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Money. Doing it Right this Time.

Discussion in 'Off-Topic' started by Cutlass, Nov 25, 2011.

  1. Cutlass

    Cutlass The Man Who Wasn't There.

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    Red Diamond

    Here in OT over the past few years the subject of money has come up a number of times in a number of contexts. Usually bad ones.

    What is money? The simplest explanation is that it is a medium of exchange and a way of accounting for exchange in the economy.

    It isn't really more than that.

    It isn't really money that is the root of all evil. Money is just the unit of account that the real wealth is described by.

    There are different kinds of money. A few are:

    Specie: Essentially a physical object of agreed upon value that is directly used as a medium of exchange. Many thing in many societies have been specie. But in the modern sense most people think of gold and silver.

    Representative money: Is paper money backed by specie at a fixed rate.

    Fiat money: Money that has value only to the extent that it is accepted as a unit of exchange. The value is dictated by law, typically. Though is varies over time do to market realities.

    That really covers what is needed to understand the modern arguments.



    Why do we use money at all? Essentially because of the economic theory of Transactions costs. Every transaction in economics has not just the cost of what is being purchased, but also the cost of actually making the purchase. Now in order to get the best deal on the product you are purchasing, you're best off paying the least for the transaction itself. In effect, the transactions costs make the whole of the transaction, and the economy as a whole, less efficient when they are high.

    Every transaction has a cost. No matter how small some of them might be, they are always there.

    Money substantially reduces transactions costs. Without money, the accounting, the tracking of what who owes to who, becomes much more complex and difficult. How many cows do I pay for car? A bottle of orange juice? And how do I make change?

    As I understand it, some Marxists want a world without money. Though I think (not certain) that Marx himself saw money as just a way to keep track of the accounting of things (as I do, but he was accounting for the labor value of everything. And I don't agree with the Labor Theory of Value). I don't accept that any complex, and and even most non-complex, societies can function without money. So even those that oppose what money represents (wealth) should not oppose money itself. Money itself is just the keeping track of things.



    So, given that money itself is just the keeping track of things, what does that tell us about what money should be? Discussions with Integral in the past have shown me that the goal of the modern monetary theorist is to have money that has the least interference with the day to day operations of the economy as possible. Except when they really want to cause changes. That is, an elastic currency that does not interfere with the price level or output of the economy. In order to do this, the quantity of money has to change to meet the needs of the economy. And needs to do so pretty much constantly.

    So what does it take to have a money that does not interfere with the economy? Essentially, constant management of it. And to allow that management, the money can't be locked into a given quantity.

    Why constant management? The basic money equation is given as MV=PQ. That is, the Money supply * the Velocity of money equals the Price level * the Quantity of goods and services sold in the economy. Now this is an equation with four variables. And so you need to know what some of them are in order to figure out what the others are. The earlier generations of monetary economists, and those people who listened to and believed them, thought that V and Q were constants. That is to say, that changes to M or P had no impact on changing V and Q, and that they didn't change (in the short run) on their own.

    Except, of course, that we always knew that they did.

    So even that we always knew that V and Q changed, the theory said that it didn't. And the real problem is not that some economists got it wrong. The real problem is that most of the general public, including public officials, persist in believing the wrong part.

    They didn't get the memo.

    And because they didn't get the memo, they constantly argue for the wrong policy for the wrong reasons. This is very common among people who think they know the basics of money, but really don't.

    Now given that we have 4 variables, and that they are all constantly changing, how can we have a money supply that does not interfere with the real economy if that money is fixed in some way to some commodity? Particularly when the quantity of that commodity is itself subject to change over time?

    And that's why gold can't work. The modern economy is just too complicated for a money supply that government doesn't have full control over.


    So why do some people want gold as money so much? There are a few different reasons. One is that there are people who actually believe that gold is "God's money". That is, that gold was created by God to be money. Otherwise, why else would it so perfectly fit the role of money? It is uncommon. It is easily identified and distinguished from other substances. It was easy to acquire (in the small quantities that it was available it) from ancient times. It does not corrode, so is essentially eternal. It is easily workable, and so is fairly divisible.

    Before modern times, that really does sound like good money.

    Except for the drawbacks. And the drawbacks are that gold supplies just don't change with the economy's need for money. And so gold constantly interferes with the real economy.

    Those who push for gold in modern times that don't have those old motives, they have others. For many, it's just a failure to understand the situation. But others do. And they have other motives. Mainly the protection of wealth, particularly inherited wealth, against all threats. Including the threat of the creation of new wealth. It's very much a zero-sum-game view of the world. It seeks to prevent the creation of new wealth in order to prevent the erosion of old wealth.



    And this is why we have fiat money. Because it meets the real needs of the economy. It favors the creation of new wealth. And it is much less disruptive.
     
  2. katipunero

    katipunero Prince

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    gold for money is one of those weird ideas you hear from people who think in absolutist and narrow terms. gold standard is simple and honest, but you can't have economic simplicity and value-for-value honesty in world like what we have to day. modern day transactions approximate the infinite, while gold is finite. eh.
     
  3. Integral

    Integral Can't you hear it?

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    Reserving post for writing monetary things of an introductory nature.

    Quick Links
    I talk about MV=PQ, as does Cutlass.

    I talk about Quantitative Easing

    Pages 2 and 3 have an interesting discussion of Graeber's "Debt: The First 5,000 Years," difficult to link to any single post.

    Cutlass talks about fractional reserve banking

    Cutlass talks about money, bubbles and asset prices

    Short post on what makes financial markets different from normal markets

    I write a long post on inflation and follow up answers to questions here

    Cutlass provides an overview of central banking

    Cutlass discusses the "Market Monetarist" school of economic thought, and I provide comment


    For now, reposting my "what went wrong" post:

     
  4. Antilogic

    Antilogic --

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    To my understanding, Marx believed that only in the classless post-socialist society termed communism was it possible that people could exist without money or a vast number of other concepts we think are permanent features of society (note this is not the same definition of communism as the American vernacular use, which is often equated with the Soviet Union). However, he was much more of a realist than people gave him credit for, and much of his thinking explored the meanings behind money, prices, value, connection of social and economic relationships, etc. He thought money would continue its existence for the foreseeable future.

    I also have to thank yourself and Integral for putting these posts together. I wish I had more to comment on, but I've argued along similar lines in the past, so I don't.
     
  5. lithium30

    lithium30 Warlord

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    Gold erodes the soul.
     
  6. Core Imposter

    Core Imposter Deity

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    Obviously the only sustainable path is to adopt a standard such as gold and restrain financial activity of governments and individuals to the properties of the standard. This would work perfectly.

    Money by fiat will work out fine that percentage of time that the entire population of those who use it are morally and ethically pure in all respects. Otherwise the use of it will simply be catastrope followed by catastrope. Ad infinitum.
     
  7. Integral

    Integral Can't you hear it?

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    The gold standard caused the Great Depression. You don't get much more catastrophic than that.

    I guess I should back up my claim. RD status after all.

    The Great Depression was precipitated by large deflationary pressures on all developed economies from 1928-1931. Now what caused these deflationary pressures? The world was on a gold standard so national currencies were all linked to gold. In the late 1920s the American and French central banks began to hoard gold and sterilize the hoarding; that is they hoarded gold but did not introduce new currency into circulation.

    Hence there was less gold out there for everyone else, because the stock of gold was more-or-less fixed. So other countries had to sharply reduce their money supplies, inducing deflation.

    And such a sharp contraction in the money supply led directly to the Great Depression.
     
  8. Antilogic

    Antilogic --

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    Given this is a red diamond thread, could you explain why the pegging your money to an commodity standard (like gold) is obviously superior? There were several recessions and depressions in human history before the transition from the gold standard to fiat currency (for the US, click here; sadly, the UK list and other nations are missing several events). Why does restraining financial activity to some "property of the standard" help?
     
  9. Cutlass

    Cutlass The Man Who Wasn't There.

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    I have already described, in this thread and others, why gold fails to work effectively as the money supply. Do you have a theoretical argument against that?
     
  10. Traitorfish

    Traitorfish The Tighnahulish Kid

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    Well, Marx doesn't just oppose money in the sense of little bits of paper that can be traded for other things, he opposes money because money is a tool of commodity exchange, and he opposes commodity exchange because commodity exchange produces societies of oppression and exploitation. He makes it fairly clear that he imagines that a post-commodity society, at least in its early stages, would utilise some form of labour-credit. The difference is that this credit is merely a token which is redeemed, like a movie ticket, rather than a circulating commodity like money.

    (For those interested, a fuller explanation of Marx's theory of money is given here and here.)
     
  11. Cutlass

    Cutlass The Man Who Wasn't There.

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    If that's Marx's point, then he's wrong. As I said above, money is just about keeping track of things. And you can keep track of anything, including labor, with it. But in the absence of money, it's far harder to keep track of things.

    To get rid of money because it can be used for transactions that you don't approve of means that it also can't be used to facilitate transactions that you do approve of. That reminds me of the Washington quote I had in my sig

    " No man is a warmer advocate for proper restraints, and wholesome checks in every department of government than I am; but neither my reasoning, nor my experience, has yet been able to discover the propriety of preventing men from doing good, because there is a possibility of their doing evil." - George Washington

    In short, he was making the same mistake others make in regards to money. Ascribing to it properties that it doesn't have and opposing it (or some aspect of it) not for what it really is, but for what it can be used for.

    It's not the sword that's evil, it's the use that its put to.
     
  12. Traitorfish

    Traitorfish The Tighnahulish Kid

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    Well, here's the thing: Marx doesn't disapprove of certain transactions, he disapproves of commercial transactions as such. His criticism of commodity society goes deeper than any particular set of industrial practices, but is a criticism of the "capitalist mode of production", which is to say a society of generalised commodity production, in and of itself, which he regards as a spiritually destructive form of social organisation. It is not merely that capitalism in practice produces oppression and suffering, but that by its very nature it must produce exploitation and alienation, precluding the free and full development of human beings as rational creators.

    So his rejection of money isn't just a strategic measure to preclude X, Y and Z, it's a rejection of money in its essence, and the social forms which it embodies. He was in that respect even more radical than many people realise.
     
  13. Cutlass

    Cutlass The Man Who Wasn't There.

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    But there are still exchanges. They're just exchanges of the approved variety. And, as such, there's still a need to keep track of them. That's all money does.
     
  14. Antilogic

    Antilogic --

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    Modern-day Marx might have a different opinion of this than 19th century Marx. All major industrial nations, back in the 19th century, were on some sort of metal standard (either gold, or gold-silver bimetal). Thus, when he made his arguments, money was a commodity.

    This is the primary reason why I'm apprehensive to apply Marx's thoughts on money to modern-day societies. I don't know much about post-Marx Marxist thinkers, who may have looked at this problem in more depth, but I would hope that somebody has updated it.
     
  15. Cutlass

    Cutlass The Man Who Wasn't There.

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    Well I don't, in this thread in any case, want to get too drawn into a debate on Marxist principles. Though Marx's and Marxist thoughts on the subject of money are fine.
     
  16. Traitorfish

    Traitorfish The Tighnahulish Kid

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    Yes, but that's a description at a level of abstraction so great as to be trivial. Marx's interest was in concrete social relations, and at that level of detail, a commodity and non-commodity society generate quite different forms of exchange.

    Edit: Although, as you say, we shouldn't get sidetracked on a discussion about Marxism. The point was just to clarify that Marx's beef wasn't with mediums of exchange for their own sake, but with the particular forms of society with which they are associated.

    Check out the videos I linked before, they explain it quite well. Marx's primary interest in money was as a medium of exchange between other commodoties, rather than as a commodity in itself, so the supplanting of the metal standard by fiat money - which had been introduced temporarily in his own era, such as the famous Civil War "greenbacks"- would not really have thrown him off.
     
  17. uppi

    uppi Deity

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    I don't know how the velocity of money is measured, but it looks like the quantities on both sides of that money equation do not to match. So it seems unlikely that the equation correctly describes the real behavior of money.
     
  18. Integral

    Integral Can't you hear it?

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    MV=PQ is at heart an accounting identity. It cannot be wrong; it can fail to be useful, but it cannot be wrong. :)

    Start with the right-hand side. PQ is the total dollar amount of transactions in an economy in (say) a year. Technically PQ is the dot product of a price and quantity vector.

    Then the left-hand side. This is the "volume" of cash in circulation: the number of dollars multiplied by the average turnover of dollars in the economy.

    Of course we're presuming that all transactions are denominated in cash, but this is a monetary exchange economy so I don't see a problem there.

    The left-hand side is measured in $/year, as is the right-hand side.

    MV=PQ is no less true than Y = C+I+G+X. Indeed the second is nothing more than a partition of the first.
     
  19. uppi

    uppi Deity

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    So it isn't actually the quantity of goods (and services) that enters here, but quantity over time, i.e. the velocity of goods? That would make more sense.
     
  20. Cutlass

    Cutlass The Man Who Wasn't There.

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    It's the quantity of goods and services that have been sold in a defined time period.

    There is a measurement problem. And that is that you just cannot measure the quantities of sales now, this moment. And so you have to wait to collect the data that is measured separately. You could do a month or a quarter year. And in fact government statisticians and economists do do that. Monetary policy is adjusted as on ongoing basis as the ongoing collection and correlation of data makes new information available.

    But because we don't know the day to day figures until a month or more afterward, when we talk of MV=PQ it is over a time period, typically a year. Though professionals in the field will use shorter time periods for a better snapshot of what is going on.

    This is a problem with all economic policy. And one of the reasons that getting it "right" is a near on hopeless task. We just don't have a way of measuring everything, reporting, and analyzing, it all day to day.
     

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