the central bank burns some bonds, then the money has less backing and it must lose value. Actually wait a minute. Change that. Those bonds would normally be the government’s liability, so as the central bank burns them, it loses assets while the government loses liabilities, so there’s no loss of backing and no effect on the value of the money. But if the central bank held some bonds that were issued by some foreign government, and burned them, then assuming the government was barely solvent, then you’d get inflation from the loss of backing.
Nick:
The central bank isn’t obligated to buy back its money in the same sense that GM isn’t obligated to pay dividends. Technically that’s true, but failure to buy back money causes money to lose value, just like failure to pay dividends causes GM stock to lose value. The only difference between central bank money and commercial bank money is that the central bank has more leeway in refusing to redeem, but such a refusal will cause any money to lose value, whether issued by a government or by a firm.
You’re still left with this problem: If the issue of private money causes base money to reflux to the central bank, and if we suppose that the central bank (or the government) has no assets with which to buy back that refluxing base money, the base money must lose value. (I think you might agree with this so far.) So the private bank, which takes a short position in base money every time it issues a unit of its money, profits from the inflation it caused, until the base money is worthless. That’s a pretty crazy world. It would be as if writers of call options caused the value of the base stock to fall in proportion to their issue of calls.
This privately-caused inflation would not be a problem if the central bank had sufficient assets to buy back its money at par. Now, since neither you nor I seem to be able to think of a single historical example of a central bank that did not keep 100% assets (assets, not reserves) against the money it issued, the 100% asset proposition starts to look pretty reasonable.
Mike: ” So the private bank, which takes a short position in base money every time it issues a unit of its money, profits from the inflation it caused, until the base money is worthless. That’s a pretty crazy world. It would be as if writers of call options caused the value of the base stock to fall in proportion to their issue of calls.”
Weird. Neat. (Only works if the private bank buys real assets, not nominal loans, but still).
Mike:
1) So we agree that banks like the Fed, the BOJ and the BOC whose balance sheets largely consist of domestic government bonds are effectively unbacked by real bills since “burning” their assets would make no difference. If they actually needed to be backed by real bills, then holding domestic bonds causes a bootstrap problem.
2) You can’t invoke foreign exchange reserves as backing. The central banks of the world can’t all hold each other up by the bootstraps.
3) You persist in ignoring the role of taxation. Central bank refusal or inability to redeem currency (in domestic bonds) will cause rates to go down which may cause inflation. But it’s entirely curable through taxation. Raising taxes takes money out of circulation, and increases the demand for money. If private banks tried to sink the currency by creating money (they did quite a bit of that recently), and the central bank was unable to buy it back, the treasury could just collect it all back as taxation and give it to the central bank. The ability of the treasury to collect revenues is vastly greater than the ability of a private bank to create money. It’s taxation, not real bills, that insures the value of money.
Nick:
I think so too. Except I no longer think it’s weird. It convinces me that any bank, including central banks, must have full backing for all the money it issues.
K:
1) I’ve never thought that the backing for money had to be real bills. I think that as long as the backing is of adequate value, that’s all that matters. But dollars can be backed in part with bonds that are denominated in dollars. It just makes the dollar more volatile.
2)True, if the US backs its dollars with nothing but pesos, while Mexico backs its pesos with nothing but dollars, you get that problem. But a reasonable amount of real assets limits the problem. I cover this issue in my paper “There’s No Such Thing as Fiat Money”, which you can find by clicking my name above.
3) I often speak of money being backed by bonds, but of course bonds are backed by taxes, so taxes are the ultimate backing. Taxes can give money value in the same way that a stream of positive future profits can give stock value. But don’t forget that governments can nose-dive into negative net worth, and when that happens they have less backing per unit of money.
I can’t resist putting in this quote about the monetization of everything. Found it in James Steuart’s 1767 Principles of Political Economy. Nick, your idea is a very old one:
“… by what we have said, it appears that there is no impossibility for a people to throw the whole intrinsic value of their country into circulation. All may be cut into paper, as it were, or stamped upon copper, tin, or iron, and made to pass current as an adequate equivalent for the produce of industry…
“That this is no chimerical supposition, appears plain by the activity of many modern geniuses, who, in an inconsiderable space of time, find means to get through the greatest fortunes; that is to say, in our language, they throw them into circulation by the means of the symbolical money of bonds, mortgages, and accounts….
“The use of symbolical money is no more than to enable those who have effects, which by their nature cannot circulate (and which by the bye, are the principal cause of inequality) to give an adequate circulating equivalent for the services they demand, to the full extent of all their worth. In other words, it is a method of melting down, as it were, the very causes of inequality, and of rendering fortunes equal.”