Friday, February 27, 2015

Money Pays For Nothing

What most people still call "money" is just an IOU for me. It is not different in kind compared to any other IOU. IOUs are always created in the same way, and cash or deposits don't make an exception. They are not created "out of thin air", because they derive their value from the promise to pay and are thus backed by the credibility, or trustworthiness, of the debtor. This backing should not be confused with collateral, which is nearly always a Plan B -- an insurance. An IOU derives its ultimate value from the later payment in goods or services which is expected to take place.

"Money", or any other IOU, cannot pay for anything. To transfer an IOU to a seller is to transfer a promise to pay later. It can be the buyer's personal promise (that is, it is issued by the buyer) or someone else's promise (issued by a third party). In neither of these cases does it make any sense to talk about a payment in "money". Handing over an IOU constitutes a non-payment.

What makes picturing all the various debt/credit relations slightly complicated is that there's often at least one of two types of intermediaries* between the debtor and the ultimate creditor: a) a financial institution (for example, a commercial bank), or b) government. These two can be quite intertwined, so it is sometimes hard to keep track of private-private-private and, on the other hand, private-public-private -- remember, the government is us, the people, so the ultimate debtors and creditors can never be public institutions -- debt relations.
As I said, the value of "money", like of any other IOU, derives from a promise to pay later in goods or services. The value is not derived from people's beliefs -- for instance, from a baseless expectation of acceptance of "money" by others as a medium of exchange ("just because it has 'always' been accepted"). Whether people realize it or not, "money" ultimately serves as a medium-of-exchange and a store-of-value exactly because it's an IOU, and it has value just like any other (non-worthless) IOU has. Of course, both the actual and the perceived quality, or strength, of a promise to pay varies from one point in time to another, and it is issuer-dependant -- we are, after all, talking about credit. 

When the system is well governed these IOUs are widely trusted, and thus accepted, in the society. As a consequence of this wide acceptance, they work well as a liquid medium of exchange. Nevertheless, it is credit which enables this exchange, just like it enables nearly all trade. Eventually, "money" becomes so liquid and widely accepted that people forget that it is ultimately just an IOU and view it more like an article of faith.

We could think of this ultimate logic -- which goes unnoticed by most of us -- behind the value of "money" as a law of nature. We could compare it, say, to gravity. Thanks to the gravitational pull of Earth, people have been able to run fast for thousands of years without knowing that these gravitational forces existed. If we somehow managed to substantially lessen Earth's gravitational pull, we couldn't possibly expect people to run, and all kinds of machines to work, just as before. This much we know now, but we have not always known it. Way back in time, when we understood much less, we could have well imagined life to proceed as before even if the mass of Earth was greatly reduced.

To me, the Chicago Plan is about breaking the supporting law, or logic, behind "money". It's about removing its link to debt -- a link which ultimately gives it its value -- and hoping that people's mistaken beliefs about "money" remain intact. It doesn't make any sense to me. And I'm actually someone who mostly agrees with Michael Kumhof when it comes to the details of our monetary system and the grave problems we currently face due to the massive, global debt stock.

One could say I'm a dismal scientist. If, through theoretical reasoning, I cannot find any easy way out of our current mess, and I'm left with only bad options, I'm able to live with it. All I can do is hope I've got it all wrong and search even more intensively (this I have done), but I won't let myself be fooled to think that there must be an easy way out. Nothing tells me that there has to be one. Looking at all the easy answers our economists are trying to offer us -- "A depression reckons, unless you listen to me and follow these simple steps..." --, I must conclude that the dismal science is dead. But the ghosts of Adam Smith, David Ricardo and Thomas Malthus still live in me.

Epilogue, and a Prologue

Above I have explained how "money" works. George Friedrich Knapp (State Theory of Money, or Chartalism) and Alfred Mitchell-Innes (Credit Theory of Money) got the logic mostly right. But as far as I know, they didn't go on to develop a more comprehensive credit theory. They seemed quite happy to stay with monetary theory; to mainly explain how money is actually an IOU. I believe I have taken a leap forward by painfully unlearning "money". Forgetting "money" has allowed me to study a pure credit economy in a way Knut Wicksell could only have dreamt of. Our contemporary economy is of course in many ways different from the economy in Knapp's, Wicksell's and Mitchell-Innes's time. Without the unnecessary confusion that arised from the gold standard we can see much more clearly how we actually do live in a pure credit economy. In addition, the types of debt, and especially their respective shares of the total debt, are different today.

Here I have only scratched the surface of a General Theory of Credit, still concentrating on "money". Once we manage to forget "money", we can focus on how credit really works in the economy. We need to descend to the microeconomic level and study human psychology. Perhaps the most important concept there is what I call maturity transmutation.

* An "intermediary" refers here to an entity in-between the debtor and the ultimate creditor -- not someone who borrows or lends "money".

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