Thursday, July 27, 2017

Peter Cooper — Short & Simple 11 – Money as an IOU


Gresham's law states that the bad drives out the good. This was true of coinage, when the metal value of coins was diluted or pared.

However, the opposite occurs in the case of money as an IOU. The higher the trustworthiness of the debtor, greater the demand of creditors for the debt. The greater the demand, the lower the interest rate needed to induce saving. 

This is demonstrated by the position of the US dollar as the global currency, that is, the preferred currency in which to save. This also spills over into US government debt denominated in the US dollar as the nation's unit of the account.

heteconomist
Short & Simple 11 – Money as an IOU
Peter Cooper

24 comments:

Andrew Anderson said...

Money can be an IOU, a liability, but it can also be a share in equity, common stock.

But why should those with equity share it when government subsidies* for private credit creation allow them to legally steal the purchasing power of the less so-called credit worthy?

*Private credit creation creates liabilities, true, but the effect of government subsidies renders those liabilities largely a sham wrt the non-bank private sector, i.e. a sham wrt the rest of us.

MRW said...

Money can be an IOU, a liability, but it can also be a share in equity, common stock."

A share in what? It can be used to purchase a stock or anything for that matter, but as a definition of money it’s bonkers.

AXEC / E.K-H said...

Money: from silly stories to the true theory
Comment on Peter Cooper on ‘Short & Simple 11 – Money as an IOU’

“… in fact he [Adam Smith] disliked whatever went beyond plain common sense. He never moved above the heads of even the dullest readers. He led them on gently, encouraging them by trivialities and homely observations, making them feel comfortable all along.” (Schumpeter)

Not much has changed in 200+ years. The homely stories about how money comes into the world go as follows:

(i) “Before money, …, we all had to barter for the goods we wanted. If I wanted wheat and had chickens, I needed to find someone who wanted chickens and had extra wheat. Money solves this “double coincidence” problem by letting me sell my chickens to buy your wheat. If we didn’t have money we’d invent it immediately.” (Stray)

(ii) “To increase and facilitate trade, …, a paper currency was organized by the Restaurant and the Shop. The Shop bought food on behalf of the Restaurant with paper notes and the paper was accepted equally with the cigarettes in the Restaurant or Shop, and passed back to the Shop to purchase more food. The Shop acted as a bank of issue. The paper money was backed 100 percent by food; hence its name, the Bully Mark.” (Radford)

(iii) “Eventually some goldsmiths noticed that the paper receipts they gave to their customers to evidence the valuables left in storage began to circulate as currency alongside their countries’ coins. A shopkeeper accepting these receipts in payment knew that he could go to the goldsmith to redeem them for gold and silver, and also recognized that a paper receipt was more convenient to use as currency than were pieces of metal.” (Turk et al.)

(iv) “For example, perhaps your neighbor offers to tend to your garden while you are away on holiday. You write ‘IOU’ on a slip of paper and promise that you will accept the slip of paper back again in payment for a service to be performed on your return. Your neighbor knows and trusts you and so accepts this arrangement. On returning home, you wash your neighbor’s car and mend a fence, accepting back the IOU as payment.” (Cooper)

(v) “When government uses the currency to purchase goods and services, it promises to accept back its IOU in payment of obligations to it. These obligations mostly take the form of taxes.”

Whether these stories are historically true does not matter much. The fatal weakness of storytelling economics is the Fallacy of Insufficient Abstraction. The theory of money has to be developed within the framework of a ‘monetary theory of production’ (Keynes).

The pure consumption economy is for a start clearly defined by three macro axioms (Yw=WL, O=RL, C=PX), two conditions (X=O, C=Yw) and two definitions (Qm≡C-Yw, Sm≡Yw-C).

Money is needed by the business sector to pay the workers who receive the wage income Yw per period. The workers spend C per period. Given the two conditions, the market clearing price is given by P=W/R. So, the price is determined by the wage rate, which has to be fixed as a numéraire, and the productivity. From this follows the average stock of transaction money as M=kYw, with k determined by the payment pattern.

What is needed are two things (i) a central bank which creates money on its balance sheet in the form of deposits = overdrafts, and (ii), a legal system which declares the central bank’s deposits as legal tender. Money comes into the world through the autonomous transactions between the business and the household sector and the transfer of deposits.

This is the fully specified analytical account that connects the variables L, R, O, X, P Yw, C, M of an elementary economy and explains how transaction money comes into the world. Note that the central bank is passive, it only carries out the autonomous transactions which, in turn, determine the average quantity of money M. There is no such thing as monetary policy. The acceptance of money is not brought about by state power or by personal trust but by enforceable law.

Egmont Kakarot-Handtke

Andrew Anderson said...

but as a definition of money it’s bonkers. MRW

Assets = Equity + Liabilities.

Thus both Liabilities and Equity are backed by the Assets.

Thus both Liabilities AND shares in Equity are forms of money.

Matt Franko said...


"as a definition of money"...

You can't define ANY figure of speech to sufficient scientific standards.... a figure of speech is created in the first place to gain efficiency in the language at the expense of specificity....

Science uses specific units and terms not figures of speech...

Matt Franko said...

You guys are trying to go backwards again..

Matt Franko said...

Logically, in our history we once used specific terms, THEN the figure of speech "money" was created....

Now you guys want to backwards back thru that.... or something...

Iow FIRST you have to have the specific terms, THEN the figure of speech is created ...

It makes no sense NOW to go backwards and argue about what the figure of speech "really means!"...

What purpose does that serve?

Matt Franko said...

You guys should argue about whether 5,000 year old cave wall paintings are part of "Hollywood" or not....

Matt Franko said...

Or just pick any current figure of speech and then go back in human history and argue about whether some specific term used long ago should today be represented by our current figure of speech... knock yourselves out....

Tom Hickey said...

Science uses specific units and terms not figures of speech...

Money is a term that denotes a type of measurement called monetary or nominal value. The unit of measurement is specified as a unit of account.

Just as in science, types of measurement are defined institutionally and there are bureaus of standards to regulate the measures, so to with money, which is highly specific in law since contracts depend on this.

Calgacus said...

Matt: I agree with Tom. The MMT etc perspective is the usual way thinkers think. I have never understood what you mean by "money is a figure of speech". It is a pretty well defined concept; the follow-ones-nose implications of the definition and its subtleties are far from exhausted.

The "specific terms" seem to me to be just misleading verbiage for the same things. It seems like saying "chat", "feline", "miw", "kitte", "gatto" "catua" are scientific, specific terms. But saying that they all mean "cat" is a figure of speech?! That is the opposite of scientific outlook. It seems to me that both you & EKH are committing what he calls the "Fallacy of Insufficient Abstraction". And unconsciously using terms (like "money") defined later, before they are defined. Like EKH speaking of (apparently monetary) "income", "prices" etc before "money". That is not how axiom systems or logical exposition work in mathematics or even wannabe math.

They may not always present it that way, nor may they always realize it themselves, but as I've been saying for a long time, and as Matt has noticed too when he talks about mathematical maturity, the MMTers think and write like mathematicians. A tightly argued, abstract logical development is there - one that appears to me to be far more abstract and logical (and therefore intelligible) than EKH's, say. MMT is a "mathematical science". So if MMT is "storytelling economics", then all of mathematics is storytelling too.

Tom Hickey said...

Science is about measurement of change. This requires setting scope and scale, and defining parameters. This involves distinguishing between discrete and continuous, stocks and flows, etc.

In monetary production economies, as all economies today are, economics is based on "money" as in money and banking, and finance. The language of money & banking, finance, and commerce is discrete, that is, recording of transactions (exchange) in journals and ledgers in a specified unit of account, and summarizing (aggregating) in financial reports.

Money as a unit of account provides a common measurement for widely disparate goods and factors.

Money is not additive. x dollars and y euro don't add up to (x + y) money. The rules require that different currencies have to be treated separately as different units of account in measurement. Exchange rates allow for conversion of units into each other.

On the other hand, economists approaching economics on the model of physics generally treat economic data as continuous. This can be an issue if they either don't understand the accounting that the data is based on or ignore it as superfluous other than in specifically monetary matters like inflation.

Economists realize that economics is discrete in that they take individual choice as basic. Every exchange involves choice by the parties to the exchange based on preferences.

In every transaction, the seller has to choose to save in the unit of account received in payment, at least temporarily, unless the transaction is a pass-through.

AXEC / E.K-H said...

Calgacus

The history of money from the cowrie shell#1 to bullion to coins to notes and to the credit card shows a clear tendency of progressive abstraction. The conclusion of the history of money is that money is information and that the concrete forms of monies are nothing but different data carriers. The ultimate data carrier is the server at the central bank and the chip under your skin.

Again, the pathetic blunder of monetary theory is the Fallacy of Insufficient Abstraction. It is a bit stupid to get caught by the numerous outer forms of money. The abstract essence of the phenomenon is this: money = information.

In the ‘monetary theory of production’ things get started like this. The firm says to the worker we pay you one dollar per hour. At the end of the first day, the firm owes the worker $ 8. Money starts as a credit relationship with the firm as borrower and the worker as lender. Let this go on until mid-month. Then the firm’s IOU is $ 120.

Now the firm goes to the central bank and tells them to transfer $ 240 to the worker. The central bank makes a book entry: firm’s overdrafts $ 240 and worker’s deposits $ 240. The private IOU of the firm has become money. The worker owes the firm 120 working hours until the rest of the month. The underlying private borrower-lender relationship has flipped. Vis-a-vis the central bank, the firm is the borrower.

Now, $ 240 is a rather abstract thing until the worker goes shopping. We know from above that the price in the pure consumption economy with market clearing and budget balancing is P=W/R. This translates into the real wage W/P=R. The ‘real’ value of money or the purchasing power is determined by the productivity. This is how the arbitrary designation dollar (euro, yuan, ruble, etc.) becomes something very concrete, i.e. value of money = productivity. Money has NO intrinsic value.

By spending the money on the consumption good the credit relationship is resolved. This is the elementary cycle of money creation and destruction. It starts with zero and ends with zero.

Note that this analytical account deals exclusively with the measurable variables L, R, O, X, P, Yw, C, M of an elementary economy and leads to testable propositions. The economist’s job is to explain the ‘quantity of money’ M with the accuracy of two decimal places and its relationship with the price P. Note well that it is NOT the quantity of money that determines the price in the pure consumption economy. And this means that the commonplace quantity theory is dead. And the MMT story, too.

Egmont Kakarot-Handtke

#1 “Shell money is a medium of exchange similar to money that was once commonly used in many parts of the world. Shell money usually consisted either of whole sea shells or pieces of them, which were often worked into beads or were otherwise artificially shaped. The use of shells in trade began as direct commodity exchange, the shells having value as body ornamentation.” (Wikipedia)

Matt Franko said...

The word "money" is a metonym:

https://en.m.wikipedia.org/wiki/List_of_metonyms

"For instance, "Westminster", a borough of London in the United Kingdom, could be used as a metonym for the country's government."

"Money" is English slang/transliteration of the name of the goddess Moneta (word still used in Iberia) in the Roman pantheon under whose temple was operated the mint where they managed and produced the denarius, aurius, etc... i.e. the components of the numismatic system...

So if you were having a conversation and had to refer to a sum or total amount of the various numismatic components , instead of saying "make sure you bring one aurius and 5 denarius and 6 churon " , you would just say "make sure you bring the money" to be more efficient in the language (less words)...

English lends itself to the introduction of figures of speech quite readily it's an efficient market language for business negotiations and that is why everybody uses it internationally in commerce... but it is not good for science in this regard because it quickly loses specificity thru easy introduction of figures of speech...




Matt Franko said...

Maybe it would be correct to say: "money" is a figure of speech (metonym) that represents any of the various components of the Roman numismatic system....

Matt Franko said...

See Egmont first says:

" This is how the arbitrary designation dollar (euro, yuan, ruble, etc.)"

Then he later says "by spending the MONEY on a consumption good...".

He uses the figure of speech "money" instead of having to type " dollar (euro, yuan, ruble, etc.)" all over again ...

He uses one 5 letter word to represent a paragraph full of numismatic terms used by the numerous nations.... he's increased his efficiency thru employing the figure of speech...

This is what the word "money" is....

Matt Franko said...

"pathetic blunder of monetary theory is the Fallacy of Insufficient Abstraction"

That is because the word "money" itself is an abstraction (figure of speech)... they can never get past it....

AXEC / E.K-H said...

Matt Franko

Nice try to start a futile semantic game. In every concrete historical situation, people know very well what money is. This, though, is a matter of indifference for the theory of money. What people think about the earth and the sun is irrelevant for astronomy, just as it is irrelevant for economics what storytellers tell about the historical emergence of money.

Money in the ‘monetary theory of production’ is in the most elementary case the stock of deposits at the central bank which is measurable with the accuracy of two decimal places. It is a matter of indifference whether it is called dollar, euro, yuan, or ruble. Take the world economy as one and define one currency and call it Bancor and all semantic variety disappears.

The point at issue is that MMT is provably false* and that Peter Cooper’s IOU story of money is beyond ridiculous. Just as your semantic crap. This is NOT a figure of speech.

Egmont Kakarot-Handtke

* Refutation of MMT: all proofs and arguments you ever need
http://axecorg.blogspot.de/2017/07/refutation-of-mmt-all-proofs-and.html

Matt Franko said...

Never a good idea to put all of your eggs into one basket... this is a complex problem we are up against... multi-disciplinary input required to solve it...

Suggest you read up:

https://en.wikipedia.org/wiki/Linguistics

It will take more than just Systems Theory to get out of it...

AXEC / E.K-H said...

Matt Franko

When social scientists (an oxymoron, not a metonymy) are at a loss they invoke complexity as an excuse. This does not work either.*

Egmont Kakarot-Handtke

* Complexity and stupidity
https://axecorg.blogspot.de/2017/01/complexity-and-stupidity.html

Matt Franko said...

Well then why isn't anybody listening to you?

You can be right technically all day long but if you can't get anybody else to understand you it does you absolutely no good...

AXEC / E.K-H said...

Matt Franko

The question on this thread is does Peter Cooper’s Short & Simple 11 – Money as an IOU hold water? And the answer is not one drop.

So MMT is refuted on all counts.*

Whether you understand the proof and its significance is your personal problem.

Egmont Kakarot-Handtke

* For details see ‘Refutation of MMT: all proofs and arguments you ever need’
https://axecorg.blogspot.de/2017/07/refutation-of-mmt-all-proofs-and.html

Matt Franko said...

A figure of speech ("money") can be applicable to numerous concepts... you might say it can represent an iou and other things, debt, an ounce of some purified metal, whatever... the word is non-specific...

Matt Franko said...

In English...