Take Bitcoin for example. It's a financial asset to whoever holds it. To whom is it a financial liability? I suppose you could say "it is a liability to the whole community of those who accept Bitcoin in exchange for goods". But that answer seems like a desperate attempt to salvage the assets=liabilities dogma. Nobody is obligated to accept Bitcoin.
Here's the right way to think about it. It's quite simple really. Very basic economics.
Suppose I sell you my car for $2,000. That would only happen if I value my car at less than $2,000, and you value my car at more than $2,000. So when I sell you my car, it must mean that the value of the car increases.
Only in a perfectly competitive market, where I and lots of others are selling lots of identical cars, and you and lots of others are buying lots of identical cars, and each buyer and seller takes price as given, does the value of the marginal car to the buyer equal the price, which equals the value of the marginal car to the seller, so the sale of that marginal car creates no net value.
Now suppose it's not a car that I sell you. Suppose I sell you a bit of paper on which I have written "I promise to pay the owner of this bit of paper $100 on 9 December 2017 signed Nick Rowe". The only way I would sell you that bit of paper and you would buy it is if the value of that asset to you is worth more than the value of that liability to me. So when I sell you that bit of paper, your asset > my liability.
Now suppose that my IOUs are more liquid than your IOUs. Because everyone recognises my signature and knows what my IOUs are worth, but I'm the only person who recognises your signature and knows what your IOUs are worth. A more liquid asset is more valuable than a less liquid asset, other things equal, to those who value liquidity. So there may be gains from trade if I sell you my IOU in exchange for your IOU. And if we do voluntarily swap IOUs, it must be that we create value by doing so, so that aggregating you and me, our combined financial assets > our combined financial liabilities.
See how easy it is? It's just like me selling you my car.
Now take the limiting case. Make the IOU that I sell you have a longer and longer maturity, approaching a perpetuity that pays an annual coupon. The greater the liquidity of that IOU, the lower the coupon I need offer to persuade you to buy it at a price of $100. If it's liquid enough, I don't need to offer you any coupon at all, and can stretch the redemption date out to infinity. It's an asset to you, but not a liability to me.
In fact, if it's liquid enough, and if you and the people you might sell it to value liquidity enough, I could even make the annual coupon negative. It's an asset to you, and an asset to me.
And in real terms, adjusting for inflation, paper currency is just like that. It pays the owner a negative real (inflation-adjusted) yield.
But, at the margin, money is only net wealth if the issuer has some sort of de facto or de jure monopoly power. Just like the sale of the marginal car creates no value in a perfectly competitive market. Which is what Pesek and Saving said back in the olden days. And it's all based on what the Austrians (and others) said, even earlier. Value is subjective.
Don't get muddled by accounting. It's just a way for me to keep track of how many cars I own. Just like a supermarket keeps a record of how many cans of beans it has on the shelf.
Update: Anwer Khan (deepwatrcreature) Tweeted: "it is net wealth due to the network effect. The surplus goes to those who establish the network, e.g. "exorbitant privilege". And I replied "Yes. Network Effect both creates Liquidity AND creates First Mover (incumbent) Advantage for de facto monopoly."
Worthwhile Canadian Initiative 
Nick said: “Don’t get muddled by accounting.”
Should I read this as a sign that my non-stop lecturing is starting to have some kind of effect on you? 😉
Money is not net wealth. This is not because the money itself is a liability to someone — here I agree with Pesek&Saving and Friedman, and you, and Eric Lonergan, etc — but because the money is a credit and there is always a corresponding debit somewhere else. Usually you find these debits reported on the LHS of the bank balance sheet, whereas the credits are reported on the RHS.
Conclusion: I agree with you on that money, the credit record, is an asset to its holder but a liability of no one (a “net asset”)*. You don’t agree with me when I argue that for all these “net assets” there is a corresponding “net liability”. Right?
* Perhaps we could call it a “net asset”, if we keep in mind that we are not talking about real assets? “Net financial asset” sounds wrong, conventionally, although it might be an accurate expression in this case.
In other words (as I said to you earlier): LETS is our real-life monetary system in a nutshell.
Antti: Yep! 😉
Where are the liabilities on Bitcoin’s balance sheet? Bitcoin corp doesn’t exist.
And if you look at the Bank of Canada’s balance sheet, it might seem that assets = liabilities (approximately), so it looks like the BoC has zero net equity (approximately). But it reports profits of (IIRC) around 0.2% of NGDP. The Present Value of the flow of profits is large, so its net equity is equally large. Because its currency liabilities pay 0% nominal, and its bond assets pay a positive % nominal. Because its “liabilities” are more liquid than its assets. Just like in my post.
Nick,
Depends on how you look at it. Suppose I start a company and issue shares. Now you can either view those shares as not liability and then say that financial assets > liabilities or you could do an alternative set of accounting to say that financial assets = liabilities.
But there is a definitive advantage of viewing bitcoin as a liability – as equity, as in the second description above (not saying all currencies are like that). It shows that Bitcoin is just a scam.
I wrote that here: http://www.concertedaction.com/2013/12/28/description-of-cryptocurrencies-using-sna/
It’s a bit like scam companies whose shares trade on stock markets – except that in the Bitcoin case those shares can be used to buy Pizza.
That is why it makes me uneasy when there is more than enough money out there to satiate liquidity needs and people, banks and businesses are hoarding it as a form of long term saving instead of doing real investment.
Nick: Bitcoin is not money. (See my discussion with Oliver in the parallel thread.)
But the PV of BoC profits is not an on-balance-sheet item, is it?
I suggest you and I, as we are in agreement on this one, stop talking about BoC liabilities or “liabilities”. OK? And if we weren’t in disagreement on the following — we are, right? — I’d suggest we stop talking about BoC assets or “assets” as well.
On the RHS of BoC balance sheet we have financial assets/credits/”positive monetary value” of agents other than BoC (equity included, in the spirit of Modigliani-Miller). On the LHS, we have financial liabilities/deb(i)ts/”negative monetary value” of agents other than BoC (with the exception of real assets, which are, counter-intuitively, best understood as liabilities of BoC itself!).
BoC’s main role is to serve as a record-keeper, along with other institutions which together form the financial system, for credits (“net assets”) and debts (“net liabilities”) of agents who form the community. Those agents don’t owe BoC “money”, nor does BoC owe those agents “money”.
The agents with liabilities have an obligation to deliver (that is, sell) goods to other members of the community.
The agents with credits have a right to accept (that is, buy) goods from other members of the community, without incurring any liabilities by doing so.
I assume not all of this makes sense to you, but perhaps you find something in it which resonates?
Ramanan: suppose you started a company, and people really really liked your (non-voting) shares, because they were extremely liquid. You could simply issue shares, buy bonds with the proceeds, and call it a day. Simply rake in the interest, pay yourself a big fat salary, and pay a few pennies left over as dividends to shareholders. Even if the shareholders knew in advance that was exactly what you were going to do. You have created net wealth. Maybe you don’t need to pay any dividends at all. Maybe issue new shares every year, and ensure capital losses on your shares. People still like to own them, because they are so very liquid.
Currency is like non-voting shares in the Bank of Canada.
Benoit: yep. Excess demand for the medium of exchange is a problem.
Antti discusses the RHS and LHS of the balance sheet. It seems to me that we can redirect this.
We can look at the balance sheet in terms of control of assets (ownership) .
From this perspective, the LHS becomes a record of all the assets controlled by the balance sheet entity.
The RHS becomes a record of who owns (has an entitlement to) which class of assets. There may be several owners unless the balance sheet is 100% debt free.
Of course, the RHS must equal the LHS to ensure that all of the assets have been reported.
Is this a valid perspective of the balance sheet?
‘But, at the margin, money is only net wealth if the issuer has some sort of de facto or de jure monopoly power’
Not totally getting this. A bank that issues IOUs where they promise to pay the bearer on demand a fixed value of whatever serves as base money can succeed as long as people trust that it can if required make good on its promise. Multiple banks can all do this at the same time. Do you mean that in this scenario , even if all banks are creating (say) Canadian dollars (that they promise to convert to notes on demand) they are all in reality monopolists in their own version of Canadian dollar (Only the BoM can create new deposits is BoMs version of the dollar) , or something else ?
MF: I’m quite sure Nick is only talking about “base money”, and probably not even all of that. He obviously doesn’t think all money is net wealth. I read his sentence as “If some money is net wealth, then it is because the issuer has some sort of de facto or de jure monopoly power”.
“Take Bitcoin for example. It’s a financial asset to whoever holds it. To whom is it a financial liability? ”
I think we need to know what a “financial liability” might be. Do we mean that someone (some entity) is responsible for the value of Bitcoin? You seem to be correct in saying “Nobody is obligated to accept Bitcoin” so apparently the value of Bitcoin is purely dependent upon the whim of the buyer.
Now we might insist that Bitcoin be entered onto a double-entry balance sheet. How about a balance sheet maintained by the entire economy? In this balance sheet, we would put the current value of Bitcoin on the LHS and the liability on the RHS under the label of stockholder equity. Right?
MF: Suppose there is perfect competition in commercial banking, so all profits get competed away by free entry. At the margin, the interest that banks pay on deposits, plus their admin costs, would equal the interest they earn on their assets.
If the Bank of Canada faced similar competition, which drove its seignoirage profits to zero, it would be the same.
It’s competition vs monopoly, not inside vs outside (“base”) money, that is the issue. Pesek & Saving not Gurley and Shaw.
Antti: if people use Bitcoin as the medium of exchange (even more so if they also use it as unit of account) then they are using it as money. Anything people use as money is money.
We disagree on our definitions of money.
Nick, good series of posts. A LETS does not create net wealth because (assuming it doesn’t implement limits to negative balances) all IOUs are made equally liquid, and thus no issuing member exercises monopoly power?
JP: thanks!
Hmmm. Dunno. Hafta think. Sounds maybe correct, at the margin. (“At the margin”, because if LETS were banned completely, assuming no competitors sprang up, net wealth would fall.)
“It’s an asset to you, but not a liability to me.”
Unless the IOU’s start refluxing to you. Then you’d need assets with which to buy back the refluxing IOU’s. How much? I’d say that if you issued $100 worth of IOU’s, you’d need to hold $100 worth of assets in order to buy back your IOU’s. If you hold only $99 worth of assets, then arbitragers would short your IOU’s.
@JP: A question on ‘A LETS does not create net wealth’. If A buys a car from B are they not both better off with the new combination of red/green money and goods they now have than before and therefore both have increased net wealth (measured subjectively) ?
‘If the Bank of Canada faced similar competition, which drove its seignoirage profits to zero, it would be the same.’
Follow up question: The seigniorage profits derive from the creation and spending of new money which CBs trend to do by buying assets that pay a return. How could these profits go to zero without also driving these returns to zero ?
Mike: Suppose that I issue money that is redeemable at par (for CPI bundles). A 0% price level path target, in other words. I will need assets to be certain I can fulfill that obligation to redeem if exercised. And those assets pay 5% interest, and the money I issue pays 0% interest.
If I am certain the demand for money will never fall (a stationary economy) writing a put option that will never be exercised in equilibrium costs me nothing. The value of that liability to me is zero.
Under uncertainty (so the demand for money might fall and the option exercised) writing that option will have some value, but less than 100%.
But at the same time, the demand for money may grow (and will grow if NGDP is rising and V is constant). So I also have a put option myself to issue more money to prevent the price level falling.
Nick:
1) If your assets earn you 5% while you pay 0% on your IOU’s, then that will attract rival money issuers and the demand for your IOU’s will fall. You could reach zero-profit equilibrium by paying 5% on your IOU’s, or if the printing and handling of your IOU’s costs 3%/year, then in equilibrium you’d pay 2% interest on your IOU’s.
2) So you’re thinking of your IOU as a put with a strike of 1 CPI basket? But if the holder of your IOU has the right to return your IOU to you in exchange for 1 CPI basket, then the IOU itself must be the underlier. That’s not normal. Maybe you mean that your IOU is a call option on 1 CPI basket with a strike of zero? That would make the CPI basket the underlier, which is the way things usually work.
Mike: “Maybe you mean that your IOU is a call option on 1 CPI basket with a strike of zero?”
I probably said it wrong. That’s probably what I should have said. Which is a liability to me. But the value of that liability as of today is less than 1 CPI basket, because it might not be exercised for a long time, if ever.
Nick:
OK, but if you plot the price of a call with a strike of zero, you don’t get the usual elbow at the strike price. The call price plots as a straight upsloping line out of the origin with no elbow, so when we try to plot the Black-Scholes curve, we find there is no curve. No matter how much time to expiration, the Black-Scholes curve is just that straight upsloping line, meaning that there is no option premium. That means when you write such a call option in your ‘uncertainty’ case, the only value it will have is the value of the underlier.
(I don’t think the results would be any different if you structured your IOU as a put.)
Mike: If I can borrow $100 at 0%, and lend that $100 at > 0%, that is a valuable opportunity. Exactly how valuable depends on how likely it is I will be asked to repay, and how long that takes. In a stationary economy, the answer is “never”.
Nick:
We agree on that much. The trouble is that the profit attracts rivals, and rivals keep coming until your lending rate=your borrowing rate. Or maybe you earn 5% on your assets while paying printing and handling costs of 5% on your IOU’s. That could create the illusion that you profit because you earn 5% on assets while paying 0% on your IOU’s.
The fact that the Fed appears to earn big profits supports the view that the presence of rival moneys is not that strong of a force. On the other hand, when we look at countries that are small, weak, and close together, it’s hard to imagine that rival moneys wouldn’t push the money issuer’s profit to zero.
Hmmm, I’m forced to argue that you are only describing half a transaction there.
To demonstrate, consider the following situation: I might be Indian and perhaps I’m somewhat politically connected so I have been given a gentle warning about some upcoming events. I offer you a fat wedge of 1000 Rupee notes in exchange for your vehicle, and you quickly check the currency conversion and figure it’s a pretty good deal. Not long after you sell me the car you are surprised to read in the news that Prime Minister Modi has declared those 1000 Rupee notes to be worthless and you think, “Holy shmoly, I’ve just given away my car!”
Clearly at the time of the exchange you thought you were gaining value, but there was an information asymmetry, I was just trying to offload those notes. The implication is that you never really wanted a big handful of Rupee notes, what you wanted was the future opportunity to spend the money on something else (maybe a different car, or a bike, or whatever). Your expectation is that someone else will accept those notes. When the rules get changed you would no doubt feel ripped off. You would feel that Prime Minister Modi has defaulted on a promise (or perhaps you might get angry that I was tipped off early).
So what normally gives those 1000 Rupee notes a tangible value? Well, Indians must pay tax, and that tax must be paid in the approved fiat currency as the Indian government declares it, so the Rupee has the value that it can be exchanged for settlement of tax debts. Also known as Mosler’s 9mm theory of currency valuation. In a nutshell, government is a protection racket, and government offers to its citizens the service of not hurting them, in exchange for their payment of tax. The note is an asset to the holder and the corresponding liability is that government must accept this note as a payment of tax.
A way to think of it is that government tax and spend policy operates a pump which drives fiat currency around the circuit. When the Indian government decides to stop accepting 1000 Rupee notes, suddenly that note is no longer pumped, and very quickly stops circulating.
Where am I going with this? OK, you see the useful purpose of having some type of medium of exchange, solves the “coincidence of wants” problem, allows people to trust one another, makes division of labour more convenient, etc. In order to make an accounting system, there need to be rules, and people need to feel confident that the money doesn’t simply appear and disappear in a seemingly arbitrary manner. You can’t just have randomized account balances, there’s a method to it, otherwise the users of that financial system will reject the entire process.
The currently established system is that you cannot allow positive sum transactions, nor negative sum transactions… all are zero sum, the entire accounting universe is zero sum. This is the basic accounting tautology. This is a social convention that goes very deep… I don’t care if you think it’s wrong, or even if you have what looks a bit like proof that it’s wrong. If people start to get the idea that their cash can arbitrarily vanish, or if new cash can pop up out of nowhere, they will be very upset. Heck, many people in India are very upset right now.
Look at it the other way around, suppose you offer to sell your car for $2000 and I walk up and pull out a small box, crank the handle and print up some fresh Canadian dollar notes, then I blow on them a bit until the ink dries, and offer to pay for your car. Are you comfortable with that? It must mean the value of the car has increased, right? Hey, tell you what, I like you kid, here I’ll print a couple extra and bring that up to $2200. It must mean the value of the car has increased even more, right?
Another example:
I buy used baby clothes for my 1y old. After six months they are worthless to me because baby has grown out of them. The value to me is now 0. So I sell them to someone else who now has a 1y old. This someone is willing to pay 20% less than what I paid when I bought them. Was value created? Destroyed? I’d say one could draw a curve depicting the decline in value according to age and use. That curve does not depict the current use value to every potential owner of the product.
“If I am certain the demand for money will never fall (a stationary economy) writing a put option that will never be exercised in equilibrium costs me nothing.”
“Never say never”. One can use the Black-Scholes-Merton (e.g. Merton 1974) framework to get the value of the put. If there is an infinitesimal change that demand value will ever fall (infinite horizon) to zero then the value of put means that the value of demand is worthless. I think it is safe to say no money will last forever.
Nick is of course right that if “the the demand for money will never fall” then liability “costs nothing”. Yet if we drop never and assume anything short of infinity then the result is completely different.
We can deduct the value of demand for money without the option theory. Assume no backing, indefinite horizon and the value of demand doesn’t last forever. So what is the value of demand at t=0 if the value of demand is zero at time t=n where n is infinity? By backward induction: at time t=n-1 the value of demand is zero, then it is zero at time t=n-2 … zero at time t=0.
Nick said: “We disagree on our definitions of money.”
This should surprise no one. This is what I call the “money problem” in economics. But don’t worry, Nick. I’m willing to let you call whatever you like ‘money’, if you’re OK with my calling nothing ‘money’. For me, there are goods and then there is accounting, which is based on an abstract unit of account. I don’t need the word ‘money’. I don’t even need “medium of exchange”. You can keep those 😉
Tel: here’s a much simpler counter-example to what I said: suppose my car has a hidden flaw, and it is much cheaper for me to fix that flaw than for you to fix that flaw. In this case my selling you the car can actually reduce the (full-information) value of the car. Now maybe you will simply sell the car back to me (at a lower price) when the flaw is revealed (or pay me to repair it), because the car is now more valuable to me. But maybe the flaw is only revealed when you are on a long road-trip.
But all these counterexamples really do is confirm that value is subjective. And that used cars make a poor medium of exchange precisely because they are idiosyncratic and the seller may have better information about their quality than the buyer (the market for lemons).
Oliver: the market value of a given set of baby clothes declines less quickly than the use value for any given owner. That’s why they get traded. Like used cars.
Jussi: change it just slightly. Let there always be a 1% chance the value of money will fall to zero next period.
Antti: It all depends on your theory of the world, and what you are using that theory to try to explain. I want to explain recessions, and I think recessions are caused by an excess demand for the medium of exchange, whether the medium of exchange is cigarettes or Bitcoin. With you it’s probably different.
Haven’t really thought much about this, but:
“Suppose I sell you my car for $2,000. That would only happen if I value my car at less than $2,000, and you value my car at more than $2,000. So when I sell you my car, it must mean that the value of the car increases.”
Make the example a business machine for $ 2 million rather than a car.
How does one account for that value increase?
By profit and/or the stock market?
Not at all?
Unmeasurable?
Accounting is irrelevant?
Accounting question rejected outright as a matter of economic dignity?
Other?
Nick: I want to explain recessions. I think credit/debt has a lot to do with recessions.
If you promise not to draw too many conclusions from this, I would say there is some kind of “borrowing from future” going on, and this is a problem. I’m with (ex-BIS; ex-BoC?) Bill White on this one. I’m also sympathetic towards what current BIS has been arguing for years; towards what Krugman calls BIS’s “attitude”. But I agree with Krugman when he says that it’s not a (full-fledged) theory. I’m trying to provide that missing theory, and that requires changes in Krugman’s theory, too.
I want you to take the “borrowing from future” with a grain of salt. No one has yet been able to explain in a precise way how it happens. So it’s something I don’t want to discuss at this point. And I don’t want it to be taken to mean that I approach it exactly the same way as others who might have used those same words to describe their intuition or “attitude”.
“Excess demand for the medium of exchange”.
This could be at least partly translated as “unwillingess to buy and to extend credit”? Speculation is also involved. I don’t think there is any exact translation between how you see it and how I see it. My (real) economy doesn’t have any “medium of exchange” as you’d define it.
How I would approach is to ask why there is such a phenomenon which you, not I, describe as “excess demand for the medium of exchange”. What causes that? The answer to that question would be at least a partial answer to the question “Why recessions happen?”. That’s where we need to search for the solutions.
“Let’s get people and businesses to spend more” is a solution which has been tried and which has failed, multiple times. I’m not saying it’s your suggested solution — I surely hope it is not. This is more complicated than that.
JKH: Define ‘value’? 🙂
“Jussi: change it just slightly. Let there always be a 1% chance the value of money will fall to zero next period.”
Nick: Then It is easy to see by forward induction: how much the money is worth today knowing it is 0.99 tomorrow, 0.99? No because if it is today 0.99 it would be 0.9801 tomorrow. How much it is worth today if it is 0.9801 tomorrow, etc. But also If it is zero in the end the backward induction is good whatever the path to zero (the expected value is (almost surely) zero at the limit).
Money creates economic value but I doubt it is enough in theory to create demand for a non-convertible money. And the real world money is convertible: http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/04/from-gold-standard-to-cpi-standard.html
JKH: Simple example. Suppose the machine earns my company $150,000 per year forever. At 10% interest it’s worth $1.5 million to my company. Suppose the same machine would earn your company $250,000 per year forever. At 10% interest it is worth $2.5 million to you. So I sell it to you for $2 million, and both our companies are worth $0.5 million more.
I have no idea how this would get recorded on the books. But the stock prices should both rise to reflect those two 0.5 million gains (assuming they hadn’t already anticipated the trade).
Antti: sounds potentially interesting. It’s OK to have a theoretical perspective that isn’t fully worked out yet; I do it all the time, and sometimes I write these blog posts to help me work it out, with aid from commenters.
The words “money” and “credit” sometimes get used interchangeably, which I think is a mistake. I prefer to think of IOUs rather than “credit” (though the IOUs may or may not be written on bits of paper, it’s easier to think of them that way). IOUs may or may not be tradeable, and may or may not be used as money, and may or may not be promises to pay money (they might be promises to pay wheat).
Bill White is a very interesting thinker and speaker. (Canadian, of course!) Not sure I agree, or even properly understand, his approach though.
Sometimes the economic problem really is as simple as people aren’t spending money quickly enough. As to the underlying causes and cures of that problem though, and how best to prevent it arising, that may be more complicated.
Jussi: “Then It is easy to see by forward induction:…”
No. You are wrong. Depends if the economy is growing, and what is happening to velocity, and whether the supply is growing or shrinking. If we hold all those things constant, then the value of money will be constant too, just as long as the 100-sided die doesn’t land on the one tails. Because people are willing to hold money even if it has a negative rate of return (-1% in this example) and all other assets have a positive rate of return. Simply because money is the most liquid of all assets.
In theory, the equilibrium where intrinsically worthless money has positive value looks very fragile. But in practice, there seems to be a helluva lot of ruin in even a really crappy money. It took a massive amount of abuse to destroy the Zimbabwe dollar. Then there’s the “Swiss” Dinar(?) and the Somali Shilling(?). (JP Koning keeps doing posts on these weird examples of currencies which are orphaned from the government that issued them, but I keep on forgetting all the details.)
“No. You are wrong.”
I often am but I do not see how your arguments refuted mine in theory. They are all based on the real world phenomena where money is convertible (as per your own link). I think that given some intrinsic value a commodity used as money can trade over that intrinsic value which shows money and liquidity creates economic value. But for example Bitcoin (intrinsic value is zero) is just a scam. And many things fall back to the theoretical state given enough time…
Jussi: basic monetary theory:
In equilibrium, Ms=Md (supply of money = demand for money). Now assume Md is proportional to PY (nominal GDP) and positively related to the real rate of return on holding money. Normally the real rate of return on holding money is minus the expected inflation rate (assuming money, e.g. currency, pays no interest to the holder). If the real rate of return is very negative, the demand for money is very small, but it only goes to zero at Zimbabwean levels of inflation.
Assume Ms and Y are constant over time, then there exists an equilibrium where P is constant (so inflation is 0%). (Yes there exist other non-stationary equilibria).
Now change the example to assume a 1% probability per period that money will be worthless next period. The only thing that changes to that is that the stationary equilibrium (Ms/P) will be lower, because the expected real rate of return on money is now lower by 1%.
Nick, you rephrased what I said. But that particular example is not really about a macroeconomic phenomenon, is it? It’s microeconomics, as far as I can tell. Not that that’s a bad thing or unimportant.
Nick said: “I have no idea how this would get recorded on the books. But the stock prices should both rise to reflect those two 0.5 million gains (assuming they hadn’t already anticipated the trade).”
Just a general comment from an accountant: There’s a thing called “prudence concept” in accounting.
An economist can casually utter a sentence like this: “Suppose the same machine would earn your company $250,000 per year forever. At 10% interest it is worth $2.5 million to you.”.
An accountant saying the same would soon be an ex-accountant.
JKH would most likely (be required by his auditors to) book the machine at acquisition price. Never higher.
To another issue…
I’m a bit confused by the use of “net wealth” in this thread. Do you refer to some present value calculations with it? I took it to mean, in this context, that the money in question is an asset to its holder but a liability to no one. Following Friedman & Schwartz (”The Definition of Money: Net Wealth and Neutrality as Criteria”, 1969, p. 2):
“Pesek and Saving start with three entirely correct propositions: (1) Commodity money and fiat money are assets to their holders, but in no meaningful sense debts to anyone. Hence, they should be included in the consolidated net wealth of the community without any offsetting entries. They are “money” without simultaneously being debt.”
Oliver: Yep, this is all based on micro. But the micro of money has macro implications.
@Mike
‘The trouble is that the profit attracts rivals, and rivals keep coming until your lending rate=your borrowing rate. Or maybe you earn 5% on your assets while paying printing and handling costs of 5% on your IOU’s’
Is it possible that in world where there were competitive money issuers, whose money was backed (CB-like) by interest-bearing assets that if the return they were getting was above the equilibrium profit level they would pay interest to people holding their money, and/or offer cashback on purchases (like some credit companies do) in order to make their money competitive against their rivals ?
Nick: My point was that that there is no demand for money which is not convertible – you cannot refute by throwing in the basic monetary theory, which just assumes the demand (“Now assume Md is proportional to”).
Take the Bitcoin and ask why someone gave up something valuable (pizza?) for Bitcoins in the first place? There was zero liquidity value for the Bitcoins, so the trade didn’t make sense, did it? Similarly it is the same with any money that has no intrinsic value. We cannot just make a circular reference to liquidity: “liquidity creates value which creates liquidity”. You need to explain why the first trade makes sense.
But it makes a lot of sense to start to trade with something valuable (e.g. gold), which then starts to create value out of liquidity (as per your post). But if you throw away the convertibility on the fly I think the system will be unstable and given enough time will collapse (#ERROR! “circular reference”).
Jussi: your forward induction argument assumed that the demand for money is perfectly elastic at an expected rate of return of 0%, so that at any rate of return < 0% the demand would drop to zero. It doesn’t. It slopes down.
The multiplicity of equilibria is another question. Von Mises’ “Regression Theory” answer isn’t great, but it’s the best I know. Languages are a similar equilibrium. People keep on using the word “cat” to mean cat, even though words are not convertible into animals.
“your forward induction argument assumed that the demand for money is perfectly elastic at an expected rate of return of 0%, so that at any rate of return < 0% the demand would drop to zero.”
Why do you think something going to be value of zero in the future would have some value as of today? If you think we can observe that from the markets it is not the case: even if the overnight rates (e.g. in euros) are negative the forward expectations (implied by O/N swaps) are not (and never was).
Nick,
That’s a reasonable answer
The book value accounting is easy – I won’t go into it
And the stock price recognition is easy
And there’s no reason why the business machine example can’t translate to a household car example in both of these aspects
Additional point: stock prices get reflected by marked to market accounting on the books of the stock holder
My larger point would be that accounting should be a facilitator of these kinds of economic arguments – not an enemy
My final observation is that (in my view) you probably rank near the top of economic bloggers whose economic arguments are in fact bolstered by logical accounting facilitation – including unique representations like red and green money, etc. You may think you’re rejecting accounting, but in fact you rely on it – even if is constructed in your own unique way.
It’s not the enemy
On a long enough timeline, any asset almost certainly will become worthless. And any asset has some non-zero probability of having zero value tomorrow. My car is just one example. And yet they are valuable.
I am willing to hold Bank of Canada currency despite this, and despite the Bank of Canada telling me that this asset will depreciate in value at 2% per year, because it is more liquid than the cans of beans or land or whatever I could hold instead.
You can say my car pays me in transportation services. And money pays me in liquidity services. I am willing to pay for those services. Yes it’s a Network effect. But then so is my car; if everyone else stopped driving the government wouldn’t keep up the roads, and my car would become worthless.
Nick writes: “Currency is like non-voting shares in the Bank of Canada”.
That does’t sound like a good description of currency to me. Here is a description I like better:
Currency is like a gift certificate valid anyplace in Canada.
“And money pays me in liquidity services. I am willing to pay for those services.”
This is agreed. I’m too holding depreciating currency for liquidity purposes – yet I believe it is in the end convertible and needs to be that way.
It is interesting that you have shown that convertibility is still (kinda?) holds true but on the other hand you still (I assume) think that money doesn’t need to be that way.