Tag: debate

In his second response, Mount Chapter 3, Nate provided four categories of money:

1. Commodity money
2. Fiat money
3. Money certificates
4. Credit money

He also answered my questions, which I shall summarize as follows:

1. When they function like money, gold and silver are commodity money, as evidenced by the historical preference for them.
2. Federal Reserve Notes are fiat money, with some characteristics of credit money.
3. TMS2 does not represent his definition of the money supply, but serves as a useful tool for estimating it.
4. All of the categories in TMS2 are fiat money; some may be credit money as well.

It was a strong and informed response, much better than one would likely receive from a professional economist or a central banker.  Two of his answers were also incorrect, for reasons I shall presently demonstrate.

Nate’s first mistake is the identification of credit money as fiat money, even though he clearly has his suspicions concerning the problematic nature of the distinction as it applies to the US monetary system.  That this distinction is false can be demonstrated in two ways, first with a legitimate appeal to authority and history, and second by the money creation process.

With regards to the first point, Mises writes:

“It can hardly be contested that fiat money in the strict sense of the word is theoretically conceivable. The theory of value proves the possibility of its existence. Whether fiat money has ever actually existed is, of course, another question, and one that cannot off-hand be answered affirmatively. It can hardly be doubted that most of those kinds of money that are not commodity money must be classified as credit money. But only detailed historical investigation could clear this matter up.”
  – The Theory of Money and Credit, p. 61

So, we recognize that while fiat money can potentially exist in theory, the question of its actual existence, in the United States or anywhere else, is not settled.  Nate himself notes that Federal Reserve Notes have some characteristics of credit money and that some of the categories in TMS2 may be credit money, but he fails to take the critical step, which is to recognize that the reason they have those characteristics is that they are credit money.  Note in particular the statement that most kinds of money that are not commodity “must be classified as credit money”.

This leads us to our second point.  The “fiat money” of TMS2 includes Demand Deposits, Other Checkable Deposits at Commercial Banks, Other Checkable deposits at Thrifts, Savings deposits at Commercial Banks, Savings Deposits at Thrifts, Demand Deposits, Time and Savings Deposits, and US Government Demand Deposits, among other things.  But from whence do these deposits come?  We know they are not simply printed by either the U.S. government or the Federal Reserve; there is simply not enough currency to account for them.

Clarity is established here via the the endogenous vs exogenous money debate.  We’re not likely to get sidetracked here, because Nate ultimately comes down on the endogenous side, he simply hasn’t connected it to his conception of fiat money.  Mises, too, comes down firmly on the side of endogenous money, as evidenced by the following passage:

“It is not the State, but the common practice of all those who have dealings in the market, that creates money. It follows that State regulation attributing general power of debt-liquidation to a commodity is unable of itself to make that commodity into money. If the State creates credit money – and this is naturally true in a still greater degree of fiat money – it can do so only by taking things that are already in circulation as money substitutes (that is, as perfectly secure and immediately convertible claims to money) and isolating them for purposes of valuation by depriving them of their essential characteristic of permanent convertibility. Commerce would always protect itself against any other method of introducing a government credit currency. The attempt to put credit money into circulation has never been successful, except when the coins or notes in question have already been in circulation as money substitutes.”
  –   The Theory of Money and Credit, p.78

The significance of endogenous money to us here is that it shows that deposits of the sort that make up the TMS2 are created by loans.  They are, to the extent they can be considered money at all, quite literally credit money.  As the market in commercial paper demonstrates, these loans, these future claims, whether created by the central bank, the member banks, or other corporations, have become a commodity in their own right.

And yet, although we can establish that M1, M2, TMS2 all consist of credit money, none of these various money supply measures can be considered money by our original definition, even with its stamp of fiat approval, because the credit money concerned is not directly convertible into commodity money on demand and has not been since 1971.  Despite its use in exchanges, by our agreed-upon definition, this credit money merely represents claims to money rather than money proper, it is a money-substitute money surrogate, which Mises rather confusingly describes as “fiduciary media”.

(“We shall use the term Money Certificates for those money substitutes that are completely covered by the reservation of corresponding sums of money, and the term Fiduciary Media for those which are not covered in this way.” Mises, p. 133)

At this point, it is understandable if the mind shies away from the inescapable logical conclusion.  The question of inflation and deflation of the U.S. money supply is a category error, because there is no U.S. money supply.  This category error and failure to understand that what we have been taught to consider money is merely a money-surrogate is why all of the various quantity theories and complicated attempts to calculate the money supply and predict the consequence of changes in it go so reliably awry, because they are attempting to estimate something by looking at the derivative without realizing that it is a derivative.

To put it in more straightforward terms, while there is no U.S. money supply, there is a money-surrogate supply that consists of fiat-backed credit money.  This was inevitable with the introduction of money-surrogates, given Gresham’s Law, which is popularly summarized as “bad money drives out good money”, and which I would modify as “surrogate money drives out genuine money when it is assigned exchange value by the State”.  This has considerable implications that go well beyond the simple question of inflation versus deflation and merits serious contemplation, however, what concerns us is the three questions it raises that are directly pertinent to the current debate:

1. What is the best measure of the money-surrogate supply?
2. Is the money-surrogate supply growing or shrinking?
3. To where has the genuine money been driven?

In conclusion, I will note that the great Austrian sage recognized and prophetically described the very process of transition from commodity money to credit money, from genuine money to money surrogate, that we have seen take place in American history, although he appears to have been more than a little naive concerning how the diminution of purchasing power might be considered desirable by those in a position to systematically benefit from it.  In the chapter entitled “Influence of the State”, he wrote:

“The exaggeration of the importance in monetary policy of the power at the disposal of the State in its legislative capacity can only be attributed to superficial observation of the processes involved in the transition from commodity money to credit money. This transition has normally been achieved by means of a State declaration that inconvertible claims to money were as good means of payment as money itself.  As a rule, it has not been the object of such a declaration to carry out a change of standard and substitute credit money for commodity money. In the great majority of cases, the State has taken such measures merely with certain fiscal ends in view. It has aimed to increase its own resources by the creation of credit money.  In the pursuit of such a plan as this, the diminution of the money’s purchasing power could hardly seem desirable. And yet it has always been this depreciation in value which, through the coming into play of Gresham’s Law, has caused the change of monetary standard.”
  –   The Theory of Money and Credit, p.77

Nate has put together an excellent response entitled Mount Chapter 3, the full significance of which I suspect even he doesn’t recognize yet, but which I will begin to illuminate in my next post on the subject:

So… now here we sit happily atop Mount Chapter Three.  Ain’t the view grand?  Now… with all of this as a basis of monetary understanding… we can address Vox’s traps… I mean… questions.

1. Are gold and silver commodity money?  All gold and silver?  Money is a condition that can be deferentially diagnosed by behavior.  Are they functioning like money?  Then they are money.  Its the behavior that makes them money.  It is the commercial commodity that lends subjective value and thus allows us to categorize them in LVM’s terms.

2. Are the Federal Reserve Notes, in both cash and deposit form, commodity money or fiat money?  The standard answer is fiat.  But in reality FRN’s have characteristics of both credit money and fiat money.

3.Does TMS2 represent your definition of the money supply? No.  like M2  it is only a useful tool for estimation.  It is flawed… but it serves for watching trends.  I am agnostic on the claim that money supply can even be measured  accurately.  But I lean toward it being a pure impossibility.  Its like watching ants at a huge ant mound.  You have no idea how many ants are actually there…  guessing is pointless… but you can stand back and watch them and tell if the swarm is growing or shrinking.

4. What are the various components of TMS2, commodity money, fiat money, or some combination therein?  Given the nature of my explanation of Chapter 3’s 4 types of money… its abundantly clear that all categories in TMS2 are fiat money.  Many are credit money as well… but its impossible to parce in our banking system due to the various shenanigans… AND… if you listen to Ludwig… well…

“As a rule it is not possible to ascertain whether a concrete specimen of money-substitutes is a money-certificate or a fiduciary medium” 
– Human Action( p. 433)

With apologies to Vox, he has taken a large list of money substitutes and asked me to  do what Mises says literally cannot be done.

Read the rest of it there.  As for those who are concerned about the score, I think I can assure you, that is almost certainly the least interesting aspect of this debate.  Not, of course, that I am conceding anything in the slightest.  I am just as capable of seeing the obvious as anyone else, the difference is that I also see that which is, apparently, considerably less obvious.

Nearly twenty years ago, I reached the finals of a karate tournament.  It was the third and final point-fighting tournament of my brief career and the first one in which I wasn’t ejected in the first match for “excessive contact”.  (I never liked point-fighting, which is essentially a version of tag.)  My opponent in the final was a good friend from my dojo, a sort of pocket Hercules who could do six reps at 275 and whose nickname was Terminator.

Our sensei encouraged the referee to let things go for once, we both fully unleashed on the other, but after the scheduled two minutes was up and the score was only 2-2, the referee turned to our sensei before the overtime and said “do these guys fight each other every day or something?”  No matter how fast and hard we threw our kicks and punches, it was very hard to penetrate the other’s defenses because we both knew perfectly well what the other guy was intending.

In like manner, because Nate and I are both familiar, and more or less in accordance, with Austrian School economics, a lot of this debate is likely to strike readers less familiar with it as pointless.  But rest assured, it is not.  It is precisely because the windows of opportunity are going to be small that an amount of testing and probing for weakness is going to be required.  Also, as a long-time reader of this blog, Nate is very familiar with my approach to critical discourse and is going to be exceedingly wary of the various traps I habitually lay for my interlocutors.  So, be patient and try to resist the urge to try to leap ahead, because this is not going to proceed immediately to the superficially obvious chasm, which is the different opinions concerning debt, that separates us.

In his first response, Nate indicated his acceptance of the monetary tradition of Turgot with two critical addenda.  He writes:

Note that nowhere in either of Vox’s proposed definitions do we find this critical factor.  Turgot omits it.  Law omits it.  Mises, Rothbard, Salerno.. and pretty much every other Austrian has agreed that the key factor of money is the fact that it completes a transaction.  Completing a transaction is the one thing that money does, that nothing else does.  In the interest of charity and goodwill… I will suggest that Turgot’s characteristics of money are all fine with me… provided that we remember that the value supposedly stored by the money is subjective, and, we add the requirement that I have hitherto beaten into the ground.  It must serve to complete the transaction.

I have no objection to either addendum and am content to accept it as a reasonable definition of money for the moment, although I reserve the right to propose alternative definitions should this definition prove to be insufficient in the course of the debate.  So, this leaves us with the following characteristics of money:

1. A medium of exchange
2. A unit of expression
3. An object of commerce i.e. an exchangeable good
4. A tool of economic calculation
5. An intrinsic store of subjective value
6. A completer of transactions

Before I proceed further, I must first explicitly answer the question Nate posed to me:

Lots of things store value.  Lots of things can be used to estimate value. Lots of things can be employed to aid in an exchange.   Money does all of those things.  But money is the only thing that does all of those things, and completes an exchange without creating a need for another transaction.  True or false?

Again, for the sake of argument and in the interest of charity and goodwill, I can only answer one way: true.  Armed as we now are with this expanded definition of money, we can proceed to begin considering the question of the money supply.  In doing so, I would recall to Nate the following two statements by Mises, with which we already know, from his previous post, he is almost surely familiar.

“We may give the name of commodity money to that sort of money that is at the same time a commercial commodity; and that of fiat money to money that comprises things with a special legal qualification. A third category may be called credit money, this being that sort of money which constitutes a claim against any physical or legal person. But these claims must not be both payable on demand and absolutely secure; if they were, there could be no difference between their value and that of the sum of money to which they referred, and they could not be subjected to an independent process of valuation on the part of those who dealt with them.”
  –  Mises, The Theory of Money and Credit, p. 61

“The nominalists assert that the monetary unit, in modem countries at any rate, is not a concrete commodity unit that can be defined in suitable technical terms, but a nominal quantity of value about which nothing can be said except that it is created by law. Without touching upon the vague and nebulous nature of this phraseology, which will not sustain a moment’s criticism from the point of view of the theory of value, let us simply ask: What, then, were the mark, the franc, and the pound, before 1914? Obviously, they were nothing but certain weights of gold.”
  –  Mises, The Theory of Money and Credit, p. 66

The same, of course, is true of the thaler, or dollar, of which the U.S. version is 24.057 grams of silver.  This, naturally, leads me to conclude with the following questions, to which I should like to see Nate’s answers:

1. Are gold and silver commodity money?
2. Are the Federal Reserve Notes, in both cash and deposit form, commodity money or fiat money?
3. Does TMS2 represent your definition of the money supply?
4. What are the various components of TMS2, commodity money, fiat money, or some combination therein?

Since I agreed to start the debate, I did not go back and re-read Nate’s initial and inadvertent post on the subject to which I linked last week.  This is not a response to that post, but as will soon become readily apparent, is a reversion to the foundation for our difference of opinion.

There are, as those who will recall my pair of YouTube videos on the subject, a variety of definitions of inflation.  The Neo-Keynesians alone have no less than five: theoretical, official, textbook, practical, and core.  It’s not necessary to get into any of them now, however, because they all eventually point to the same subject, and ultimately, the same question: what is money?  This is the crux of the matter, because despite the various opinions concerning the subject of inflation, what it is, and precisely what causes it, there is no extant theory of economics that takes serious exception to Milton Friedman’s statement that “inflation is always and everywhere a monetary phenomenon”, the outdated and long-disproven Keynesian notion that it is a phenomenon somehow inversely related to unemployment notwithstanding.

In reviewing the various definitions of money and looking at everything from Richard Cantillon to the three major current schools, Samuelsonian, Friedmanite, and Austrian, it rapidly became clear that the Austrian School economist, Joseph Salerno, had already walked the path that I was beginning to tread in his excellent paper “Two Traditions in Modern Monetary Theory: John Law and A.R.J. Turgot”, which is the first essay in his book Money, Sound and Unsound.  In this essay, Salerno shows that there are fundamentally two competing ideas about money, neither of which are even remotely new, as both monetary doctrines predate Adam Smith.

Of the first tradition, which dates back to John Law, Salerno writes:

In 1705, Law published his principal work on money, entitled Money and Trade Considered: With a Proposal for Supplying the Nation with Money. Law’s “proposal” was intended to provide his native Scotland with a plentiful supply of money endowed with a long-run stability of value. The institutional centerpiece envisioned in Law’s scheme resembles a modern central bank, empowered to supply paper fiat money via the purchases and sales of securities and other assets on the open market. Also strikingly modern are the theoretical propositions with which Law supports his policy goals and prescriptions.

Law initiates his monetary theorizing with two fundamental assumptions about the nature and function of money. The first is that if money is not exactly an original creation of political authority, it ideally functions as a tool to be molded and wielded by government. Law believes that the State, as incarnated in the King, is the de facto “owner” of the money supply and that it therefore possesses the right and the power to determine the composition and quantity of money in light of the “public interest.”

Writes Law:All the coin of the Kingdom belongs to the State, represented in France by the King: it belongs to him in precisely the same way as the high roads do, not that he may appropriate them as his own property, but in order to prevent others doing so; and as it is one of the rights of the King, and of the King alone, to make changes in the highways for the benefit of the public, of which he (or his officers) is the sole judge, so it is also one of his rights to change the gold or silver coin into other exchange tokens, of greater benefit to the public.…

Translating Law’s statement into modern terms, money is an “instrument” that is or should be deliberately designed to achieve the “policy goals” considered desirable by political money managers and other government planners.

Law’s second basic assumption is that money serves solely as a “voucher for buying goods” or an “exchange token.” Thus, for Law, “Money is not the value for which goods are exchanged, but the value by which they are exchanged: The use of money is to buy goods and silver, while money is of no other use.” In other words, money is a dematerialized claim to goods having no valuable use in itself.

It is more than a little startling to read Law’s statements, particularly in light of the smug, self-satisfied way we hear the same sentiments echoed more than three hundred years later by those who think themselves clever for realizing that money has no intrinsic value, and therefore, cannot possibly serve as a store of value in its own right, as it only possesses the exchange value conferred upon it by the power of the State.

Salerno notes that the Law monetary tradition is the dominant one, and comments: “The neo-Keynesians, monetarists, and supply-siders, differ among themselves in important areas of theory and policy, but all share most of Law’s fundamental ideas about money.”  He goes into some detail concerning the primary factors the three schools share concerning money and monetary policy, which include:

1. Money as a policy tool
2. Money as an exchange token
3. Stabilization of the price level
4. The resource costs of a commodity money
5. The supply of money as a political monopoly

I will not go into detail to support Salerno’s conclusions, but a brief glimpse at the most influential textbook in modern economic history, Paul Samuelson’s Economics, should suffice to prove that they are fair and accurate.

“There are two distinct functions of money: as a medium of exchange and as a standard unit of value….  We may summarize our analysis of the use of money by listing its two essential functions: (1) as a medium of exchange and (2) as a standard unit of account or common denominator of values.”
– Economics, pp 57-58

The second and competing monetary tradition traces back to Turgot, the man whom Joseph Schumpeter and the Austrian School tend to regard, with Richard Cantillon, as the true father of modern economics, whose rightful place in the history of economic thought has been usurped by Adam Smith.  Of the Turgot tradition, Salerno writes:

Turgot flatly rejects Law’s primary contention that money is merely an exchange token, whose supply must be manipulated by the political authorities in order to achieve selected policy goals. According to Turgot money is essentially a medium of exchange and the unit in which relative prices are expressed: “These two properties, of serving as a common measure of all values [i.e., the unit in which all prices are expressed] and of being a representative pledge of all commodities of a like value [i.e., the medium of exchange], include all that constitutes the essence and utility of what is called money.…”

As Turgot points out, however, these two functions of money can only be performed by an article which is already widely used, valued, and exchanged under barter: “… all money is essentially merchandise. We can take for a common measure of values only that which has a value, and which is received in Commerce in exchange for other values: and there is no pledge universally representative of a value save another equal value.” Since money thus necessarily originates as a useful commodity from within the market economy itself, Turgot emphatically denies the possibility that “a purely conventional money” without a pre-existing purchasing power can be imposed from outside the market. According to Turgot, “It is not in virtue of a convention that money is exchanged against all other values; it is because money itself is an object of commerce, a part of wealth, because it itself has a value, and in trade all values are exchanged against equal values.”

 So, the primary factors of money in the Turgot tradition are:

1. A medium of exchange
2. A unit of expression
3. An object of commerce i.e. an exchangeable good
4. A tool of economic calculation
5. An intrinsic store of value

Having laid out the two primary definitions of money, I now turn it over to Nate to declare which of these two competing traditions he holds to be money, or if he has some third definition of money he believes would be better utilized concerning this debate.