Only Criminals Use Honest Money
Fiat money does not exist in prison. Prisoners do not dye sheets of paper green and attempt to circulate them as money. No inmate would accept this as money, not even if the penal equivalent of a Bretton Woods agreement existed between the toughest gangs. Why is it that criminals continue to use real money in their transactions? Because they have not been fooled. FULL ARTICLE
Comments (79)
Don Lloyd
Chris,
"Such a situation may currently exist with prisons in testing the validity of fiat currency. Since money is banned in prisons, the historical use of cigarettes by prisoners as money avers that money requires alternative value (i.e., value apart from its use as money) and proves that our present system of fiat currency (and fractional-reserve banking) is eventually doomed."
No, this is a misreading of Austrian monetary theory. Money needs an alternate value as it originally becomes money, but once a money is established there is no requirement for an alternate use and value.
Regards, Don
Published: June 3, 2009 8:01 AM
greg
Cigarettes have great demand in prison because they have value in use.
Gold had great demand in the past because people wore their wealth in life and death.
Today, gold has very little use other than the demand from ETF's that are required to carry reserves to match their deposits.
Our economy is much more complex than a prison environment. But your comparison is interesting, if left on it's own to develop an economic system, the crooks and thieves will take over!
Actually, this whole arguement is worse than basing it on 18th century France. And I bet that most of the prisoners would give up their entire wealth of cigarettes to get out and return to our current society.
Published: June 3, 2009 8:26 AM
Taras Smereka
The point was that people tend towards hard money by default when the government and banking cartel are not there to force people into fiat currency.
Published: June 3, 2009 8:37 AM
gene berman
This is a perfect little gem of an article. No one should confuse its lack of length with a lack of
important content. In the space of its few paragraphs,
it contains practical allusions to the likely origin and spread of the use of money according to Misesian theory and, for the careful and reflective reader, provides the stuff from which to construct a vision of the most likely shape of the economic/monetary future, both at home and around the world.
But, I hasten to add a negative--or cautionary--comment.
What has the author seen that others do not? Why has this truth eluded the "best and the brightest" for generations (if not for centuries)? The answer to the first question is "nothing"; he merely states a truth that many (if not all) have long recognized. The answer to the second is that, for a very long time, the cost of "selling out" to go along with "the system" was reasonably low (like a few percentage points of additional tax) for the very many and, for very many among the brightest and most agile, not only not a burden or tax on their fortunes but a veritable sure-fire enhancement of those fortunes (and often underpinning their very source).
Further on the negative side (though I do not fault the author for this--it's a somewhat different topic) is the
diagnostic and prescriptive conclusions to be drawn.
How many of you (I mean you!) have recently (or ever) read the two pages of very simple explanation appearing on pages 767-769 of HUMAN ACTION,
"Observations on the Causes of the Decline of Ancient Civilization?" To any who have mastered (or who are even reasonably familiar with) Misesian theory, the two pages (and the projections to the present of the conclusions therefrom) should be "child's play" (and it ain't pretty, to put it as mildly as possible).
That's the greatest recommendation for the article in the first place--that, in a simple, straightforward way, it arouses and directs attention to a problem threatening to be the "greatest ever" in the history of civilization.
Published: June 3, 2009 8:38 AM
cy
greg,
what "value in use" does our current paper money have?
Published: June 3, 2009 8:40 AM
ray
what "value in use" does our current paper money have?
lighting fires
Published: June 3, 2009 8:45 AM
ronb
"Today, gold has very little use other than the demand from ETF's that are required to carry reserves to match their deposits. "
pretty ignorant... but I'd be happy to instruct you by exchanging all your shiny gold for veeery useful copper gram for gram!
seriously, 5 minutes and google and you can find 1000 uses for gold.
Published: June 3, 2009 8:51 AM
John Brock
A thought provoking article. One of the best as of lately. Good stuff. Well done.
Published: June 3, 2009 8:52 AM
Philip A Hayes
Having worked in a medium security prison myself, I think its worth noting that cigarettes are considered contraband in all prisons across Oklahoma, Texas, and many other states. This is not to say that cigarettes aren't used as a commodity money, they are. And just as they are able to get people to bring in cigarettes, they are also able to get people to bring in fiat money. And they do use that as well.
What surprised me it how elaborate the prison economy really is, neither cigarettes nor fiat cash are used exclusively, (probably because if a guard finds any, it is confiscated immediately), but all sorts of things are used in trade, most of all, honey buns and soups. These have become the top mediums of trade since they are long lasting, easily tradable, and can not be confiscated by corrections officers.
I've been intending to write an article on the prison system from a libertarian point of view, but so far it has been almost impossible to wrangle, and I have been too busy. hopefully this reminder will get me back on track.
Published: June 3, 2009 8:59 AM
Mike Sproul
You have taken the first step of recognizing that there is no such thing as fiat money in prisons. The next step is to recognize that there is no such thing as fiat money in the outside world either.
Prior to 1933 the dollar was convertible into gold, and the fed had sufficient assets (gold+ bonds) to buy back all the dollars it had issued. Since 1933 the fed has refused to buy back its dollars with gold, but it still buys them back with bonds. Meanwhile, the gold and bonds are still there on the Fed's balance sheet. Before 1933, the Fed used to suspend convertibility into gold every weekend. The dollar did not suddenly become fiat money over the weekend, only to become backed and convertible on Monday. The dollar was backed the whole time. During the week it was backed and convertible, while over the weekend it was backed and inconvertible. The 'weekend' has been extended to 76 years, but the dollar is still backed by the fed's assets. Furthermore, the fed still maintains financial convertibility--it stands ready to buy back its dollars with bonds, if not with gold.
There are many kinds of convertibility: physical, financial, instant, delayed, at the customer's option, at the bank's option, etc. In 1933 the fed suspended one kind of convertibility: instant physical convertibility at the customer's option. Every other kind of convertibility remains, and the fed still has its gold and bonds. Where then, do we get the idea that the dollar is fiat money? Only from our own inability to distinguish the words 'unbacked' and 'inconvertible'.
If any institution were able to issue colored pieces of paper and have other people value them, then that institution would get a free lunch. The free lunch would attract rivals who would issue competing moneys, and the value of the first money would be competed away. This is just as true in the outside world as it is in prison.
Published: June 3, 2009 9:52 AM
Current
Mike, that is a load of rubbish.
Money does not need to be convertible to remain in use.
In an isolated economy it does not matter if the central bank own no assets at all. If it keeps the stock of money stable then citizens have no reason not to use it.
Published: June 3, 2009 10:02 AM
newson
jeff tucker referred to the use of mackerel as money in another prison setting -
http://online.wsj.com/article/SB122290720439096481.html
Published: June 3, 2009 10:25 AM
danny
LEGAL TENDER LAWS!
ask zimbabwean shopkeepers who rejected Z$ what Mugabe's paratroopers did to their shops....
ask the Nevada biz that paid in gold coin... (now in court)
Published: June 3, 2009 10:29 AM
newson
well that's a cautionary tale - read the article carefully before posting. apologies to mr casey.
Published: June 3, 2009 10:30 AM
Mike Sproul
Current:
At least you said 'isolated economy', as if you recognize the possibility of competing moneys driving the value of fiat money to zero.
I agree that money does not have to be convertible to be used, but it must be backed by valuable assets, or it will have no value.
If fiat money were possible, then there should be many central banks that hold no assets yet still manage to issue valuable currency. There is, however, no such central bank.
Published: June 3, 2009 10:38 AM
DD
"Austrian economists are not fooled, because they reject the idea of empirical data in the validation of theory in the social sciences"
Don’t you mean in the absence of controlled experiments? It is not empirical data per se that is invalid, but empirical data that is uncontrolled, as is always the case in economics.
Published: June 3, 2009 10:51 AM
Inquisitor
Well he's not entirely incorrect, it's just obscurely phrased... they do reject the verification/falsification models insofar as the social sciences are concerned, but not empirical data per se as it remains to interpreted and praxeological theorems are at their core abstracted from empirical phenomena anyway (inductive concept-formation in the classical sense of the adjective.)
Published: June 3, 2009 10:56 AM
Kevin
I suggest the title be changed to "Only Prisoners Use Honest Money." Our central bankers and politicians are the biggest criminals out there. They steal from everybody by not using honest money.
Published: June 3, 2009 10:57 AM
billwald
(thought experiment) Joe, the barber and Sam, the butcher, are the first to sign on to the new central money computer system. The agreed upon transfer is CR 10. They enter their ID and the transaction - Joe is credited CR 10 and Sam is debited CR10. I buy CR 20 from Sam. I am debited CR 20 and Sam is credited CR 20. Sam now has a net balance of CR 10.
The accounts are published on the web which will keep this system honest.
Maybe the government decides to scrap dollars for Credits. All sales and income taxes are canceled. The government imposes a 10% tax on every transaction, 5% from the debited account and 5% from the credited account.
THUS AN HONEST MONEY SYSTEM INVOLVING NOTHING BUT A PUBLIC DOUBLE ENTRY BOOK KEEPING SYSTEM
Published: June 3, 2009 11:00 AM
cy
Mike-
If the fed is simply issuing dollars that are actually backed by assets, how do you explain the constant depreciation of the dollar relative to our society's real resources?
Published: June 3, 2009 11:11 AM
Current
Mike Sproul: "I agree that money does not have to be convertible to be used, but it must be backed by valuable assets, or it will have no value."
No, not necessarily. Mises describes this problem in the Theory of Money and Credit ~p.160.
People value money because they can reliably use it as a medium of exchange. They don't necessarily value it because it is backed by assets.
What difference does it make if a note is "backed" by assets if it cannot be converted under any circumstances?
For example I may own an acre of land. Another man has the right to prevent me from entering that land on weekends. However, I can use it otherwise. Clearly the ownership is still useful to me however it is limited. Compare that though to the situation where I "own" an acre of land. another man has the right to prevent me (or my agents) from accessing it at any time. In this case the "ownership" is clearly meaningless.
Strictly speaking there is no need for a government to "back" its currency, or convert it. It may be pure fiat money.
All that is necessary is that the people believe that the state will not print too much of it.
Published: June 3, 2009 11:11 AM
Mike Sproul
cy:
Inflation results when assets fall relative to liabilities. Either the issue of money rises faster than assets, or the fed's assets lose value.
current:
If money cannot be converted under any circumstances, then it will have no value. But that is not the case for the dollar, or any other so-called fiat money. As I said, the fed suspended only one kind of convertibility in 1933: instant physical convertibility at the customer's option. All the other kinds of convertibility remain.
Even if the government promises not to print to much, that does not prevent other institutions from issuing competing moneys, and as these competing moneys are issued, the value of the so-called fiat money will be driven to zero.
Published: June 3, 2009 11:35 AM
cy
So you're essentially saying that the fed systematically overpays for the assets it purchases, benefiting those it buys from (bond-dealing banks) at the expense of currency holders? Doesn't this seem like a criminal organization funneling real resources from all money holders to a few privileged groups?
Also, you say that only one type of convertibility has been suspended. To my knowledge, I cannot walk into a fed branch and convert my dollars into anything else. What types of convertibility exist for the average citizen?
Published: June 3, 2009 11:51 AM
Mashuri
Mike,
There most certainly is such a thing as fiat money. The key here is counter party risk. Gold, for example, carries no counter party risk as it's supply is well known and can only increase at a very slow rate. My gold coins do not rely on the guarantee of some person, government or other entity to maintain its value. Gold-backed currency that is freely convertible is the next best thing but does carry the risk that said currency will inflate vs its gold reserve. Despite its free convertibility, I still consider this "semi-fiat" in the sense that we are revaluing a piece of paper (or bits in a computer) based on what it promises. Full-floating currencies, like the dollar, are 100% fiat in that they rely solely on the reputation of its issuer. What would happen to the value of the dollar if the US government and banking system collapsed? What would happen to the value of gold if even every government in the world collapsed? There's your difference.
Published: June 3, 2009 11:53 AM
Current
Mike, this is what you wrote earlier: "Prior to 1933 the dollar was convertible into gold, and the fed had sufficient assets (gold+ bonds) to buy back all the dollars it had issued. Since 1933 the fed has refused to buy back its dollars with gold, but it still buys them back with bonds. Meanwhile, the gold and bonds are still there on the Fed's balance sheet. Before 1933, the Fed used to suspend convertibility into gold every weekend. The dollar did not suddenly become fiat money over the weekend, only to become backed and convertible on Monday. The dollar was backed the whole time. During the week it was backed and convertible, while over the weekend it was backed and inconvertible. The 'weekend' has been extended to 76 years, but the dollar is still backed by the fed's assets. Furthermore, the fed still maintains financial convertibility--it stands ready to buy back its dollars with bonds, if not with gold."
I don't think you are correct. I have in my wallet several Euro notes and a UK pound note. I don't believe that these will ever be convertible to any asset. I use these notes because they are accepted by others as a means of payment.
I haven't met anyone who values banknotes because they believe that they will one day be able to convert them.
Fiat money notes are very like the acre of land I mention above. Nobody has access anymore to what they once represented. That though does not affect their use as a medium of exchange.
Money is not the same as other goods.
Mike Sproul: "Even if the government promises not to print to much, that does not prevent other institutions from issuing competing moneys, and as these competing moneys are issued, the value of the so-called fiat money will be driven to zero."
No. Legal Tender laws require shopkeepers to accept the money of the state.
Even if they did not people would not necessarily stop using fiat money. As long as the issuing authority can be believed when they say that they will not issue more than a certain amount then there would be no reason to discontinue accepting it.
Published: June 3, 2009 11:55 AM
T.G.G.P
Phillip Hayes' comment about prisoners using contraband dollars reminded me of an article that appears at this site a while back on Iraqis continuing to use the old dinar even after the change in regimes. Peter Leeson has a paper on Somalia titled "Better Off Stateless" that discusses what happened to their currency once there was no longer a government to debase it.
Published: June 3, 2009 12:35 PM
G8R HED
Kudos to the illustrator.
I am surprized no one has noticed yet that the illustration depicts fish that are of a species other than the mackerel highlighted in the article.
Yes, if you look again you will notice that the currency-cloaked fish are indeed SUCKERS, not mackerel.
Published: June 3, 2009 12:40 PM
greg
There is much more to a society than it's medium of exchange. There is more to the value of a society than the amount of gold they have in reserves.
For example, is a society that spends $500 an ounce to produce gold better off than a society that spends $2 a bushel to produce corn? So what is wrong with both societies printing money backed on their production capacity.
You may say the country producing gold could buy whatever they want with their currency backed by gold. But what if the other society has no need for gold. Just look to South Africa as a good example.
And the CA gold rush is another good example. Most of the fortunes made was not from gold, it was from people supplying the miners and the economies grew around the suppliers. There is more to economics than money supply and interest rates.
Published: June 3, 2009 1:23 PM
Current
Greg - you are starting with the wrong question. Societies don't make decisions, individuals do.
greg: "For example, is a society that spends $500 an ounce to produce gold better off than a society that spends $2 a bushel to produce corn? So what is wrong with both societies printing money backed on their production capacity."
I agree that making consumers good is often useful, as it making commodity money. This doesn't tell us much though.
The question with your sentence above is *how* can this be done? A "society" cannot back money.
greg: "You may say the country producing gold could buy whatever they want with their currency backed by gold. But what if the other society has no need for gold. Just look to South Africa as a good example."
That is an aspect of trade though and the use of commodities, not monetary theory. As is your example about the CA gold rush.
Of course there is more to economics that money supply and interest rates.
Published: June 3, 2009 1:30 PM
Philip A Hayes
I guess the biggest mistake that is being made here, and it is both small and subtle, is that a prison isn't a isolated economy.
Trade is always moving in and out of the prison gates, and everything from cell phones to captain morgan's are brought into prisons, thats where the fiat currency comes in, because no guard would turn dirty for honey buns or cigarettes.
Onto another note, with "current" the dollar is in use because it is "legal tender" that means that you must pay with those notes, and with nothing else.
And if there were any other argument, what gives the federal reserve notes their value is that the Federal Government declares you owe them so much money every year, and what they call money, I call worthless paper, but it isn't so worthless after all because if I don't get some of it to pay my taxes, the government will kill me.
Published: June 3, 2009 1:37 PM
Current
Philip A Hayes: "Onto another note, with "current" the dollar is in use because it is "legal tender" that means that you must pay with those notes, and with nothing else."
Not only that though. The dollar is accepted as money. Even if there were no legal tender laws it would continue to be accepted.
What risks it's acceptance as money is that the US state is printing more of them. Legal tender laws allow the state to do this with more impunity than they would be able to otherwise.
Published: June 3, 2009 2:03 PM
Coury Ditch
This is easily one of my favorite articles. Thank you!
With irreverent pith you cover the most vital of topics: The market creation of money with intrinsic value; Aprioristic epistemology and the methodology of Austrian (good) economics.
All with great humor to boot!
You wrap your wisdom within contemporary topics such as our prison system, hospitals, and oil markets.
Bravo! Very insightful and entertaining. So much said in such little space.
Published: June 3, 2009 2:25 PM
Mike Sproul
cy:
The fed might overpay for assets, or it might lose assets through its costly operations, or it might simply choose to maintain financial convertibility at a lower rate than its assets can support. The dollar would lose value from any of these causes.
You can convert your dollars into US government bonds, which are in turn backed by taxes. Most people don't think that they will ever be able to demand gold from the fed. Do those people believe that the fed will never sell its gold for dollars? If it did, it would be maintaining physical convertibility--just not at the customer's option.
Mashuri:
Remember: Prior to 1933, the fed suspended convertibility every weekend. Over the weekend the dollar was still backed by the fed's assets, but it was inconvertible. The dollar was not fiat or semi-fiat over the weekend. So now the weekend has extended to 76 years. The gold and bonds are still held by the fed. The bonds are regularly used to buy back some of the dollars. A true fiat money would be issued by a bank that has no identifiable assets. There has never been such a bank, because there is no such thing as fiat money.
Current:
Standard monetary theory, which is not very different from Austrian theory, says that fiat money has value because of supply and demand. Government limits supply, while people demand it for the liquidity it provides. As rival moneys are issued, the demand for the fiat money would fall and it would lose value, with no stable value short of zero.
Mexico obviously can't stop US dollars from being used there, legal tender or not. Standard monetary theory gives us no explanation of how the peso holds its value in the face of competition from the dollar. But the real bills doctrine gives the simple explanation that the value of the peso is determined by the assets and liabilities of the mexican central bank.
Published: June 3, 2009 3:05 PM
BioTube
A piece of paper has value because of what it represents. Drawing rights on gold is one thing that can give it value, the fact that you lose your house if you don't pay the government so many notes is another.
Published: June 3, 2009 3:24 PM
2nd Amendment
I wonder what "wealth" do prison guards create ?
I wonder what kind of "work" do prison guards accomplish ?
I wonder if any prison guard can look at himself in the mirror with a straight face before going to bed and say to himself, today I contributed to society, today I contributed to make this world a more prosperous world.
Prison guards are useless and contribute nothing to society. I would be totally depressed if I had to "work" as a prison guard.
A prison guard produces no wealth whatsoever and is a parasite to society in my own opinion.
A prison guard is nothing but destruction, I don't see any construction, creativity, innovation, I don't see any use of brain power.
Prison guards are pure tax eater and all their salaries are just pure loss of money for the taxpayers.
Let the taxpayers arm themselves and defend themselves from criminals and let the prison guards find a real productive job that will increase the economic output of society.
Free and stop harassing the false criminals, all those who smokes weed and evades taxes etc.
And let the true criminals eat lead !
Published: June 3, 2009 3:25 PM
Alex
Mike Sproul:
A government prints up $100 of big pieces of paper (Gov bonds) and $100 of little pieces of paper (bank notes). The government then creates a central bank with balance sheet as follows, and, by the way spends the $100 of bank notes on goods and services:
Assets: $100 gov bond; Liabilities: $100 issued bank notes
By doing these machinations, the gov has obtained goods and services from the public out of thin air (okay, printing big and little pieces of paper). The amount of goods and services the government has so acquired, of course, is precisely the amount of tax that has been imposed by these actions. The tax is spread over the population by the price increases that will occur from the money supply (bank note) increase. (Let's not bother with a banking system to unnecessarily complicate things.)
Now if we burn the gov bonds held by the central bank as well as its balance sheet, the government will still have the goods it acquired by this process from the public and the bank notes will neither lose or gain value by the fire. The tax is imposed at the time the government acquires the goods from the public, and the price increases for goods is how the tax is paid as well as determining who in the public pays the tax. None of this process depends on whether the central bank has any government bonds or even bothers to keep a balance sheet.
Published: June 3, 2009 3:28 PM
2nd Amendment
BioTube,
"the fact that you lose your house if you don't pay the government so many notes is another. "
That's why I don't own a house under my own name and that's why I stash my gold in a safe hiding place.
Government tax liens on property is a big disencentive and big deterrence to buy property.
Government should not be allowed to seize your property because you "owe" them tax money.
I don't owe the government anything, but they owe me, my freedom, my property and my wealth to leave us the fuck alone !
Published: June 3, 2009 3:33 PM
David K. Meller
As life and work in what used to be the "land of the free" comes to resemble prison life for everybody, and fiat "money" continues to lose purchasing power and utility, one may wonder if this presages our future in more ways than one.
It isn't that hard for governments--even democracies--to turn the countries that they govern into prisons. Look at the former USSR, their prison-state colonies in Eastern Europe, Nazi Germany, and most African countries after so-called independence. The only difference is that convicts in prison know that they will be released at the end of their sentence (or earlier for "good behavior") whereas subjects of governments are imprisoned for life.
PEACE AND FREEDOM!!
David K. Meller
Published: June 3, 2009 3:40 PM
2nd Amendment
A factory worker assembling brooms and umbrellas is producing net wealth for society.
A computer programmer developing software to optimize the plant's production is outputting a lot of wealth for society.
A prison guard harrassing and intimidating a "criminal" who's in jail for possessing marijuana produces absolutely NOTHING of value for society.
He is wasting the hard earned tax dollars of productive citizens only to harrass and destroy non-criminals.
The "work" accomplished by prison guards do not increase the wealth of society. There is no capital increase and in fact there is capital decrease after the prison guard performed his "work".
True criminals, those who rob and kill need to face their armed victims and rot in the graveyard, not in prison.
Being a prison guard must be worse than being an inmate from a moral and justice standpoint !
The prison guards, who harrass non-criminals, are true criminals themselves.
Who's the victim when a junkie smokes his joint ?
Who's the victim when a prison guard batters and intimidates an inmate ?
I thank God everyday I am not a prison guard. I'd rather gather chickens and hogs than be a prison guard.
And somehow, I feel police officers too don't contribue to society.
There is absolutely nothing that a police officer does that a private citizen cannot do himself.
This whole thing about police officers protecting the citizen is complete bullshit. Citizens are best protected by packing heat than packing a cell-phone.
And cops represents the biggest threat to citizen's freedoms and safety. Cops can very well turn against their own citizens for whatever reasons dreamed by the government.
The Waffen-SS were a POLICE force !
I truly believe that the police exist only to protect politicians from angry and disenfranchized taxpayers, and to loot the reluctant taxpayers.
I also absolutely HATE the power trip and superiority complex the police have. I see that the police "service" attracts the worse of society's elements just like manure attracts flies.
The police exist only to rob citizen's from their freedom to protect themselves. The police are not in the business to protect the citizen and more often than not the police assault and brutalizes the citizen.
I'd feel safer and happier in a world without cops. In such a world I could keep my entire paycheck and send to heaven any criminals who dare attacking me.
Also, a world without police officers is a world where you could express your emotions and frustrations without feering the psychiatric ward nor psychiatric labels.
Published: June 3, 2009 3:46 PM
Mike Sproul
Alex:
Those bonds are backed by taxes. Think of a landowner who buys groceries by writing up an IOU promising 1 oz of silver. The landowner accepts his own IOU's for rent payments, so people will value them and use them as money. Now, if that landlord issues a bond worth 100 oz (backed by a lien on his land) then he could subsequently issue 100 of his 1 oz. IOU's and use them to buy back the 100 oz. IOU. The 1 oz IOU's are now backed by the bond, which is in turn backed by rents. Change 'landowner' to 'government', and 'rent' to 'taxes', and you have the right picture of our so-called 'fiat money'.
Published: June 3, 2009 4:24 PM
haragan
I guess looking at what actually happens in prisons is 'not' considered empirical verification
Published: June 3, 2009 4:34 PM
Thinker
As Mises described, money is the result of optimization of both widespread acceptance and containment of value, the most valuable commodity that everyone will accept (although subdivisions occur as money becomes more and more valuable and small transactions require smaller units of value). Traditionally, this has been gold because its scarcity gives it value and its utility is approximately the same for all individuals (goldsmiths excepted). Of course, gold is rather bulky and heavy, so paper money developed to represent that value. The benefits of paper money are limited to convenience and use as kindling, and these are nullified by the time and effort necessary in converting to back to gold (humans prefer present goods to future goods, remember?).
Fiat money comes about only through the instrument of government, which forces consumers to accept its standard of value. The government declares that the paper money it prints is the most valuable and universally valued commodity, and anyone who disagrees is subject to punishment. This is obviously just asking for a revolt, but as long as most people are cowed or duped into acceptance of the fit money, the government retains its ever increasing power.
Published: June 3, 2009 4:50 PM
Alex
Mike Sproul:
Mike, the landowner cannot himself money. When the landowner buys his back his 100 oz bond with his 100 1 oz I.O.U.s that are functioning as a medium of exchange, the NET RESULT is that he owes the outside world 100 1 oz of UNSECURED DEBT (represented by the 100 1 oz I.O.U.s).
When a central bank issues $100 of bank notes, this too represents unsecured debt. But here is the difference. The landowner will redeem the his I.O.U.s for rent. At least people believe he will; if he does not, then he has effectively taxed those who hold these worthless I.O.U.s.
A central bankès (sorry, I canèt seem to get apostrophes on my keyboard at the moment), bank notes (actually, the entire monetary base of a modern central bank) represent perpetual unsecured debt to the public. The other term for government issued perpetual interest free debt to acquire goods and services from the public is a TAX.
When a government issues bank notes, either through a central bank or directly, the bank notes represent a tax that has been levied. Those who pay the tax are those who are hurt by the ensuing price increases. But the tax occurs at the very moment the government spends the proceeds of the bonds it sells to its central bank.
Whenever the government acquires goods and services from the outside world is when taxation occurs. Hence, the nonsense President Obama is creating when he spends and says that taxes wonèt go up very much. The taxes have already occurred; itès only a question of who pays them.
Published: June 3, 2009 7:37 PM
Mike Sproul
Alex:
The 1 oz. IOU's must be secured by claims to the landowner's wealth, or else nobody would value them. They are not unsecured debt.
The government will accept its dollars for taxes just as the landowner will accept his IOU's for rent. No doubt a lot of people would call his IOU's fiat money, on the spurious grounds that they are not convertible directly into silver.
Money issued by a government will only lose value if the issue of money has outrun the government's assets. Thus there does not have to be an 'ensuing price increase'.
Published: June 3, 2009 8:34 PM
P.M.Lawrence
Mike Sproul wrote "The government will accept its dollars for taxes just as the landowner will accept his IOU's for rent. No doubt a lot of people would call his IOU's fiat money, on the spurious grounds that they are not convertible directly into silver."
That is a straw man. The test of whether it is fiat isn't whether it's not directly convertible to silver, but whether the only underpinning of the value - the things without which it would have no value - are the government or whoever saying "you must do these things", usually "you must pay taxes with this stuff". Once you have that, many people can (say) buy silver with it, but only by literally passing the buck to others who give it up; the silver isn't doing the support, even indirectly.
Published: June 3, 2009 9:27 PM
Mike Sproul
PM Lawrence:
There is no important difference between the government saying 'You must pay taxes.' and the landowner saying 'You must pay the rent'. Either of those things can back money money, and it is that backing that gives it value, whether or not the money is convertible into silver. We might actually agree on this one. (!!)
Published: June 3, 2009 10:25 PM
Stephen Yearwood
I heartily endorse Kevin's suggested change (quite a few posts back) to the title of the article.
Prisons make for a more interesting economic system than anyone has realized. The money supply is democratically distributed: Everyone gets the same (in the official distribution, anyway). There is then a free-market system in which supply and demand determine prices. The really important thing is that the money supply is an exogenous variable, and cannot be changed by anyone in the 'economic system'. Whether a money supply is metal, backed by metal, or purely fiat currency, if it can be arbitrarily manipulated, that is a problem. If it can't be, then the other variables adjust to it, and we have neutral money (which was always the Eldorado of the Austrian economists). With neutral money, there can be no cycle of expansion/contraction.
If anyone is interested, I've developed an economic model based on a democratically distributed income that has neutral money. There would be no limit on how much money one could earn (the democratically distributed income would not be the only way to earn an income) or how much property one could acquire. There would be no transfer payments of any kind. There would be no taxes of any kind. Government would be more minimal than it has ever been. Also, there would be at least a chance for environmental sutainability and no involuntary unemployment or poverty--not that there's anything wrong with those things. Really, what's not to like? (There's more at ajustsolution.com)
Published: June 4, 2009 6:58 AM
cy
(I don't know if this conversation is still going on, but I'll give it a shot.)
Mike-
You did not answer my question regarding convertibility for average citizens. Also, while I agree that the fed does regularly swap dollars for assets (bonds), to my understanding they only do so at their whim. Put differently--the fed may transact with private parties, but only when it wants to. The fed can call JP Morgan and ask for prices, but JP Morgan cannot call the fed. (I may be very wrong about this, but this is my understanding. Regardless, even if JP Morgan could call the fed for prices, the fed could always quote ridiculous wide prices, rendering JP's attempt at convertibility useless.) Therefore, this convertibility you say the fed maintains is completely an illusion. This would be like using a bank who does not allow you withdraw or deposit when YOU want to, but only when IT wants to. That's clearly an absurd situation, and no one would use that theoretical bank unless he was compelled to do so by law.
Published: June 4, 2009 8:42 AM
ganpalou
The article shows tremendous promise, but is terribly flawed. There are some useful basic assumptions which may generalize to economics, but they must be correct at the start. I do not know if the authors conception of Austrian economics is correct, but his conception of prison economy is whacked. I am reminded of the disagreements between the old fishermen in San Francisco whom I knew in the '60s; those from Naples arguing with those from Palermo (I suspect that many were communists tossed out by Il Duce, and many were, by admission and war stories, rum-runners during prohibition.) The Napolitano's argued that money buys power; the Polermo's argued that power attracts money.
The first assumption which must be dealt with is the prisoners' universal claim to "not trust anyone;" after all, they are all criminals. Trust may be limited, but prisoners are compelled to trust others with their lives daily. There are simply not enough individual cells to avoid people living with people that they hate. Generally, only those who are hitting and stabbing hard enough will get an individual cell. So the prison economy is based on trust.
Second assumption, the equivalence of money and power is expressed at various levels:
"Inmate accounts" are controlled by a designee of the warden. They provide the official infusion of capital to run the economy. Deposits to the accounts are generally made by family or others who may be the first victims when the inmate is paroled. There is no control over the amount of extortion involved in these accounts. Other creative enterprises fund these accounts.
Rents are charged to inmates who do not have power. An overlooked truth in prison and gang dynamics is that gang members are the "first victim" of the leadership. The gang members may call it loyalty, but they can call it any thing they want as long as they pay up. Anything that belongs to the member belongs to the leader.
Prison jobs are assigned with approval at the captain's level or above, and the current holder of the job often gets to name his successor. Laundry distribution is one of the most powerful prison jobs. An inmate who consistently receives new laundry has power, and is paying for it in some way. If your laundry roll contains size 28 tidy whiteys, you are going to have a bad day. The inmate electician's helper has the same bureaucratic power as a manager of the Department of Energy; he will influence the schedule of repairs according to the power of the customer.
The "scarcity" and price of sex, drugs and gambling (debts) is dictated generally by staff surveillance. Inmate control of means of settlement is a form of capital exercised by the powerful. They are fungible, and exchange traded. The "brokerage house" may only have custody of a "blind spot" where accounts can be settled. Accounts may be settled in the community.
Soups, cigarettes, mackerels, etc. are pocket cash, as available as credit cards to consumers, and burn the capital of the inmate accounts. But these items are seldom exchanged for power. They are too available, and are approved by policy.
So we have an economy in which consumption is approved at the staff surveillance level. But we also have an economy wherein the stability of a balance of power is maintained, even if illicit. And all of this is maintained in the trust that the inmates and staff will not kill each other willy-nilly.
Prison is not so different from the nation state. I personally prefer an economy of trust, wherein I can accept the official medium of exchange, and do not have to see the other fellows gold before and during the transaction. Failing that, I prefer an economy wherein the other person will complete the transaction with gold, and I dont have to fight him for it. An economy based on hot lead is the least desireable to me.
Published: June 4, 2009 9:36 AM
Current
I think Mike Sproul's arguments have been handled well by others. But, I'll answer the post Mike addressed to me.
Mike Sproul: "Standard monetary theory, which is not very different from Austrian theory, says that fiat money has value because of supply and demand."
Yes, that is correct.
Mike Sproul: "Government limits supply, while people demand it for the liquidity it provides."
Yes.
Mike Sproul: "As rival moneys are issued, the demand for the fiat money would fall and it would lose value, with no stable value short of zero."
Not necessarily. Only if the rival moneys are better in some way to the fiat money already in employment. As long as sellers continue to accept the older fiat money it is not under threat. Those sellers will accept the money so long as others continue to accept it. It is a network phenomenon.
What would challenge an accepted fiat currency would be inflation. If another form of currency provided more security it would be more attractive to hold. That other currency would have to provide many of the services of the original fiat money too, it would have to be widely accepted.
I agree that in the long term fiat currencies are not stable.
Mike Sproul: "Mexico obviously can't stop US dollars from being used there, legal tender or not."
Of course they can. They can, for example, imprison anyone who uses anything else. This is what was being done in Zimbabwe until recently, for example.
It can also require that taxes are paid in Mexican Pesos.
Mike Sproul: "Standard monetary theory gives us no explanation of how the peso holds its value in the face of competition from the dollar."
Of course it gives an explanation. The peso is widely accepted as currency in Mexico. The holder of pesos may buy almost any good for sale in Mexico.
Mike Sproul: "But the real bills doctrine gives the simple explanation that the value of the peso is determined by the assets and liabilities of the mexican central bank."
But you must explain *why* the assets and liabilities of the mexican central bank are important. If this supposedly important factor gives the currency value then why is it never discussed by ordinary people? Why are central bank bond holdings hardly ever discussed in the financial press?
Published: June 4, 2009 9:52 AM
Alex
Mike Sproul:
Okay, Mike, let me try a different approach. Suppose an isolated island uses only barter in trade. The island produces 95 baskets of goods and services each year. One day, the island elders decide that they will print up 1,000 $1 bank notes to be used as legal tender. The labor time saved in using the bank notes as a medium of exchange (as opposed to bartering) is used to produced 5 baskets more goods and services each year. Suppose that any additional bank notes would save not save any more labor time and thus have no additional real value.
The real value of the existence of the $1,000 money supply is thus 5 baskets of goods and services. In other words, the value of (price of) each basket of goods and services is $1,000/5 baskets = $200 per basket.
A new group of elders is elected and they issue $1,000 more bank notes. The total money supply is now $2,000.
Since the additional money issue has no additional real value, the total money supply of $2,000 is worth exactly 5 baskets, as was the old money supply of $1,000. Each basket of goods and services is, in other words, now worth $2,000/5 baskets = $400 per basket.
The above result holds whether or not there is a central bank and whether or not a central bank goes through the fiction of "backing" its money with elder committee (government) bonds.
Published: June 4, 2009 10:05 AM
Alex
Regarding my example, if it is of any interest how the bank notes get into the island economy, suppose they are simply handed out to the residents on an equal per person basis.
Published: June 4, 2009 10:37 AM
Current
A further comment on the discussion comparing a landlord to a government.
Mike Sproul: "The government will accept its dollars for taxes just as the landowner will accept his IOU's for rent. No doubt a lot of people would call his IOU's fiat money, on the spurious grounds that they are not convertible directly into silver.
Money issued by a government will only lose value if the issue of money has outrun the government's assets. Thus there does not have to be an 'ensuing price increase'."
Here Mike is conflating credit money with fiat money. These are different things.
Credit money is a type of money backed by some sort of debt. This type of money have occurred frequently in history. For example, I could issue IOUs for beer payable at a certain time. If I am reliable enough in fulfilling them they could be accepted as currency.
The issuing of new credit money need not cause price inflation. I must hold assets that I can convert into beer, or hold beer directly. In this situation, if I were a brewer I could request that those who buy from me use my credit money. However, that doesn't mean that anyone else has to deal in them.
The situation with government is different. As Jonathan Friedman would say, we have "no exit" from the state. We must deal with them, there is no choice.
A landlord or brewing capitalist who issues credit money then dilutes it will find the money falls out of favour. The state is not similarly limited, it can force people to pay taxes. It can prevent people from leaving and prevent currency and assets from leaving.
So, the state need not back it's fiat currency in any meaningful way. Alex describes the inflationary way that the state does back it's currencies.
Published: June 4, 2009 10:54 AM
Current
Alex: "Regarding my example, if it is of any interest how the bank notes get into the island economy, suppose they are simply handed out to the residents on an equal per person basis."
What you describe is quite similar to some sorts of local currency scheme. A fiat currency is invented. A set of parties agree to take it as payment. Each of them are given an amount of the new currency.
Most local currencies schemes don't work this way however.
Published: June 4, 2009 10:59 AM
Mike Sproul
cy:
One bank might issue and IOU that is redeemable at the customer's option, while another might issue an IOU redeemable at the bank's option. Both will have value. Financial securities that pay at the issuer's option are fairly common. The fed's dollars are redeemable at the fed's option. If the fed redeems at a high rate, the dollars will have a high value, and vice versa.
Published: June 4, 2009 12:34 PM
Mike Sproul
cy:
One bank might issue and IOU that is redeemable at the customer's option, while another might issue an IOU redeemable at the bank's option. Both will have value. Financial securities that pay at the issuer's option are fairly common. The fed's dollars are redeemable at the fed's option. If the fed redeems at a high rate, the dollars will have a high value, and vice versa.
Published: June 4, 2009 12:35 PM
Ron
Mike Sproul,
So the number of dollars that individuals are willing to accept for goods and services has no bearing on the value of the dollar?
Published: June 4, 2009 12:41 PM
Julien Couvreur
"... a penitentiary does not include a warehouse issuing receipts for cigarette packs or cans of mack.If they ever do, we know what will follow: ..."
There is a difference between paper receipts and legal tender. Why do you think that any receipt system would be doomed?
Published: June 4, 2009 2:25 PM
Current
Mike Sproul: "One bank might issue and IOU that is redeemable at the customer's option, while another might issue an IOU redeemable at the bank's option. Both will have value. Financial securities that pay at the issuer's option are fairly common."
Yes. Austrians would describe the former as fiduciary media or possibly credit money. The latter doesn't have a clear designation in Austrian terminology.
Mike Sproul: "The fed's dollars are redeemable at the fed's option. If the fed redeems at a high rate, the dollars will have a high value, and vice versa."
If you want to persuade us then explain how that follows.
Published: June 4, 2009 2:39 PM
Current
Mike, let me see if I've got this right....
The Fed have not redeemed any paper dollars for decades. Most of their assets are denominated in paper dollars.
You are saying that the market values these paper dollars because there is the hypothetical possibility that they will be redeemable for bonds at some later date.
By what reasoning do you come to that conclusion?
Published: June 4, 2009 2:46 PM
Alex
Mike Sproul:
Since you didn't respond to my last argument for the value of money, let me respond to another one of your statements. You said, "Money issued by a government will only lose value if the issue of money has outrun the government's assets. Thus there does not have to be an 'ensuing price increase'."
Are you saying that the price level increases in Zimbabwe occurred because Mugabe did not print up enough Zimbabwean government bonds to hand over to the central bank while the central bank was busy printing money?
Published: June 4, 2009 3:22 PM
Mike Sproul
Current:
If anyone, including a government, issued a piece of paper promising 1 oz. of silver in 1 year, that paper would sell for about .95 oz. today. Anything higher or lower would lead to arbitrage opportunities. If anyone issued a piece of paper promising zero next year, that piece of paper would sell for zero today. Anything higher, and there would be arbitrage opportunities. That's why I say that the value of so-called fiat money can't rise above zero.
People spend US dollars in mexico all the time. I've never heard of them being arrested for it.
Why do assets and liabilities matter? Because assets are what allows any institution to back up (or buy back) its liabilities. No one doubts that assets and liabilities determine the value of corporate stock and bonds. Why do you doubt that they determine the value of money? And why do you accept a theory that asserts that worthless pieces of paper can have value just because the government limits their supply? You are rejecting the sensible theory while embracing the crazy one.
Credit money and (so-called) fiat money are not different things. They both have value equal to their backing.
If it is taxes that give money value, then those taxes are backing money just as the landlord's rents back his money. But it's backing just the same. If the state lost the ability to collect taxes, its money would lose value.
If the fed maintained physical convertibility (at its option) then if the fed redeemed at a high rate (1 oz./$) then the dollar would be worth 1 oz. If the fed redeemed at a low rate, (.5 oz) then the dollar would be worth .5 oz. With financial convertibility, if the fed starts buying back dollars with bonds when the dollar drops below 1 oz, then the dollar will be worth 1 oz. If the fed only starts buying dollars with bonds when the dollar drops below .5 oz., then the dollar will be worth .5 oz. Like I said: high rate, high value.
This is explained in more detail in my paper "There's No Such Thing as Fiat Money", which you can find by clicking my name above.
Published: June 4, 2009 9:20 PM
Mike Sproul
Alex:
Your island money has no backing, so it will have no value. If the elders announced that they will accept the paper money instead of coconuts when collecting taxes, then they'd be worth 1 coconut, assuming the elders maintained adequate assets to buy back the money they have issued.
The inflation in zimbabwe happened because the government bonds (which backed the money) lost value, at the same time that the central bank issued new money without increasing its assets in step with the money.
Published: June 4, 2009 9:28 PM
Mike Sproul
Ron:
"So the number of dollars that individuals are willing to accept for goods and services has no bearing on the value of the dollar?"
You might as well have asked "So the number of shares of GE stock that it takes to buy a bike has no bearing on the value of GE stock?"
or
"So the fact that it takes 10 shares to buy a bike has no bearing on the fact that 1 share will buy 1/10 of a bike?"
The one value is defined by the other, but the share value is determined by GE's assets and liabilities.
Published: June 4, 2009 9:37 PM
cy
(sorry to keep this going, but I feel we're close)
Mike-
Your answer to my question of conversion optionality leaves me HIGHLY dissatisfied.
You state-
"One bank might issue an IOU that is redeemable at the customer's option, while another might issue an IOU redeemable at the bank's option."
This is 1000% false.
Some definitions- IOU means I Owe You. I think you know what the words "I" and "You" mean, but "Owe" means "to be under obligation to pay or repay." Therefore, an IOU implies there is an obligation for the "I" party to be repaid by the "YOU" party. Once you grant the "YOU" party an indefinite option to repay, there is no longer any obligation, and therefore the fundamental structure of the IOU is completely destroyed.
You further state-
"Financial securities that pay at the issuer's option are fairly common."
This is one trillion % false. In fact, I'd challenge you (or anyone) to name one. Think about it- were you to loan your neighbor $10k, would you ever stipulate that the neighbor can pay you back whenever he feels like it for the rest of time?? Even if the neighbor promised to pay you back an infinite amount of interest on this loan, you'd be foolish to accept these terms, because it's obvious to everyone that the neighbor would simply never pay you back. Perhaps you are thinking of callable bonds, in which the issuer can elect to pay the back the principle whenever it (the issuer) wants, BUT callable bonds certainly stipulate a date by which the loan MUST be paid back (again, an obligation.)
I'm sorry, Mike, but a loan, with no legal obligation for repayment, is not a loan--its charity. The fed, obviously, does posses some real assets that I suppose could loosely be thought of as a sort of backing for its liabilities, but since the fed doesn't have any obligation to ever deliver assets to the liability holders, the liabilities may as well be backed by nothing. In other words, we're dealing with fiat money.
Published: June 4, 2009 10:18 PM
cy
sorry, this paragraph should read like this...
Some definitions- IOU means I Owe You. I think you know what the words "I" and "You" mean, but "Owe" means "to be under obligation to pay or repay." Therefore, an IOU implies there is an obligation for the "I" party to repay the "YOU" party. Once you grant the "I" party an indefinite option to repay, there is no longer any obligation, and therefore the fundamental structure of the IOU is completely destroyed.
Published: June 4, 2009 10:25 PM
Mike Sproul
cy:
I had a discussion of this with Mike Rozeff (finance prof, SUNY) a while back. I've pasted his discussion of convertibility at the bank's option below.
Economically speaking, even though this kind of conversion privilege is often absent and
justifies the use of the description “inconvertible,” voluntary redemptions occur by other
means. Consider GM as a case in point. The stockholders cannot redeem into assets at will, so
GM stock is inconvertible in the standard defined sense. Suppose that GM has a tender offer for
the stock, or suppose that GM repurchases stock in the open market. Then GM exchanges its cash
(which is an asset) for shares that are voluntarily provided by those holders who wish to sell.
These processe create a kind of conversion, but instigated by the company. But since the
company is controlled by the stockholders, they are effecting a conversion. It is because these
processes can and do occur that we should broaden our concept of what convertibility means if
we are to undertand its possible influence or lack of it on value.
Banks do not have conversion of dollars for assets in the current setup. But when a bank sells
any of its assets in exchange for dollars, it is permitting its depositors to tender their cash
if they wish to. It is providing a means of conversion. Banks can buy bonds sold by the Fed,
for example, and in that way they convert dollars to assets held by the Fed.
These methods of conversion, by open market sales of assets, are economically significant. I
conclude that the dollar in fact undergoes conversion, albeit not by a traditional route of the
depositor having an option to convert at his will.
If the conversions are initiated by the company or bank, that gives it flexibility to choose
the time, manner, and amount. If it ties itself down to a particular and inflexible method of
redemption or of disgorging cash, that may not be as good for it. Companies in fact do tie
themselves down by making dividend payments, which is an alternative to repurchase of stock.
These observations add another argument to the notion that there is no fiat money. To the
extent that people have thought of fiat money being fiat partly because it is inconvertible,
the money is in fact capable of conversion and has been converted at the bank’s instigation,
not the depositors.
Published: June 4, 2009 11:39 PM
newson
to mike sproul:
another unfortunate analogy. if asset backing diverges long and far enough from market value, an investor with deep pockets will intervene and privatize the company. happens all the time.
Published: June 5, 2009 4:34 AM
Current
I find it rather worrying that in this day we still have to oppose such ancient falsies.
Mike Sproul: "If anyone, including a government, issued a piece of paper promising 1 oz. of silver in 1 year, that paper would sell for about .95 oz. today. Anything higher or lower would lead to arbitrage opportunities."
For a normal bond that is certainly true.
Mike Sproul: "If anyone issued a piece of paper promising zero next year, that piece of paper would sell for zero today. Anything higher, and there would be arbitrage opportunities. That's why I say that the value of so-called fiat money can't rise above zero."
That is wrong, you are ignoring the special properties of money. Money is unlike other goods.
Things would be the same if all goods were traded in a centralised manner. Imagine that we lived in a village. In the centre of the village there is a big board with all prices of goods written on it. On this board the bond would be valued as you describe. Fiat money would similarly be valued at zero. In fact money would be unnecessary. Direct barter would replace it entirely.
The situation is different in an "unorganized" economy. When something becomes money it must possess some sort of value. However, once it has become money that is no longer the case. The question to ask is: What concerns each person about their money? What an individual is looking for in money is to exchange it for goods. It is a form of security, it allows a person to provision for purchases they can't yet anticipate. So, what is important is that it is widely accepted. This is the service that money provides. It is not necessary that it be "redeemable" for any asset.
Certainly when I look at money I don't look at it as an investment. I don't think much about "how much will this money be worth in a years time", though I do think about it a bit. What concerns me is whether or not it will be accepted by places I want to shop. I think that those shopkeepers look at money the same way.
Read about the situation with Austrian Krone and Gulden in the 19th century that Ludvig Von Mises describes in the Theory of Money and Credit.
Mike Sproul: "People spend US dollars in mexico all the time. I've never heard of them being arrested for it."
Certainly. I don't think that taxes can be paid in dollars though. I think that outside of tourist places there are probably many shops that don't accept dollars. So, the dollar isn't a substitute for the peso.
Mike Sproul: "If it is taxes that give money value, then those taxes are backing money just as the landlord's rents back his money. But it's backing just the same. If the state lost the ability to collect taxes, its money would lose value."
You are attempting to confuse the issue. If a government could no longer collect taxes then the only form of revenue it would have would be the printing of money. The value of money would fall in advance of that event.
Also, once the state could no longer charge taxes then a free-market in money would operate. New forms of money could be created. This would take a long time, but it could be done.
This is not similar to the situation with a landlord. Unless that landlord was the landlord of a whole country. In that case the landlord is the government.
Published: June 5, 2009 5:13 AM
Don Lloyd
Current,
"The situation is different in an "unorganized" economy. When something becomes money it must possess some sort of value. However, once it has become money that is no longer the case. The question to ask is: What concerns each person about their money? What an individual is looking for in money is to exchange it for goods. It is a form of security, it allows a person to provision for purchases they can't yet anticipate. So, what is important is that it is widely accepted. This is the service that money provides. It is not necessary that it be "redeemable" for any asset."
This is exactly correct. Any money must have some initial non-monetary value when it starts to become money, but then establishes its own value as money from the demand of people to hold its purchasing power. A paper receipt can easily be valued initially by its backing, but this is only an intermediate step on the way to the paper acquiring its own monetary value without the backing. The purposes that money serves at any point in time have no need for the backing. The backing is only an aid in limiting the profitability of producing new money.
When someone receives a paycheck, it is allocated into three parts: consumption, investment, and the holding of a cash balance. Over a full pay period, the cash balance is run down to a minimum by both predicted and unpredictable purchases. By the last day of the pay period, the remaining cash balance may be seen as either too big or too small, if it has not been exhausted completely. The response to this is to either increase or reduce the cash balance allocation for the next paycheck as needed, at the expense of consumption and investment. This is what causes the unit exchange value of money to dynamically adjust to changes in the quantity of both money and goods.
Regards, Don
Published: June 5, 2009 6:28 AM
Mike Sproul
Newson:
The point of your last post is not clear.
Current:
Money is unlike other goods? You mean money is not subject to arbitrage? As soon as you recognize that there are competing moneys in the world, you should start asking how any of those moneys can be valued above its backing. The answer is that it can't, since arbitrage would eliminate any excess value. Governments are not all-powerful, and currencies can easily cross borders. When they do, they reduce the demand for any local so-called fiat money, thereby reducing its value to zero.
I assume you mean this passage from Mises:
"How could it come about that the government bonds, bearing interest at five percent, could be valued less highly than the non-interest-bearing currency notes? This could not possibly be attributed, say, to the fact that people hoped that the currency notes would be converted into gold before the bonds were redeemed. There was no suggestion of such an expectation. Quite another circumstance decided the matter.
The currency notes were common media of exchange—they were money"
The answer is that money does bear interest, it's just that money also has a cost of issue, and this cost normally eats up the interest. But people are willing to hold money anyway because of its liquidity services, while the same is not true of bonds. This is explained in my "No Such Thing as Fiat Money" paper. If the cost of issuing money is c%/year, then today's value of an IOU promising 1 oz. in 1 year would be 1/(1+r-c), and if c=r, today's value would be 1 oz. The money would thus appear to bear no interest. But the cost of issuing a bond is relatively small compared to its interest, so the bond will sell for more like 1/(1+r). Thus it is no surprise that the money sells for more than the bond, even though they are both claims on the same creditor.
Published: June 5, 2009 9:54 AM
cy
Mike Sproul-
Real life. I want you to take the following steps...
1. Contact the mises.org administrator and secure my email address.
2. Email me your address, and I'll email you mine.
3. Send me 1oz of gold.
4. Upon receipt, I'll send you an IOU for 1oz of gold, however the IOU will stipulate that only I can decide when the IOU can be redeemed. We can get lawyers involved so that this contract is totally legit.
Now, I'll have an ounce of gold, and you'll have a legally-binding piece of paper promising an ounce of gold at some undetermined time.
According to you, our respective net worth's have not changed, since that piece of paper is legally worth one ounce, and I now have one ounce.
5. Go on Ebay and try to sell that IOU. Make sure you make it clear that the issuer, and not the holder, will determine its time of conversion.
Again, according to you, after a frenzy of eBay bidding, you'd receive the exact market price of one ounce of gold (we will assume no transaction costs).
My guess is you'd receive far less than the market price for an ounce of gold, despite this IOU being completely "backed" by the gold you sent me. How could you possibly expain this?
Published: June 5, 2009 4:26 PM
Alex
Cy:
Gosh, I hope Mike Sproul answers your last post.
Published: June 5, 2009 6:12 PM
Mike Sproul
Cy and Alex:
I'll go you one better. I'll print up some green pieces of paper and promise to print only so many of them. As believers in fiat money, you would naturally be willing to hand me valuable goods for those papers, even though they have no backing.
Published: June 5, 2009 8:55 PM
Alex
Mike Sproul:
"I'll go you one better. I'll print up some green pieces of paper and promise to print only so many of them. As believers in fiat money, you would naturally be willing to hand me valuable goods for those papers, even though they have no backing."
I'm not sure what you mean by "believers in fiat money," but would the government please "only commit to print only so many of them" (actually, would they only commit to create so much of a monetary base." These green pieces of paper are money only because the government has decreed them to be legal tender. I and others accept these bits of paper only as long as I believe yet others will accept them in exchange for goods and services.
Published: June 5, 2009 9:18 PM
Alex
By the way, Mike, how about answering Cy's question.
Published: June 5, 2009 9:19 PM
cy
Mike-
For the record, I'm not convinced I'm on the right side of this argument. I'm simply reading, thinking, and commenting as things come into my head. As a professional trader, I'm constantly trying to explore new ways of thinking about money, relative values, etc., and you've exposed me to a new way of thinking about currencies... for which I thank you. Part of my process for learning new ideas is trying to try to poke as many holes as possible and see what sticks. If I've come off as snarky or dismissive, I apologize: it was not my intent.
Obviously, as I've stated, the fed, BOJ, ECB, etc. certainly do have assets on their balance sheets, so I do agree that currencies are not the completely unbacked "fiat currencies" they are often thought of. However, I'm still not convinced these currencies are all perfectly offset by central bank assets. It seems to me that if a gov't wanted to create a means of exchange it could freely debase, starting with a fully convertible currency and gradually closing off more and more convertibility options would be a pretty effective way to do it. Especially when combined with legal tender laws that make contracting in any other means of exchange impossible.
Published: June 5, 2009 10:18 PM
cy
Whoa, Mike, stop the presses...
http://en.wikipedia.org/wiki/Swiss_dinar
How does the real bills doctrine explain the iraqi swiss dinar? This was an out-of-print paper currency, endorsed by no government, and explicitly and obviously not backed by central bank assets that continued to circulate and actually appreciated against other currencies, simply because everyone knew more of the currency could not be printed.
I know that believing everything I read on wikipedia is not wise, but were this to be true, it'd be a damning condemnation of real bills.
Published: June 5, 2009 10:30 PM
Mike Sproul
cy:
The wikipedia article notes that the authorities eventually redeemed the iraqi swiss dinar for some other currency. Thus people valued the dinar because of this expectation, and the dinar was in fact backed by the currency into which it was redeemed. When the south lost the civil war, nobody expected anyone to redeem the confederate dollars, and they lost all value, as the real bills doctrine implied.
The real bills doctrine says that the value of money is equal to the value of the assets backing it. (If the currency were worth more or less, there would be arbitrage opportunities.) So if some government issued currency in exchange for assets, and then started squandering those assets, or otherwise removing them as backing for the money, then the currency would lose value.
Published: June 6, 2009 12:55 PM