I want to make the case that thinking of money as a product specifically designed to be used as money and produced by a producer is often a useful perspective, and that this perspective remains useful for government created money. From this perspective, the Federal Reserve (a branch of the Federal government) is the producer of US dollars and the Chinese government is the producer of the yuán. This perspective grew out of my ongoing debate with Silas.
It is not difficult to imagine money which is not produced by anyone. An economy that uses pure gold in no particular shape uses money which is not anyone’s product. There might be gold miners, but they do not produce gold for use as money necessarily, and it could be the case that gold is simply found on the ground occasionally. It is also easy to see the drawbacks of such a money. If gold is in nonstandard lumps it must be weighed and purity tested for each transaction. It also means that people must keep a real resource that might otherwise be used for some productive purpose, so it may mean gold is not used in the optimal manner.
One can ameliorate some of these problems by using a similar but separate product specifically designed to be used as money. A sedan is serviceable for transporting lumber, but a product specifically designed for the task, such as a truck, is much better. Perhaps some bank or government will start minting standard weight and purity gold coins specifically to be used as money for a fee, and people will come to prefer using these coins to gold lumps, perhaps trading at a premium to gold lumps. Now these coins have become different product from gold lumps. The bank takes gold lumps and produces gold coins that have extra properties. These coins can meaningfully said to be the product of that bank or government and not the product of any other bank or government even if competitors produce very similar coins.
If such coins are to succeed it is important for it to bear the bank or government’s name or be otherwise branded. If the coins are not branded or brands are not respected, then it is easy for counterfeiters to ruin the product by producing similar but lower purity coins. However, it is important to distinguish between counterfeiting and merely competing products. A rival bank or government who mints their own coins with a different brand has produced a separate product, much as Gucci bags are not counterfeits of Chanel bags even if they look similar. If a competitor with a different brand produces lower quality coins, they will just ruin their product no one else’s.
This perspective applies very well to government monies. All government monies that I have seen bear a brand of that government (US dollars say “Federal reserve note”), and other people are not allowed to produce money with that brand. Some countries, including the US allow competitors, and some countries do not (link). Most central banks, including the Federal Reserve, turn a profit from their activities.
Most methods of improving a non-product money will involve making money into a product, for the same reason that most methods of improving wild tomatoes as a food source involve making tomatoes into a product. It is almost certainly optimal for most money to be product money.
One implication of this view is that it is meaningful to talk about the optimal level of money production by a bank or government, for the same reasons it is meaningful to talk about the optimal level of bread production by bread producers, there will be some level of production that maximizes welfare (and/or producer profits depending on your optimization criteria).
Another implication of this view is that government produced money is not necessarily special. It is possible that it is special because private producers can’t commit to appropriate production or because money production has some externality that private producers do not take into account, but this is something to be demonstrated rather than true a priori.
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October 25, 2010 at 12:28 pm
Silas Barta
First, some big-picture stuff: It’s clear from this post that you’re talking about a different topic than what originally got us into our disagreement. You’re basically saying that there are good ways to run a currency that can avoid inefficiencies. However, what originally got me on the topic of criticizing mainstream monetary economists (MMEs) was how they (and you) seemed to believe that this poor money policy the Fed has is preventing a recovery, and during the ’08 crisis it “hurt the economy” — properly defined, of course.
But from these comments, it seems like you diverge from them, in that you’re saying the issue of optimal money issuance is mostly orthogonal to our current economic problems: that yes, having a different monetary policy can improve efficiency; but unlike the MMEs I criticize, you don’t consider it the defining factor of why we can’t get out of this recession; nor do you believe that encouraging people to spend on things they don’t currently consider worth buying to be a good idea.
In contrast, MMEs, when talking at the most lay level, take it as a given that increasing the amount of money being lent or spent (preferably to its c. 2005 levels) is a good thing, something that will get us out of the economy — that changing bank incentives until they regard it as optimal to lend 4% is “better than nothing”. I have yet to see any layman-oriented writing from MMEs that recognizes the changes in any metric are only good to the extent that they reflect a better ability to collectively satisfy our wants.
Unlike you, I don’t think this is a case of “poor communication”. Rather, I think it reflects poor understanding: they have made the metrics an end in themselves, turning the concept of an “economy” into something more like a volcano god. Gene Callahan, someone I normally disagree with strongly, surprised me recently in making essentially the same point.
Long story short, any economy that is “hurt” by “too much saving”, or that requires people to keep spending on the same things and taking out the same level of loans … is not an “economy” I care about.
***
With that in mind, I want to discuss my area of agreement with you, and where I see the value of USD as ultimately coming from.
I find it helpful to think of the Fed as like Nintendo issuing Pokemon cards (or Wizards of the Coast issuing Magic: The Gathering cards, etc.). Ethically, there is nothing wrong with Nintendo having a monopoly on the right to issue Pokemon cards, and they must strike a balance between flooding the market with worthless cards, vs. making them so scarce no one can actually play. In that sense, there is an optimal supply of Pokemon cards.
The difference is in why money is valued. Unlike Pokemon cards, the ultimate valuation doesn’t come from the desire of people to play card games with USD. Rather (I claim), the value of USD comes from this:
1) Past debts have been denominated in USDs; people with such debts have an immediate use to put the USDs toward.
2) USDs can be used to pay taxes.
3) A large enough number of people value USDs for purposes 1) and 2) above so that most Americans are removed a few steps from such a person that they know their dollars can always be traded for real goods.
Now, if the Fed were simply conducting operations to keep USDs in optimal quantity to meet the needs as described above, I wouldn’t have as much objection to its operation.
But that’s not what’s going on. Rather than printing USDs to make sure that they continue to be used for commerce, they find themselves in the position of favoring certain activities over others. For example, when an institution is suffering liquidity problems that ultimate derive from a _real_ shortcoming, and the Fed lends them money on favorable terms, it is propping up an inefficiency, not eliminated.
Or when people currently regard certain production processes or output as crap and not worth buying, and the economy needs to fundamentally retool, the Fed (with support from its court economists) has shown a willingness to make whatever loans are necessary to keep existing businesses involved in these inefficient processes afloat, rather than letting market forces run their course.
Contrary to what you claim, the financial markets don’t simply route around such inefficient purchases — they can’t, as they rely on evaluations from the real economy. Rather, they change the apparent optimality of different processes. If a production process is a really stupid use of resources, then a committment by the Fed to make all the loans necessary to keep it in business will make it appear to be a good use of resources — and other businesses will retool around this inefficient enterprise, workers will optimize stupider and stupider skills to better interface with this process, etc.
I think that by focusing on whether free money is injected into the right places for an optimal monetary policy, you and MMEs are ignoring the effects on real production that this will encourage. I think that these policies keep us in an economic dark age.
Hope this is responsive to the issues you’re raising.
October 25, 2010 at 2:22 pm
jsalvati
I am a little confused by your comment, it seems mostly about our ongoing debate rather than about the point I made in this post. I didn’t mean this post specifically in that context. My intent with this was to discuss the more general question of what reference class you should use for money to start with and why. You seem to more or less agree with me on what kind of reference class you should use for starting to think about money (pokemon cards). If you meant the bulk of this post as a continuation of our ongoing debate, I would appreciate it if you reposted it in the main thread for that.
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