Tuesday, October 22, 2019

About the rules of the monetary circuit — Dirk Ehnts

In “Monopoly”, the bank can “print” money indefinitely, the players get into debt, and the state adds 200 Marks each round. But what if everyone had to pay 200 Marks each round and would suffer negative returns when owning railway stations? 
Even if “Monopoly” comes from the US, it has long since become a classic German game. And it goes like this: In the ideal case four players buy and sell roads, build houses and hotels and pay each other rent, which depends on the price of the road and the number of real estate. So, the money circulates nicely in the “private sector” or, put differently, among the households. At some point, however, players will run out of money and will no longer be able to make payments. The only thing left is to sell streets, which in the real world is called “fire sales”. But with that they rob themselves of future sources of income. The resulting inequality brings the game to an end – when only one player has any money left....
econoblog 101
About the rules of the monetary circuit
Dirk Ehnts | Lecturer at Bard College Berlin, research assistant at the Technical University of Chemnitz, and spokesperson of the board of Pufendorf-Gesellschaft eV in Berlin
Crossposted at econinterest under Modern Money Monopoly and in German at Makroskop


Matt Franko said...

Missing the Treasury and Depository functions...

AXEC / E.K-H said...


Criminals and the monetary order

Comment on Paul Koning on ‘If Nick’s tech-fueled counterfeiting story doesn’t explain why bank IOUs beat out coins, what does?’

In order to determine the effects of criminals on the monetary order, one first needs a description of the elementary production-consumption economy. This economy is constructed from scratch with the following set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

Under the conditions of market-clearing X=O and budget-balancing C=Yw in each period, the price is given by P=W/R (1), i.e. the market-clearing price is equal to unit wage costs. This is the most elementary form of the macroeconomic Law of Supply and Demand. For the graphical representation see Wikimedia AXEC31.#1

The firm pays the monthly wages with a standardized IOU and declares that this conveniently denominated title will be unconditionally accepted at the firm’s store. The employees accept that the IOUs discharge their wage claim against the firm. The firm issues private money that takes the material form of a slip of paper. It is assumed that the total monthly wage is Yw/12 = 100 monetary units (Euro, Dollar, Ruble, Yuan, etc.). The household sector fully spends its period income, so consumption expenditures C per period are equal to wage income Yw, i.e. C=Yw, i.e. 1,200=1,200

The IOUs are created out of nothing by the firm, handed over to the household sector in the form of wages, return in the form of consumption expenditures, and are thereby destroyed. There is NO such thing as a fixed quantity of money.

The value of money follows from (1) and is given by W/P=R (2), i.e. the real wage W/P is equal to the productivity R. The value of money depends alone on the production conditions of the economy and NOT on the material value of the firm’s IOUs which is virtually zero.

The difference between the real value of money (= R) and the lower real production costs of IOUs opens an opportunity for criminals. What happens if counterfeiters exploit this difference?

It is assumed that the counterfeiters bring the fake IOUs at the demand side into circulation, that is, they buy stuff. The market-clearing price is determined by P'=(C+C')/O which is higher than P=C/O=W*L/R*L=W/R. Because the new real wage W/P' is lower, the part of total output O that the wage income recipients receive is lower and the difference O−O' goes to the counterfeiters as booty. The redistribution of output is carried out via the price. The higher market-clearing price does not signal increased natural scarcity but indicates that the hidden hand of criminals is at work.

For the business sector as a whole, profit is defined as Q≡C−Yw. Under the initial condition of budget-balancing C=Yw, macroeconomic profit is zero. With the counterfeiters’ additional expenditures C' the business sector posts a profit of Q=C'. Because the business sector gets more IOUs back than it had issued in the form of wages, macroeconomic profit in a private money economy takes the form of surplus IOUs.

In a world of honest people, IOUs could be a functionally satisfactory type of money. In a world of crooks, though, the incentives for corruption have to be eliminated. One obvious way to close the difference between the high real value of money and the low real production costs is to increase the production costs, for example by replacing the cheap data carrier paper by the expensive data carrier gold/silver. This, of course, runs against the principle of economic efficiency.

See part 2

AXEC / E.K-H said...

Part 2

Let us now replace private money by public money which is produced by the Central Bank. Instead of issuing its own IOUs, the business sector now becomes the debtor of the Central Bank in the form of overdrafts and gets uno actu deposits of the same amount. Central Bank deposits are money. These deposits are used for wage payments and subsequently for the households’ purchases of the consumption good. Thus, the business sector’s overdrafts are again reduced to zero. The idealized transaction pattern is shown on Wikimedia AXEC98.#2

Money is created out of nothing and is again zero at the end of the period. Money consists of a number on the liability side of the Central Bank’s balance sheet that is exactly equal to the number on the asset side. The real value of money is not in these numbers but depends on the productivity R.

The average stock of transaction money is given as M=κYw, with κ determined by the payment pattern. In other words, the ‘quantity of money’ M is determined by the autonomous transactions of the household and business sector and created out of nothing by the Central Bank in the form of deposits and overdrafts. The economy never runs out of money.

In this monetary system, the challenge for criminals consists of creating a deposit on the own account and an overdraft at somebody else’s. Again, the Central Bank’s counter-measures consist of driving up the production costs of counterfeit money by making their IT systems impenetrable.

In a fiat money system, the production of counterfeit money takes an entirely different form and a gigantic dimension. If the Central Bank creates money on behalf of the State and the amount G is spent into the economy with taxes left at zero, the effect is the same as money-printing by the counterfeiter. The market-clearing price P'=(C+G)/O increases and the part of output that is available to the wage income receivers diminishes. The redistribution of output happens via the price mechanism. The real wage is lower than the productivity. All this is nontransparent to the general public who is told that the invisible hand pushes the levers of the price mechanism.

See part 3

AXEC / E.K-H said...

Part 3

With the State’s additional expenditures G, the business sector posts a profit Q=G or Q=G−T in the general case of a budget deficit. So, it holds Public Deficit = Private Profit. Because the business sector gets more deposits back than it had spent in the form of wages, macroeconomic profit in a public money economy takes the form of an increase of the stock of Central Bank deposits, i.e. money. The counterpart of the business sector’s deposits is overdrafts of the State. The financial wealth of the business sector grows in lockstep with public debt. The general public is not aware that it owns the public debt which has to be repaid at some unknown date in the future.

Public deficit-spending is the wrong way to inject money into the economy. This way is NOT different from bringing counterfeit money in the economy. Both the printing of counterfeit money and public deficit-spending have in real terms the same negative effect on WeThePeople. The only difference is that private counterfeiting is illegal but public deficit spending is legal.

The foundational defect of the fiat money system is NOT that the Central Bank can create money out of nothing and charge interest to cover its costs, or that the money is not backed by gold, the defect is that the Central Bank enables the State’s deficit-spending which worsens the real situation of WeThePeople and increases the financial wealth of the Oligarchy.

From the macroeconomic perspective, running a public deficit is as criminal as printing counterfeit money. The first rule for a Central Bank is NOT to keep inflation at 2% but to prevent both surpluses and deficits and to keep the public deficit at zero.

In a well-designed corruption-free monetary order, the Central Bank is by law committed to a Schwarze-Null/Black-Zero government budget. The fighting of inflation or unemployment requires other tools.

Egmont Kakarot-Handtke

* Twitter-Reference

#1 Wikimedia AXEC31

#2 Wikimedia AXEC98