Friday, February 27, 2015

Peter Cooper — What is Modern Money?

A modern money system, as that term is applied in Modern Monetary Theory, typically has three key features. Two of these features are always present. The third is optional but normally should be in place for the full benefits of modern money to be enjoyed: 
1. The currency is a public monopoly. Government issues the currency and is the only entity allowed to do so. 
2. The currency is nonconvertible. It is a fiat currency. The government does not promise to convert its currency into a precious metal or some other commodity at a set price. 
3. The exchange rate is allowed to float. The government does not promise to maintain a fixed exchange rate with any foreign currency. Instead, the exchange rate is ‘flexible’ or ‘floating’. As already mentioned, this feature is usually operative, but not always. 
Taking these three features together, we can say that modern money normally involves a ‘flexible-exchange-rate nonconvertible currency’, or ‘flex-rate currency’ for short....
heteconomist
What is Modern Money?
Peter Cooper

8 comments:

Matt Franko said...

Jumping on top of what jr and magpie bring up over there wrt

"By importing more than they export, these nations experience a depletion of foreign exchange reserves, because foreign currency is needed to pay for the imports. "

If the product was brought to a foreign nation I think it would typically be paid for in the local currency upon arrival.... perhaps would never leave the dock of the original nation unless it was already paid for (in some currency)...

I think this topic area of the "free floating" aspects of the MMT theory (free floating, non-convertible) is a good area for some additional work...

(to me) it looks like this functional area is a bit treated like a "black box" (engineering term...) by the MMT folks..(for simplification probably and probably appropriate in most instances...) but, sticking with the "black box" analogy, somebody has to know ultimately what is going on inside the "black box" for a complete systemic understanding...

to me, while it can indeed look like the exchange rates "freely float", this "freely float" is a bit "invisible hand-ish" so this is a tip-off ... there must be a causal explanation that can be worked out within the context of existing institutional arrangements, and the typical "self-interest" of the parties involved and "power relationships" of the parties also... that would provide a more detailed explanation of why we often see the so-called "exchange rates" between two different currencies vary over time...

iow we may say within MMT that "a country can always devalue its currency...." but I would submit that is not what ever happens, we usually never see a country do this, but yet, the currency can become "devalued" vs another currency...

who is doing this? and why? imo it is not anyone in govt policy positions the govt people are usually advocating a "strong currency" for their nation blah, blah...

Previous policy of Switzerland (the policy just terminated) a notable exception...

rsp,

Neil Wilson said...

Causality is the wrong way around.


To import more than you export there has to be somebody prepared to save in your currency *otherwise the deal never happens and there are no imports in excess of exports*.

It's a StrawMan argument that keeps getting repeated again and again.

The deal happening causes the necessary savings to come about as a consequence.

It's just like investment causing savings.

Neil Wilson said...

In a floating system of course.

peterc said...

"In a floating system of course."

Just to clarify, the sentence immediately preceding the one Matt quotes begins:

"Fixed or pegged exchange rates are most problematic for nations running trade deficits ..."

The paragraph in question is talking about the reduced policy space available when operating under a fixed or pegged exchange rate.

peterc said...

My (limited) understanding in the case of a low-income country with a flex rate is that a difficulty can arise if the need for essential imported items exceeds what can be obtained with foreign exchange earned through exports -- the reason being, as Neil indicates, that foreigners may not be interested in saving in that nation's currency. If so, the deal won't happen, which, if the items are essential, will be problematic unless a workaround can be found.

Matt Franko said...

Points taken Neil and Peter...

But I would point out, for multinational corporations, for financial accounting purposes, they can just count some foreign currency balances or foreign financial asset values as "earnings" for their shareholders just like they would count any "money" they would make in their home country...

So it may not be like they are "saving" in the foreign currency, they are "making money" and trying to make as much "money" as they can...

So if a US firm were to export some industrial stuff to Greece and get paid in a hypo new Greek drachma, lets say the exchange rate was 1:1 and Apple sold some iPhones over there and made 1B drachma, they would report they made $1M (DOLLARS!) just as if they made it in the USA... but it is REALLY in drachma (at 1:1) they dont care what currency it is in they just want to "make money!"...


So to Apple, they are not thinking: "hey! I got it! lets sell the Greeks some phones for some drachmas and hence be able to save some drachmas!"

They are thinking: "Hey lets make some money over there!", etc... and things like: "at what price do we sell our phones in drachma at over there?"

They dont care what it is in... but their bankers probably do as they have to comply with the banking regulations of BOTH countries...

rsp,

Tom Hickey said...

Not sure that the deal won't happen is a good general rule. The foreign exchange market is both huge and highly liquid.

As long as an exporter can shed a currency acquired in transaction for a harder currency quickly enough to avoid taking a hit, the deal will ordinarily happen. It only becomes problematic if the currency is so unstable that the terms are unclear.

Importers and exporters pay very close attention to exchange rates. I have had friends who were importers or exporters and they watched the market closely, knowing exactly the point at which they would enter. They would then finalize a deal that may already have been in the works for some time waiting to close.

BTW, the Russian cb is both buying gold from their own mines and also shedding dollar reserves. They know that they can always sell gold for dollars if needed, and they are reducing that need through various deals and swaps, too.

Central bankers realize that central banks set inflation targets, so the bias of a floating rate currency is inflationary. In that case gold serves as a hedge instead of accumulating foreign reserves that are likely to inflated since that's what the central bank is aiming at.

peterc said...

I think also, in the case of Greece, that a newly issued drachma would initially be scarce if implemented effectively (in particular, as Warren M emphasizes, by making sure that euro deposits are NOT automatically converted into drachma). Basically, the Greek govt should (i) require taxes to be paid in drachma and (ii) conduct govt spending in drachma. Then leave the onus on would-be drachma users to get hold of the new currency, which they will have to do, if nothing else, to meet their tax obligations.