Different Theories of Fiat Money, with Balance Sheets

Hyman Minsky said: ‘Discipline your thinking with balance sheets’ (quoted in the new fantastic book by Randall Wray).

My last post seems to have generated a lot of confusion. I didn’t discipline my thinking with balance sheets.

What I was interested in was different theories of how fiat money works. Each of these different theories implicitly proposes a different accounting convention, to explain the operations of spending and taxation by the state. Let me try to lay these out in balance sheets, so that it’s clearer what is being said by each theory.

To keep things simple, I’ve concocted an example in which the state balances its budget. It taxes back the same amount that it spends. Each of these balance sheet constructions is perfectly capable of representing a deficit or a surplus. Right now, that isn’t the point, though I’ll touch on this at the end.

The Vulgar View

As an introduction, let’s start with the vulgar, naive view about spending and taxation – the one we tend to hear from the mainstream media.

On this view, as Thatcher said, ‘the State has no source of money other than money which people earn themselves’. We, the citizens, have money, which can just be represented as a pure asset. We also have the goods and services that the state buys from us. The state has, first, to tax our money, and then to use the money it has taxed from us to buy our services.

Here is how it looks in balance sheets. We start with 100 units of currency, and 100 units worth of goods and services (g&s), giving us a total net worth (n/w) of 200. The state then taxes 100 units of currency from us. Next, it uses that currency to buy goods and services from us. In the end, the 200 units of net worth are split between us and the government. The government has, effectively, appropriated 100 units of wealth from us. Here are the balance sheets:

Screen Shot 2016-01-15 at 10.08.07

This view overlooks the fact that the state is the issuer of the currency. We don’t just start out having currency, which the state takes from us. Where did we get it from? We transfer currency around by paying each other, but we don’t issue it ourselves.

Currency as a State Liability

So let’s take a different view. This is the view implied in the standard accounting convention, which treats currency as a liability of the state.

Here, the state creates currency by issuing a new liability in order to purchase goods and services from us. It simultaneously imposes a tax liability on us. We settle the tax liability by returning to the state its own liability, in exchange for it cancelling our tax liability to the state. Here are the balance sheets:

Screen Shot 2016-01-15 at 09.27.17

Currency as an Asset Created by the State

Eric Lonergan (see his comment on my last post) warns against reading too much into the current accounting convention. We can instead (if I’m interpreting him rightly) view currency as an asset created by the state and possessing value of its own accord. Just like in the vulgar view, currency is a pure asset rather than a liability ‘backed’ by something else. But now it is an asset of the state rather than ‘our’ asset. Lonergan defends this view by pointing out that when you hold, say, a $10 note, printed by the state, nobody owes you anything.

On this view, the state first ‘prints’ currency, creating an asset for itself out of thin air. It then exchanges this asset for our goods and services. Then it taxes back the currency from us. So the state first creates wealth (n/w) for itself, then swaps this wealth with us to procure goods and services, and then, finally, takes back the financial wealth that it has offered in exchange for goods and services through taxation. Notice that in this representation, unlike in the two above, there is a net increase in wealth.

We start with net worth of 100 units. The state creates net worth for itself of 100 units. And at the final position it has ended up with the whole 200: the 100 from us and the 100 it created. The balance sheets look like this:

Screen Shot 2016-01-15 at 10.09.02

My worry with this view is that it leaves taxation entirely unexplained. By the time the state has bought goods and services, it already has everything it needs. What is the point of taxing back the currency from us? It has already got what it needs: our goods and services. Why should it tax back currency that it is capable of printing? Why should it take our wealth when it is perfectly capable of creating wealth on its own?

One answer might be that if the state continually pays for everything by printing money it will cause hyperinflation. A relentless increase in the money supply will drive up prices. But what does this matter to the state? However high prices rise, it can always print enough money to pay them. We all know the images of cash wheelbarrows in Weimar. But with electronic money, this wouldn’t be a problem: how hard is it to store a few more zeroes on a computer record?

The real problem with spending and not taxing is that it renders the state’s currency not just less valuable but rather valueless. This is the neo-chartalist point. ‘Taxes drive the currency’, as they say. We already have our wealth, in the form of our goods and services. There is simply no reason for us to exchange it for worthless tokens issued by the state, unless the state demands back those tokens for tax payments. If we just wanted the tokens to facilitate exchange, we could create them for free rather than giving up real stuff to the government to get them.

Currency is Backed by Public Services

This brings me to the point that motivates my own representation. In the ‘Currency as State Liability’ view above, the currency is effectively ‘backed’ by its capacity to settle tax debts to the state, which are simply imposed on us. I don’t have much of a problem with this view. But I do think it leaves out the fact that we get something for our tax payments besides the settlement of a liability. If you paid your taxes and your situation did not change in any way, then why would you bother? Settling a liability means more than just shifting numbers around on a balance sheet. You get something: a new legal status if nothing else. My representation simply incorporates this fact into the ‘Currency as State Liability’ view.

What we get for our taxes is access to public services. We also get to avoid being sentenced for tax evasion. These are real, tangible goods. I’ve represented them as ‘citizens passes’. Imagine that when you pay your taxes each period, you’re given a time-stamped ‘citizens’ pass’. This entitles you to access public services legally; if you don’t have a pass, the tax-collectors will be on your case (those who fall below the tax threshold get an exemption so that they don’t need citizens’ passes).

In my representation, the state begins with an indefinite amount of citizens passes for each potential taxpayer – I’ve set this at 100. It then purchases goods and services by issuing currency. Currency is now again treated as a liability of the state; it is really a promise of citizens’ passes. Finally, the citizens exchange the currency they have earned from the state for citizens’ passes. In terms of wealth, there is no creation or destruction – the state has simply exchanged 100 units worth of citizens’ passes for 100 units worth of goods and services. Citizens effectively pay for their access to public services by helping to provide those services.

And here are the balance sheets:

Screen Shot 2016-01-15 at 09.30.30

Somebody complained to me that my view can’t make sense out of government deficits / citizens’ net saving. But it can. When the state runs a deficit, it just keeps a few citizens’ passes in reserve. Citizens then hold some of their wealth in currency rather than in citizens’ passes, and the government gives more exemptions, so that people can keep using public services (and stay out of prison) without having to purchase citizens’ passes. Just think of a stadium selling only 90 tickets but letting 100 people in.

Here is what the balance sheets will look like when the government runs a 10% deficit:

Screen Shot 2016-01-15 at 09.32.03

It should be obvious what a surplus will look like, but just in case:

Screen Shot 2016-01-15 at 09.32.40

What I prefer about my representation is that it accounts for two important facts: first, that taxes drive the currency, and, second, that we get something in exchange for our tax payments (even if it’s just the relief of getting the tax-collector off our backs).

But now I’ve given you the various representations as clearly as I can. So you can make up your own mind.



12 thoughts on “Different Theories of Fiat Money, with Balance Sheets

  1. synchretist

    I’m having this stream of thought this morning that money is, in a very literal sense, power.

    the power of sovereignty is based ultimately on the monopoly possession of the right to use force, codified in a body of law.

    so, for example, if you pass the appropriate laws, you get Kristalnacht, a legal taking of property based on ethnicity (or religion).

    that monopoly possession of the right to use force is then delegated to the individuals and institutions within that sovereign realm through various legal means, one of them being monopoly sovereign fiat currency.

    so in a literal sense, currency transfers pieces of fundamental sovereignty to the recipient in exchange for real goods and services, because of its status as legal tender.

    this is consonant with the left’s arguments about justice and economic equality, with pragmatic capitalist arguments about the danger posed by inequality, and right wing claims of the sovereignty of kings or the elite.

    based on that, can you not simplify the categories of citizens passes and currency to just citizens passes represented by currency?

    1. axdouglas Post author

      Yes. I should have used a different term. ‘Citizens’ passes’ was meant to stand for the actual resources, including the resource of freedom, that is allocated with the device of fiat money. In another sense, you’re perfectly right to say that the currency itself is the ‘citizens’ passes’. G.A. Cohen calls money ‘a means of structuring freedom’. http://www.howardism.org/appendix/Cohen.pdf

      1. Simon

        Neil-as a relative newcomer to this I get confused between stocks and flows.

        Can I simply say this in relation to the above: Stocks have no +/- sign? I wonder if , for some (me!) the problem of these models is that a ‘stock’ as an abstracted pre-flow state; a ‘positive-flow’ and a ‘negative flow’ a both ‘Janus-like’, ‘looking’ in opposite directions.

        Wouldn’t flow charts be better? Bill Mitchell tends to use the on his blog and (to me) they seem more intuitive and have less of the ‘frozen abstraction’ about them. For example: http://bilbo.economicoutlook.net/blog/?p=381

        Stocks are often defined as ‘snapshots’ of flows-the question then arises for me when is a stock not a flow , because of the ‘camera’ or something more inherent?

        Any help with this much appreciated!

      2. Simon

        Mosler tends to repeat a lecture he gives to uni students where he uses the image of a man with a gun at the door and you can’t get out without the passes which he issues-of course the currency IS the ‘pass.’

      3. axdouglas Post author

        Yeah, so in that case imagine that my ‘citizens’ passes’ stand for the actual getting out of the door, not the currency you pay to do so.

    2. Simon

      ‘right wing claims of the sovereignty of kings or the elite.’

      Synchretist-I tend to think of those claims as ‘oligarchic’ (in the sense of Burke et al)-the right, in it’s ‘purest’ sense I tend to think of being expressed by the ‘ibertarian right’ where the state is shrunk to it smallest possibilityt-I think Thatcher favoured that (anarcho-capitalism) but got oligarchy of financilaisation instead.

      1. synchretist

        I’m referring to sovereignty in the original sense, that was handed down to the sovereign by god – divine right. “the state” is the realm of the king and his peers, and he delegates rights (e.g. to extract tribute, to own property). As far as I understand it, libertarianism is based on a democratic ideal.

  2. Simon

    Not sure using both + and – in the asset/Liability sides helps-wouldn’t it be clearer to always use + for asset and – for liabilities? (maybe its just me-combinatorial thinking was never a strong point!).

    1. axdouglas Post author

      You might be used to a different convention, in which positive flows are represented just as normal numerals and negative flows are represented as numerals in parentheses. In that case just think that ‘-x’ for me means ‘(x)’ in that convention. I didn’t use it because I wanted to distinguish among *three* sorts of values: stocks, positive flows, and negative flows.

  3. gbgasser

    Excellent post

    I think the past 30 years have shown that the Reagan/Thatcher folks knew this to be true and one of the strategies of the right through the last 30 years has been to degrade the services the govt provides either by underfunding them or just putting incompetents in charge (Good job Brownie! comes to mind). One service you won’t hear anyone talk bad about though is those boys overseas fighting for our free-dumb.

    Combining this post with your more recent one on Girard (just found your site today thankfully) gives us the reason the Reagan movement was so successful, scapegoat the govt!! Who’s gonna admit they like the govt.

    Here is the problem they are running into though. The privatized versions of those services eventually end up even worse in terms of quality, price and volume of distribution.


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