Money. Doing it Right this Time.

[Integral]

Graeber's thesis is that trade arrangements followed a barter -> credit -> money sequence, rather than barter -> money -> credit.

I don't see much wrong with that, though I'd have to read the book to evaluate his claims properly. I read the introduction and was put off by his writing style. Hopefully the body of the book is better.

@Narz: I like your post but will refrain from responding until I'm less tired.

 

[Monsterzuma]

I believe he has at various points pulled the very existence of barter economies into question, though. He asserts there is no clear historical trace or record of such trade circumstances. Granted, a barter economy wouldn't need to exist for a long time for a money-economy to emerge from it. And there are contemporary records of the emergence of money in a spontaneous way from primitive trade:

http://www.albany.edu/~mirer/eco110/pow.html

Maybe that study on it's own makes some of Graeber's firmer claims somewhat dubious. I still expect him to be well worth reading, though.

 

[pi-r8]

I believe he has at various points pulled the very existence of barter economies into question, though. He asserts there is no clear historical trace or record of such trade circumstances. Granted, a barter economy wouldn't need to exist for a long time for a money-economy to emerge from it. And there are contemporary records of the emergence of money in a spontaneous way from primitive trade:

http://www.albany.edu/~mirer/eco110/pow.html

Maybe that study on it's own makes some of Graeber's firmer claims somewhat dubious. I still expect him to be well worth reading, though.

He actually argues that barter has only ever come up in areas where the currency system failed, like in the breakup of the soviet union, and that it's never been a stable long-term system of exchange.

 

[Monsterzuma]

That has been my interpretation his views:

Occasional brief period of barter? yes.

Barter-economy? no.

This is how he explains it himself:

http://www.nakedcapitalism.com/2011...pathy-and-the-true-function-of-economics.html

All this is not to say that barter never occurs. It is widely attested in many times and places. But it typically occurs between strangers, people who have no moral relations with one another. There is a reason why in just about all European languages, the words ‘truck and barter’ originally meant ‘to bilk, swindle, or rip off.’ [4] Still there is no reason to believe such barter would ever lead to the emergence of money. This is because barter takes three known forms:

a. Barter can take the form of occasional interactions between people never likely to meet each other again. This might involve ‘double coincidence of wants’ problems but it will not lead to the emergence of a system of money because rare and occasional events won’t lead to the emergence of a system of any kind.

b. If there are ongoing trade relations between strangers in moneyless economies, it’s because each side knows the other side has some specific product(s) they want to acquire—so there is no ‘double coincidence of wants’ problem. Rather than leading to people having to create some circulating medium of exchange (money) to facilitate transactions, such trade normally leads to the creation of a system of traditional equivalents relatively insulated from vagaries of supply and demand.

c. Sometimes, barter becomes a widespread mode of interaction when you have people used to using money in everyday transactions who are suddenly forced to carry on without it. This can happen, for instance, because the money supply dries up (Russia in the ‘90s), or because the people in question have no access to it (prisoners or denizens of POW camps.) This cannot lead to the invention of money because money has already been invented.

http://blog.mises.org/18371/murphy-replies-to-david-graeber-on-menger-and-money/

Here the evidence is simply in and you’d think an honest economist would acknowledge it. As Caroline Humphreys of Cambridge in the definitive anthropological work on barter put it, “No example of a barter economy, pure and simple, has ever been described, let alone the emergence from it of money; all available ethnography suggests that there never has been such a thing.” (By “barter economy” of course she means a community in which this is how everyday goods are normally distributed amongst neighbors.)

 

[Yeekim]

I read the part about Graeber about five times to understand what exactly is this "stunning reversal of conventional wisdom". Is his point that credit is older concept than cash? Why would anyone find that surprising?

 

[Cutlass]

Monsterzuma, innonimatu started a thread on that in the History forum. Unfortunately, it didn't get a lot of traction. It's an interesting idea. I'm unclear how easy it is to prove or disprove. But, that said, isn't personal credits a form of money or barter in and of themselves? Remember, money is a medium of exchange. So something else which fills the medium of exchange is, for practical purposes, money.

I'm skeptical that money is simply a neutral way of keeping track of things. Money always seems to have a way of rising to the top.

From what I've read alot of the current wealth-distribution issues started really exacerbating when central authorities starting banning local currencies during the Renaissance. In Life Inc Douglas Ruskoff talks about this.

It seems like those in power tweak & alter the rules of money while the poorest just try to scheme ways to get enough to stay alive. Personally, I always enjoy ways to avoid using it as much as possible, barter, reusing & recycling the products I already have, etc. I can see why money is necessary but it pisses me off how dominated it is. Like if two gamblers meet somewhere to gamble, no matter who wins those at the top win. Because 90% of that money is going straight up, to the global food megaliths, gasoline companies, Chinese factory owners, etc. Some might go back to their communities but most of it probably does not.

Narz, I think you are confusing the uses money can be put to with the nature of money itself. No one ever claimed that money can't be put to "bad" uses as well as "good" uses. Only that money facilitates all uses. The rest is politics.

 

[say1988]

It fails as a unit of account and possibly as a store of value.
Even as a medium of exchange there is an issue in that most times it is limited to exchanges between the involved parties.

I do not dispute that currency and money are not equivalent, but personal credit fails at 1 and possibly the other 2 functions of money.

 

[Cutlass]

Personal credit is more limited than money. That's true. But that doesn't mean that it doesn't fill essentially the same role.

 

[say1988]

Well, it partially fills one (maybe two) of the three roles of money. It can act as a substitute for money for individual transactions, but that doesn't mean it is money.
Though I suppose your definition of money is important to consider. As I have been taught in undergrad economics courses to be considered money it must fulfill all three roles (unit of account, medium of exchange, and store of value).

 

[Cutlass]

Do they even talk about "store of value" anymore? Considering that the real purchasing power of money is always in a state of change, that seems to be something that would be easily misunderstood.

 

[uppi]

I am wondering, if there is any way to have (long-term) monetary policy without a fiat currency. A country on a strict gold standard cannot do much to influence the amount of money in circulation. The only thing I could imagine is a government on a commodity standard has control of all production facilities, produces enough of that commodity to actually make an impact and can restrain itself from spending all of it. That doesn't seem to be realistic.

Does anybody know, whether there is any way to do this and how it could look like?

 

[Cutlass]

I would have to say no. Either a commodity is in a naturally occurring rare state, which is one of the attractions of gold, or it is not, and the government would have to regulate it pretty aggressively. If the former is the case, then it offers no advantage over gold, and suffers the same drawbacks. Notably that the quantity of it will not change with the need for it to change. And so it would cause major economic disruptions from time to time. Or, of the later, then it has no advantages over a pure fiat money, in that the government has full control of the quantity and can cause it to change at will. So you get all the disadvantages of fiat, but no advantages that fiat doesn't offer you. And it is possible that if a really rabid increase in money is needed, such as 2007-8, they would be constrained from doing so. So all the disadvantages of fiat plus at least some of the disadvantages of specie.

 

[Cutlass]

This is an issue that has raised a lot of attention, misunderstanding, and misinformation in recent years. And so a primer.

Modern banking can get very complicated. But in traditional terms, banks have two sides to what they do. They take in deposits and make loans.

Why? What role does that fill? Banks are part of the industry called "financial intermediaries". That is, middlemen. Depositors have more money than they have a use for at current. They want to earn some money putting their money to work. Borrowers need more money than they currently have. And they are willing to pay to use someone else's money.

Banks make the connection between these two groups of people.

They reduce the risks and the transactions costs to both borrowers and lenders. And by doing so, they make capital for businesses cheaper and more available. And that allows a greater creation of wealth to the society.



Banking of this sort has been with us a long time. It's not a new thing in the world. English kings explicitly allowed goldsmiths to engage in banking at least 400 years ago. It may well date to the early 13th century in Italy. I'm not aware of it existing older than that. But wouldn't be surprised if it did.

It has been around for all of the modern era. And has largely made the modern era possible. To attack something that all of our prosperity rests on in nonsensical. It demonstrates an ignorance of how the world works that is dangerous to all of us.



*****
Someone want to chime in with the Marxist critique of banking? As I understand it, making money work is not work, and so does not deserve an income.

But as I just showed, making money work is work. And so does deserve some sort of an income for doing so.
*****

So banks make the connections between savers and borrowers. What else do they do and how do they do it? Banks have two primary kinds of depositors. Checking accounts and savings accounts. Simple version, savings accounts earn interest for the depositor, checking accounts make the depositors money quickly and easily available for a variety of purposes.

The money to pay for all of this comes from the loans the banks make. All those loans charge interest, which is the primary revenue of the bank. Out of that revenue, the bank has to pay the interest on deposits, and cover all the costs of the checking accounts, plus all the costs of running the bank and some rate of return to the bank's owners.



But banks can't loan out all of the money that is deposited with them. Because they never know when their depositors are going to want their money back. And so they have to keep a fraction of it in reserve to cover what their depositors are going to want on any given day. Now in the US we normally talk about a 10% reserve ratio. Why? Well it makes the math easy But really, because it's dictated by law. It doesn't have to be 10%. Some nations have gotten away from mandatory reserve requirements. They can do that because they have more properly regulated and run banks, and so can safely run with a lower reserve.

You see, the higher the reserve requirement, the less money the bank has to loan out. But the lower requirement, the more the banks can loan. Lower reserves mean lower interest rates and more loans to the economy, and so more economic growth. Higher reserves, higher interest rates, less growth.


Contrary to current political myth, fractional reserve banking in and of itself does not push inflation. Because all the money "created out of thin air" when loans are made is destroyed again when the loans are repaid. It is not an ever expanding quantity of money. It is a stagnant amount of money until the monetary base is expanded again, or the slow but inexorable velocity of money speeds up a bit.

The thing is, that most of the danger that comes out of finance does not come out of conventional banking. Conventional banking is actually very well understood and easy to deal with. The problems come when finance is allowed to be creative. When it is allowed to take chances.



The fundamentals of money and banking are among the simplest and most basic in economics. There's really no disagreement about the principles. And so there's really no reason for anyone who has had high school AP economics or a few college courses to get it so fundamentally wrong as we hear in some of the political debate today.

 

[Traitorfish]

Someone want to chime in with the Marxist critique of banking? As I understand it, making money work is not work, and so does not deserve an income.

But as I just showed, making money work is work. And so does deserve some sort of an income for doing so.

The Marxist critique wouldn't be that banking isn't work, but that the income of banks is not reflective of the actual work done. The tremendous profits made by major banks do not reflect any corresponding expenditure of effort on the part of the owners, but the exploitation, to whatever proportion and degree, of employees and debtors.
But, Marx, at least, would stop short of saying that bankers "do not deserve an income", because he had very limited interested in moralising his way to a more equitable capitalism. His criticisms were not of any particular practice or institution, but of capitalism as such, which he argued was structural incapable of producing an equitable distribution of wealth. So he wouldn't really have been interested in producing some righteous OWS-style criticism of the banking sector, any more than he would have specifically attacked, say, pet insurance companies.

 

[Terxpahseyton]

Money is only a tool. And hence defined by how it is used. And that source lies within the nature of human beings. So its stupid and ed up.
As a consequence, the role of money is of utmost importance and must be watched. To rationalize it away with fancy but all too simplifying models of theory is not helpful in all instances.

 

[onedreamer]

money in any of its current forms is easier to hoard and amass than any other valuable thing that can be bought with it, which means it can stimulate greed, which is why it is called the evil. Just my 2 cents.

 

[Cutlass]

There are plenty of other things that can be hoarded. In older times, hoarding land was an issue. You keep the people off it that need it to grow food and reserve it for only the use of the owner. Gold, silver, gems, any of the things that can be bought with money.

What money gives you is a greater ease of having it and letting others use it. In practical terms, there really isn't hoarding, as it is commonly thought of, in the present times. That money is available for the use of other, only at a price. Where hoarding in the old fashion way just took it out of the economy and set it to the side under guard.

 

[Leoreth]

What I'm really curious about is the effect lax monetary policy has on economic bubbles.

It's often suggested the increased amount of money in circulation is what's behind the diminishing intervals between creation and burst of bubbles in recent times. If that's true, isn't that an indication there is too much money, and the people wanting to invest it don't find any real assets to do so and end up with "imagined" assets, i.e. those created by bubbles? Or is that more of a problem of wrong incentives and lack of regulation?

I'd really like to know if these explanations have any merit and how much research has been done on it, because it gets thrown around a lot since the financial crisis.

PS: Great thread so far, thanks Cutlass and Integral for your elaborate posts and explanations

 

[Integral]

Leoreth: good question and I will try to get to it this weekend. Busy busy week.

For today, one more piece of evidence that interest rates != monetary policy.

If I told you that interest rates across the entire yield curve rose this morning, you'd probably think that the Fed did some massive monetary tightening overnight. But you'd be wrong.

Six central banks led by the Federal Reserve made it cheaper for banks to borrow dollars in emergencies in a global effort to ease Europe’s sovereign-debt crisis.

Stocks rallied worldwide, commodities surged and yields on most European debt fell on the show of force from central banks aimed at easing strains in financial markets. The cost for European banks to borrow dollars dropped from the highest in three years, tempering concerns about euro’s worsening crisis after leaders said they’d failed to boost the region’s bailout fund as much as planned.

“It’s supportive but not necessarily a game changer,” said Michelle Girard, senior U.S. economist at RBS Securities Inc. in Stamford, Connecticut. “The impact is more psychological than anything else” as investors take heart from policy makers’ coordination, Girard said.

The premium banks pay to borrow dollars overnight from central banks will fall by half a percentage point to 50 basis points, the Fed said today in a statement in Washington. The so- called dollar swap lines will be extended by six months to Feb. 1, 2013. The Fed coordinated the move with the European Central Bank and the central banks of Canada, Switzerland, Japan and the U.K.

Comments
1) Look at the interest-rate reaction first in the US, not mentioned in the article. Both nominal and real interest rates in the US rose mildly this morning across the entire yield curve.
2) But look at other asset prices: US and German stocks rose on the news, European interest rates fell and US and European inflation expectations rose. Clearly this is expansionary policy for both Europe and the US despite the rise in US interest rates.

Moral: while the analysis of monetary policy starts with interest rates, it can't end there. Look at the entire spectrum of asset prices before judging a policy "expansionary" or "contractionary".

Further moral: "long and variable lags" is a myth; monetary policymakers can move markets with the mere announcement of future policy, so long as the policymaker is credible.

Moral 3: if the "psychological effect" mentioned in the article can move markets in excess of 4%, then I'd consider that mechanism pretty powerful and not worthy of immediate dismissal.

 

[Cutlass]

Leoreth, Integral's better prepared to give that explanation than I am, at least with any depth. But that said, I'll try a bit. In my last post above I noted how in the modern economy money is not really ever hoarded. That is, it is never just put away in large amounts and sat on. It's always available for the use of borrowers. And that is because the owners of that money are always seeking to make more money by loaning or investing the money that they have.

(There is always some money that is just "sitting there". But that is just emergency stashes, and cash held for near future transactions. Or cash held by criminals who are isolated from the banking system to protect their anonymity. So it really doesn't amount to enough to worry about on the scale of the economy.)

Now given that the money is always out there looking to earn more money, where does it go? Now not to get into the theories behind investments, which is more Whomp's and JerhicoHill's fields, different investors have different preferences in what they invest in. Some like a steady and reliable return over a lengthy period of time. Others want a maximum rate of return now, even though that entails higher risks. The higher the rate of return looks to be, and the lower the risk looks to be, the more attractive an investment is. That's why US Treasury Bonds are the investment of last resort: There is no investment in the world that has lower risk or greater certainty. But by the same token, the rate of return on them typically isn't very high.

So all that money is out there looking to make more money. Where does it go? But it doesn't always have good options for doing so. And the investors often have faulty knowledge to work with as well. Plus, of course, there's irrationality in play.

Real business investments have uncertainty plus typically long time horizons for payoff. And the more uncertain the economy as a whole is, the more uncertain the investments in it are. And so money looks for a use elsewhere. They look for a sector of the economy that's really booming. Or they look internationally for a booming location. Or they look for something new that they can get in on the ground floor of.

Or they look for something that's safe as houses.

And when enough money finds one of these places, that's where you get a bubble.

Now bubbles draw money away from real productive business investment. Investors misjudge the safety of the investments. And so the high returns look really attractive. And it is sometimes difficult to tell where legitimate asset growth leaves off and a speculative bubble starts. The borders can be blurry, and even the "experts" can disagree. A number of people called housing a bubble in the US in 2005-6. But a number of others didn't see it for a critical couple of more years.

That money could have gone to productive business investment. But stagnating consumer purchasing power made that look like a less attractive bet. While housing looked, for many reasons, including vast amounts of outright fraud, to be both a higher return and a safer bet.

From there, I want to see what Integral has to say. I suspect that he's much more comfortable with the monetary explanation than I am. Now it is money. But that doesn't tell you all that you need to know. And I'm uncomfortable saying that it is all about the money. You can shut off the spigot of money, but that doesn't go straight to shutting off the bubble. It shuts off the whole economy, and probably the bubble last of all. And that's why I'm leery of a monetary response to bubbles. It can't be targeted in that way.

I suspect that a lot of the answer to why bubbles are flying so fast and furious these days is primarily 2 things: 1) Money is much more concentrated now than it has been in the modern era. That means that there's far more investable capital, but there is a smaller proportion of consumer purchasing power. And that means that the opportunities for productive business investment are artificially narrowed. And so there's just more money chasing fewer real investment opportunities. And 2) the speed with which money can flow from one investment to another, both with in a country and worldwide, has simply gotten so fast that money rushes around faster than people really think and analyze what they are doing. In the money markets now it is all about moving faster than everyone else in order to get that little more rate of return than they get. And all that rushing around means that there is just less thought and planning involved.


********


Question for Integral.

One issue I've always had with monetary policy that I've never gotten a satisfactory answer for is about the monetary base. The theory says that the monetary base comes from the central bank. But these days so much money flows across international borders and between economies that it seems to me that has to interfere with the CBs monetary base determinations. What's the story behind that?