But Is It Money?

chrismartenson_chapter6_whatismoneyThanks to Mike Otsuka for pointing me towards a new article by Smit, Buekens, and Du Plessis in the Journal of Institutional Economics, which addresses the vexed question what is money?

Here is the first part of the abstract:

What does being money consist in? We argue that something is money if, and only if, it is typically acquired in order to realise the reduction in transaction costs that accrues in virtue of agents coordinating on acquiring the same thing when deciding what thing to acquire in order to exchange.

In giving that answer, Smit et al explicitly reject John Searle’s proposal, that “an object is money if it is collectively counted as money among a group of agents” (329). Their reasoning is: people debate whether bitcoin (e.g.) counts as money. Searle’s view seems to imply then that bitcoin is money for some people and isn’t money for others. But:

This, however, is not very satisfactory. It seems to leave a basic theoretical itch unscratched and to miss the degree to which the people who dispute such things take themselves to differ on some substantive issue. (329)

The authors go on:

A more compelling answer to whether bitcoins are money would be to identify some theoretically interesting, explanatory characteristic shared by those things we uncontroversially consider to be ‘money’ and to see if bitcoin has the characteristic in question. (330)

They then examine three proposed characteristics. Money:

  1. functions as a medium of exchange
  2. functions as a store of value
  3. functions as unit of account

They then rule out 2 and 3 by pointing to counterexamples. People often hold money even when it depreciates in value; we do not therefore say it isn’t money. So 2 is out. 3 is ruled out by a more elaborate and hypothetical counterexample, in which inflation renders a currency inappropriate as a unit of account, but it is still used to settle payments (sellers quote prices in some unit other than the currency, to avoid menu costs, and then calculate the currency-price at the point of exchange).

This leaves 1. But “medium of exchange” isn’t very informative, so the authors spell it out in more detail. First we should recognise that “the transaction costs incurred by an economic agent decrease as a function of the amount of agents that she transacts with that transact in the same currency.” (330)

This is a reference to the old “double coincidence of wants” problem associated with barter societies. Money is more convenient than barter, which is what we would have if we didn’t have money. This is the textbook story of the function of money; here it is in a textbook (Samuelson and Nordhaus, 2010, 459):

Screen Shot 2016-08-24 at 08.21.42

This leads the authors to their definition of money:

something is money among a group of interacting agents if, and only if, it is typically acquired in order to realise the reduction in transaction costs that accrues in virtue of such agents coordinating on acquiring the same thing when deciding what thing to acquire in order to exchange. (331)

Right away the authors clarify:

Note that we need not require that the agents in question understand their practice in such terms. The agents themselves may have all manner of false beliefs about their practice. Yet their practices are sustained, and their behaviour explained, by the fact that the adoption of a currency has such a coordinating function. (331)

My question here is whether money really does function to reduce transaction costs. It is important for the account above that a barter society is what we would have if we eliminated money. This is different from the question of whether there ever was a barter society in the past. What needs showing is that, given human psychology and social arrangements, the lack of an “agreed medium of exchange” in our society would give rise to the higher transaction costs of a barter society.

There are many other ways of avoiding those costs without money. One is to have a social convention such that anyone with an abundance of some good should share it with anyone in need. Thus you share your surplus wool with whoever needs it, and somebody else shares a spare axe with you. Barter isn’t necessary at all.

There are less benign ways also. One is just to steal what you need. This could have violent repercussions, and we might say that these are transaction costs in themselves. But that is not obvious: the violence might be constrained through conventions to minimise its real damage. It might even be enjoyable for participants.

I am not entirely making things up; there are examples in the anthropological literature of societies that look a little like both of those, and there are many, many others of different sorts. But my point here is only that we shouldn’t assume we just know what our society would be like – given our psychological dispositions and our other conventions – if we took away money. Do we really know that much about ourselves?

The crucial point, of which anthropologists have been trying to inform economists for decades, is that the institution of money changes us in fundamental ways. It changes how we think, what we value, how we interact with each other. Untune the string of money and who knows what discord, or concord, might follow? Maybe we would barter; maybe we would share; maybe we would steal. How can we know? What is the standard of evidence for judging that counterfactual?

Once we appreciate the range of possibilities here, we see right away that there are many other functions that money could serve besides the three examined by Smit et al. The MMT story, for instance, is that money serves the purpose of allowing the state to provision the public sector with labour and capital, without paying in kind. I am working on my own story, drawing on Bernard Laum and René Girard, according to which money serves a religious purpose of channelling human violence into ritual channels. A certain type of Marxist believes that money is an instrument of exploitation.

All of these stories suggest a picture of a non-monetary society. The difference between that society and ours is the cost (to some or all members of society) that money exists to reduce. Without money we might have an inconvenient barter society, or no public sector, or uncontrolled violence, or the overthrow of capitalism. We can’t discuss the function that money serves without discussing which of these pictures seems the most accurate.

Economists don’t engage on this question at all. They just assert without argument that a society without money would be a barter society with high transaction costs. Philosophers follow them on this point, I believe, out of a misplaced “naturalism”. The economists can elaborate their barter-into-money story with fancy game theoretic models and equations. What is in fact an unsubstantiated assertion is dressed in the trappings of the natural sciences. And philosophers in the early 20C got a big scolding  for failing to bow low enough to the natural sciences.

The remedy is simply to recognise that there is no current science that could tell us with any certainty what our society would look like if we just deleted one of its central institutions. Thinking through the possibilities takes imagination. Economists are often unimaginative – I often wonder if the explosion of unnecessary mathematics is to compensate for a lack of inspiration. But philosophers don’t need to follow suit. On one point, at least, we don’t want to vindicate J.K. Galbraith:

These are the days when men of all social disciplines and all political faiths seek the comfortable and the accepted; when the man of controversy is looked upon as a disturbing influence; when originality is taken to be a mark of instability; and when, in minor modification of the original parable, the bland lead the bland.

Advertisements

10 thoughts on “But Is It Money?

  1. NeilW

    “The remedy is simply to recognise that there is no current science that could tell us with any certainty what our society would look like if we just deleted one of its central institutions”

    There is. Children.

    http://psycnet.apa.org/journals/dev/52/8/1299/

    We all run an internal ledger of who owes us a favour and who we owe a favour to.

    Then we learn to contra our internal debts with somebody else “Jim owes me a cabbage, but I don’t want a cabbage. Fred wants a cabbage though, and I owe him two eggs, so if I ask Fred to let me off two eggs if I get Jim to give him the cabbage”.

    After a while that gets complicated – like over the counter foreign exchange. So at that point somebody invents a clearing house and calls it a ‘bank’.

    And off we go.

    Reply
  2. Stephen Ferguson

    The ‘MMT story’ you gave is just is the end point, MMT economists also accept everything that anthropologists (e.g. Graeber) say about money’s origins.

    Graeaber, and also MMTers such as Wray, say the true tribal origins were about imposing debts to avoid blood feuds, which sounds awfully like the “channelling human violence” line you are now following from other quarters. As the saying goes ‘Evil is the root of all money’ :).

    PS Agree with Neils point. IOUs are innate and also the ‘ties that bind’, its not possible to have a society without them.

    Reply
    1. axdouglas Post author

      Yes, I think the account I want to develop is fully MMT-consistent. I just want to develop it further in that direction.

      PS I agree with Neil too. But the ties that bind amplify the threat of violence also, and I want to look at the institutions that that creates.

      Reply
  3. David Chester

    MMT theory is incorrect because it claims that money is wealth. All that money is is the means for others to recognize that the owner of the particular sum has recognition in its exchange value for something else, which often is materially valuable and is wealth.

    MMT claims that the banks make money by creating debts. This is not true, because every debt must be balanced by a corresponding credit. In this case is in the form of savings. Only when the loan is returned to the bank can it be loaned out an additional time.

    MMT supporters are warmed-up Keynesians who still think that money can be created. Even when new money is printed and used by the government, the effect is to inflate the apparent value of the goods (which then cost more in numerical terms), so in truth nothing has been done to increase the total amount of wealth. The other side to it, (and all macroeconomics considerations are two-sided) is that with more money being circulated its scarcity reduces and so in terms of absolute value it is depreciating.

    Reply
    1. Steve Francis

      David, you state: “MMT claims that the banks make money by creating debts. This is not true, because every debt must be balanced by a corresponding credit. In this case is in the form of savings. Only when the loan is returned to the bank can it be loaned out an additional time.”

      Yet the Bank of England states: “When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created.”
      Source: Page 11 of http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1.pdf

      The whole BoE bulletin is an excellent description of how money is created in today’s economy.

      Reply
      1. David Chester

        Unfortunately the Bank of England is not being sufficiently truthful about this. The banks do not create money, because they first need permission to release, it and this permission comes from the government. The money is taken from savings.

        This criticism of the Bank of England publications has been made before by people with better knowledge and influence than me, it is very disappointing that these lies can be spread as being the truth, but in order to understand how this part of our social system works we need to study it all, and unfortunately banks are incapable of doing this and like many other micro-economists they take a subjective view. MMT supporters are similarly inclined and politically unaware of how their thoughts are a distortion of the Big Picture.

      2. mrkemail2

        “The banks do not create money, because they first need permission to release, it and this permission comes from the government.”

        Not really. Loans create deposits. Deposits are used to buy capital in banks. Banks backfill any shortfalls in their ratios after the event.

        A loan doesn’t happen at an instant in time. It is a lengthy process (known as the ‘sales pipeline’). When you get prospects in the door with a loan application, you can use statistics to estimate how many of those will actually end up drawing down a loan. That, along with lots of other data, is used by the Funding and Treasury departments in a bank to make sure all the numbers add up – and to constantly update the current price of money and feed it back to the sales teams.

        To get capital all a bank has to do is persuade enough depositors to swap some of their shiny new deposits for capital bonds and the regulator is a happy bunny again. The bank persuades people to buy capital bonds in the usual fashion – they pay a greater return on them.

        Similarly with the reserve ratio. The central bank has to make sure there are enough reserves in the system so that all the banks can hit their reserve ratios. If they don’t then they *lose control of their policy rate*. The banks all then borrow and lend the reserves to each other until everybody conforms with what are arbitrary ratios.

        The only constraint is if banks run out of creditworthy borrowers prepared to pay the current price of money.

      3. David Chester

        Thank you mrkemail2, you are right. This is not the usual explanation, and the stupid claim that money can be loaned into existence is still what the majority of MMT people seem to believe. Before we can examine the role of money we need to understand about how the WHOLE system works. Write to me at chesterdh@hotmail.com for my free e-book or for a quick review try SSRN 2600103 “A mechanical Model for Teaching Macroeconomics” on open literature.

  4. grkstav

    “MMT theory is incorrect because it claims that money is wealth.”

    That’s an inauspicious start. Bogus, erroneous first assertion. Not worth it to read the rest.

    Reply

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s