Tag: economics

In his post entitled Fiat or Shenanigans, Nate contested the idea that US money is credit money and not fiat money with the characteristics of credit money:

Remember I said our money was fiat money… with characteristics of credit money.  Right?  Vox says I am wrong about that.  And… while I considered rushing off to donate some money to an unrelated charity in his name and make a video about it…  instead… I just decided I would address his well made point like an adult…  mostly…

Vox said: “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.”

He then provides a quote from Mises, that I agree, does indeed say that fiat money doesn’t yet exist and probably hasn’t existed.  Vox appeals to Mises who appeals to history.   And Nate points out… well shit…  this book was written in 1912…  it appears we have some more history to investigate before that holds water doesn’t it?  Well lets look at this new history then… especially… recent history.

Say what does our buddy Murray have to say about fiat money?

“Under a fiat money standard, governments (or their central banks) may obligate themselves to bail out, with increased issues of standard money, any bank or any major bank in distress. In the late nineteenth century, the principle became accepted that the central bank must act as the “lender of last resort”, which will lend money freely to banks threatened with failure. Another recent American device to abolish the confidence limitation on bank credit is “deposit insurance”, whereby the government guar­antees to furnish paper money to redeem the banks’ demand li­abilities. These and similar devices remove the market brakes on rampant credit expansion.”

While the quote from Mises does date back to the 1912 text, Mises himself lived until 1973 and witnessed all of the innovations mentioned, even the removal of the convertibility to gold by President Nixon.  I am not aware of any point at which he changed his opinion on this matter, nor does Nate suggest that he did.

Given the fact that the FDIC’s deposit insurance observably does not take the form of paper money being furnished to redeem the failing banks’ demand liabilities, but rather transfers those liabilities to other banks in the system without any paper money at all being furnished to anyone, I think it is safe to conclude that Murray does not have a sufficient grasp on the difference between fiat money and credit money for his statements to be relevant here.  Moreover, the statement that the central bank is “the lender of last resort” itself tends to underline the fact that the “deposits” are, in fact, credit and not pure fiat.  The central bank is not actually “lending money” to banks under duress, it is merely inflating the amount of credit at their disposal.

Recall that when you make a payment from your ebanking account, the bank declares it will make the payment “provided there is sufficient credit” on your account.  It’s all credit, both in electronic form and paper form.

Nate continues:

Are we done?  No… no no no… we’re along way from done.   Remember.. Mises characterized fiat money by legal privilege.  Legal Privilege?   Consult the MisesWiki!  According to Hülsmann, there are four groups of legal privileges granted by the state (usually more than one is granted):

1. legalized counterfeiting – the promises of banks are allowed to be more “elastic”. For example, a coin marked “an ounce of gold” will be allowed to have any amount of gold or none, and can have any meaning. Banknotes were named “promises to pay”, but were obscure on the details.
2.  monopoly – only some monetary products may be produced by law, like a specific metal; or only the banknotes or coins of a certain bank. This limits the freedom of choice of users of money and benefits the producers and first recipients at the detriment of others.
3. legal tender is a money, that must be accepted in exchanges under a predefined price. Some monies may be driven out of the market due to Gresham’s Law.
4.  legalized suspension of payments allows banks to avoid paying their obligations, while receiving payments from their debtors. If a bank is freed from contractual obligations to redeem its money and it is also legal tender, its banknotes become genuine paper money. With legal privileges are the banks allowed to behave more irresponsibly, which increases moral hazard.

Here we get to the crux of Nate’s error.  Nate is correct to point out that the Federal Reserve’s credit money is declared to be legal tender and is legally privileged by the federal government.  In this sense, he is correct in saying that the US monetary system is fiat money.  However, this only is the wider sense in which the Mises Institute defines the term:

Often called paper money, fiat money is in a wider sense any money declared to be legal tender by government fiat (ie law). In the narrower sense used here, fiat money is an intrinsically useless good used as a means of payment and a storable object.

The narrower sense of fiat money is clearly the sense Mises was using the term when he declared “most of those kinds of money that are not commodity money must be classified as credit money” and questioned whether fiat money had ever existed.  And that narrower sense cannot possibly apply to the Federal Reserve notes, as most “dollars” are a) not a good, useless or otherwise, b) not a storable object, and c) not a risk-free convertible claim to real money.

Nate would be correct to claim credit money is fiat money in the wider sense, but then, I completely agree with that.  I am simply declaring that US currency is credit money that is not fiat money in the narrower sense.  Nate is incorrect to say that it is fiat money in the narrower sense, which is the sense that most people believe it to be.  Nate continues:

Now are we done?  Well… not really.  Because what I’ve done here isn’t intellectually honest, in the sense that I have not represented the whole of Vox’s point.  The reason I hated Chapter three is not because of confusing terms like fiduciary media.  Its because Credit Money itself is a category error.

Credit money is a description of leverage. But…  Leverage can be applied to all types of money….  Thus… Credit Money… is a subcategory.  Credit Money is what happens when you take money of any other type.. and then leverage it up for lending purposes….  Leverage is something that happens to Money Types.  It isn’t a money type itself.  Its like including cancer cells in a discussion of  human  cells because they form in the human body.  Cancer cells aren’t human cells.

We must always go back to competition.

Money is money because of the constant commodity competition   Every day the competition is on going… and every day one commodity is winning.  that one commodity that is winning… is the money.   The money types… are explanations of WHY the competition is being won.  Fiat money is fiat money because the government helped it win artificially and it wouldn’t have won otherwise.  Take away the government advantage… and its not the money anymore. Commodity money types?  Well they have no artificial government advantage.

That is the true definition of sound money.

Its money that wins the competition… every minute of every day…  the on going competition… not some past competition .. on its own without aid of the government.

All modern paper currencies are fiat money.

The bits that are loaned into creation from thin air?  Those are credit money too… but it is dishonest to ignore the fact that it is fiat money as well.  Loans may have created the individual dollar bills… but those dollar bills wouldn’t be money… if it wasn’t Fiat.

May God have Mercy on my soul…   Ludwig Von Mises… was wrong.  You cannot disregard the fiat nature of the original money… just because most of it was created through leverage.

So Fiat?  Shenanigans?

The answer is both.  Not one.  Not the other.   Both.  To fail to grasp that… will totally blind you to the inherit problems of our current economic system.  The money is fiat money and credit money.. because much of which was created via leverage… but also much of it was created through counterfeiting.   This is why I created the word “clusterfutastrophe” while attempting to parse the US money supply.

Nate is stumbling towards the truth here, which is that credit money is fiat money in the wider sense but not the narrower one, but is still stumbling.  He is still hung up on the basic concept of credit money, which is why he erroneously calls it a category error.  What he is failing to grasp is the central importance of credit in the monetary process, one which precedes the role that government plays in either guaranteeing the credit claims or establishing the legal privilege of those claims.

“When all exchanges have to be settled in ready cash, then the possibility of performing them by means of cancellation is limited to the case exemplified by the butcher and baker and only then on the assumption, which of course only occasionally hold good, that the demands of both parties are simultaneous. At the most, it is possible to imagine that several other persons might join in and so a small circle be built up within which drafts could be used for the settlement of transactions without the actual use of money. But even in this case simultaneity would still be necessary, and, several persons being involved, would be still seldomer achieved.

These difficulties could not be overcome until credit set business free from dependence on the simultaneous occurrence of demand and supply. This, in fact, is where the importance of credit for the monetary system lies. But this could not have its full effect so long as all exchange was still direct exchange, so long even as money had not established itself as a common medium of exchange. The instrumentality of credit permits transactions between two persons to be treated as simultaneous for purposes of settlement even if they actually take place at different times”
 – Mises, The Theory of Money and Credit, p. 282

The important aspect of credit is not its ability to be leveraged, which is a consequence of the characteristics of money rather than an integral aspect of credit, but rather its ability to transcend time.  It is the fact that the credit is a claim to money rather than to some other commodity that permits its expansion beyond the existing money supply.

“A person who has a thousand loaves of bread at his immediate disposal will not dare to issue more than a thousand tickets each of which gives its holder the right to demand at any time the delivery of a loaf of bread. It is otherwise with money…. The fact that is peculiar to money alone is not that mature and secure claims to money are as highly valued in commerce as the sums of money to which they refer, but rather that such claims are complete substitutes for money, and, as such, are able to fulfil all the functions of money in those markets in which their essential characteristics of maturity and security are recognized. It is this circumstance that makes. it possible to issue more of this sort of substitute than the issuer is always in a position to convert.  And so the fiduciary medium comes into being in addition to the money certificate. Fiduciary media increase the supply of money in the broader sense of the word; they are consequently able to influence the objective
exchange-value of money.”
 – Mises, The Theory of Money and Credit, p. 267

Note that the credit aspect not only predates the broader fiat aspects, but is, in fact, intrinsically necessary for the eventual expansion.  Nate concludes with a question

Its not that there is no money.   I already explained that there is always money.  Money…is like energy.  It cannot ever be destroyed.  It can change forms… its velocity can change.  But it cannot be destroyed.  The problem is… our system is so screwed up through fiat and leverage… that we can’t even measure the money supply any more.  Come Vox… be sensible… you’re absolutely right to point out that the leverage can’t be ignored… but you were wrong to suggest that the fiat aspects can.  Now tell us Vox…  What IS the best way to measure the abomination posing as the US money supply?  He asked knowingly…

First, I’ll point out that since we have a system “in which the actual transfer of money has been completely superseded by fiduciary media”, it doesn’t matter that we can’t measure the money supply anymore.  Because we’re no longer using actual money, we are merely using possibility of money in order to support the extensive system of potential claims to theoretical future money.  Or, as Nate rightly calls it, a financial abomination.  As strange as this sounds, it was anticipated at least 101 years ago, as Mises notes:

“Use is made of money, but not physical use of actually existing money or money substitutes. Money which is not present performs an economic function; it has its effect solely by reason of the possibility of its being able to be present.”

In answer to Nate’s question, the best way is to measure the sum total of all the current outstanding claims.  This is approximated in the Federal Reserve’s Z1 Flow of Funds Accounts, specifically the L1 credit market debt outstanding report.  And it is the expansion of this supply, though not strictly speaking “inflation” per se, that effects exchange value and therefore the prices of goods and services.

Nate boldly elects to defends his position concerning fiat money in a post entitled Fiat or Shenanigans:

You.  Whimpering in the corner.  Suck it up and get back on your feet.  You knew the US money system was a wreck or you wouldn’t be reading this debate in the first place.  So Vox and I conspire through competition to show you precisely how wrecked it is… and at the first glimpse you curl up in a little ball.

Man up.  Its not going up hill from here.

Setting aside the obvious difference of opinion that we have (he’s wrong by the way which I will presently demonstrate with no little amusement), our view of where we stand in the grand scheme of things is profoundly similar.   If you look carefully… you’ll see that I was the one that dropped the bomb… not Vox.  Vox just stepped back and said.. “did you see that bomb he dropped? Say boys… That’s a big freaking bomb.  I doubt even he knows how big a bomb he just dropped.”  Then, being the cruelty artist he is, he explained the bomb. Then you realized…  “Oh damn.  There’s a bomb.”

You see what this debate is important?  It’s the format.  The format itself allows you to accept things that you would otherwise refuse to believe. 

The five or six of you still attempting to follow this debate should read the rest of it there.  My response will be posted tomorrow.

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?