Locklin on science

A peregrination on the nature of money

Posted in philosophy by Scott Locklin on December 1, 2009

I’ve never studied economics. What I have read of economics appears to be ideology combined with bad math. Since so much of what passes for modern thought is annoying ideology combined with bad math, I try to avoid such unpleasantry. History, on the other hand, I always have time for. I would like to think using history to think about mysterious concepts like money is useful, but maybe not. It amuses me to do so in any case.

What is money? As I see it, money is a measure of economic output, which is used to create liquidity in markets, and which is backed by social agreement. Without money, you can’t buy things. If you can’t buy things, you’re stuck with your own economic output to make a living. Have fun dirt farming.

The earliest form of money was commodities. If you wanted a horse, you’d trade some grain for it. Later on, people learned to love silver and gold, and the rarity and density of these metals made them useful to trade for other things. The fact that gold was rare, inert and next to impossible to fake made gold that much more valuable than other materials as a trading instrument. The Lydians were the first to invent coin money in the 600’s BC. Coin money was a standardized mass of precious metal with a proof mark on it. People seem to think commodities are good hedges against inflation, and this is sometimes true, but, for example, Europe experienced hyper inflation in the 1500s and 1600s when Spain brought enormous gold hoards into the European economy. In a commodities denoted economy, if there is a sudden increase in supply of a commodity without an increase in economic output, inflation follows. Nobody did any more useful work, but there was more money. Therefore, you needed more money to buy a given amount of work, or anything else. If an increase in the supply of gold was accompanied by a similar increase in productivity, everything would balance out. For example, if your increase in gold comes from inventing the steam engine, you can use the gold to buy all kinds of other stuff made with steam engine productivity. On the other hand, if you only use gold for money, and experience a huge increase in per-capita productivity without an increase in the amount of gold, money doesn’t circulate freely; you get deflation. This means, holding gold is a better idea than spending it on stuff. This happened in the 1930s in America. This is why the 1930s sucked. This is also why people who want to return to the gold standard are insane. Gold works great when your society and economy doesn’t change much, but when it does, you need more flexible kinds of money. Another way to think of it: imagine your society has one hundred people with X pounds of gold. Now imagine hundreds more goldless people start to move in. Your gold becomes more valuable, so you’re less inclined to spend it as long as people keep moving in. That’s deflation. Now imagine your population of 100 people with X pounds of gold catches plague. The amount of gold stays the same, but the number of people who can do work gets smaller, so you get inflation.

A slightly different form of money is commodity backed money. In the old days, for example, the British Pound was backed by a pound of sterling silver. The first form of commodity backed money I know about was from ancient Sumeria, where they used clay figurines of goats to represent real goats. Between 1945 and 1971 (or 1973, depending how you count it), the US dollar was backed by gold reserves, though it was illegal for individuals to own gold reserves of their own, to prevent a run on the bank. Why? Because the Federal Reserve didn’t have enough gold in it to pay every depositor off. So, even though we used to have gold backed paper money, it was really just an idea of being paid off in gold. Between 1945 and 1971 nearly all forms of money in the world were based on US dollars. We had large gold reserves because we looted the world of gold as payment for WW-2. Since nobody else had any gold, and there really wasn’t enough physical gold, the convenient method of exchange was the dollar, as symbol of gold. The fact that all currencies were based on the dollar was not necessarily a good system for anybody (and it periodically had to be adjusted by moron economists: whenever it was, it caused huge problems), but it is an important historical fact. Commodity backed money is simple to understand. It’s just a convenient symbol for the stuff it’s backed by. In principle, it’s equivalent; just more portable. While people may look at that era as an, um, “golden era of hard currency, they somehow overlook the fact that the gold was a social fiction. I’m certain we didn’t have as much gold as dollars, though I don’t know how well this is documented, or even where it would be documented. The gold standard was really an idea, rather than a big pile of metal.

Another form of money is fiat money. That’s what we use now since the dissolution of the Breton Woods agreement. This agreement was broken in 1968, because the US was systematically devaluing its currency to fund Johnson’s “great society” programs, the Vietnam war, and the Space Program. Gold began to float against the dollar in 1971, basically because we didn’t have any more gold to keep up the social fiction. Now, US dollars are worth whatever you want to pay for them. In some ways, dollars are a bet on the US economy, which remains the largest, most stable and most productive in the world, despite all the present horrors. So, people still tend to base their currencies on dollars. Especially when they do a lot of business with America, which virtually everyone does. Problems can happen, however. If you export a lot to America, and your currency is fixed to dollars, you have to buy American debt. Which means, you’re buying your own currency, setting it on fire and sending America stuff in exchange for the currency you set on fire. This more or less works, until the debt becomes close to your GDP. Once the trade imbalance becomes severe, a correction is inevitable, and unfortunately for the holder of the bonds, they end up being worth a lot less. Fiat money is a bet that the US government will give you stuff if you give them dollars. Fiat money in America was originally issued by states to pay state taxes with.

Fiat money was not invented in 1971. America had gone on and off this type of money many times in its history. The glorious Song Dynasty in China invented fiat money in the 10th century. It was generally used by governments through out history when they wanted to fund large projects, like wars. It has many advantages over commodity backed money; for example, you can easily make more of it if your economy expands. If you have less money than you need to run your economy, you get big problems, like Great Depressions. Why buy anything when your money is a better investment than the economy itself? Currency which is a better investment than the economy itself is an abomination which negates its own purpose. Let that sink in: it is important and as far as I can tell, irrefutable.

If you have too much currency in circulation for your economic output, you get inflation, which is a sort of tax on people who have too much money saved up. Inflating currency on purpose can be done to avoid deflation; as the Fed is attempting now. Inflating currency on purpose can be done to avoid paying debts, as the Germans did after Versailles. You generally don’t want too much inflation, or your money isn’t worth anything (post WW-1 Germany), and so it isn’t useful for trade, but it is really just as harmful if money deflates even a little bit. When currency becomes more valuable over time, people will sit on their dumb pile of money, and nothing will ever happen. America and most of the world in the 1930s was an example of not enough money in circulation. One of the reasons the fascists (and, more obviously, the Swedes) did so well economically, is they issued fiat money. When you read the primary sources for the history of the Great Depression, you can see that all of FDR’s crazy ideas were ham-fisted attempts to create inflation without actually going into debt (Hoover was doing the same thing; I don’t know why he gets such a bad rap). The real answer was much simpler; create more money. When FDR did this to fund the destruction of Europe and Japan, the economy finally got better.

A prevalent but mysterious form of money is “credit money,” which is fiat money backed by banks, rather than by governments. People make a lot of noise about how credit money is some new form of supreme evil. Credit money is actually very old. Any time a bank would issue cheques or notes which were not backed by gold, they invented credit money. Now a days, banks issue credit money when they sell bonds. You can think of fiat money as a form of credit money issued by a government. But banks issue even more money by writing loans which are backed by bonds. In the old days, this was even more obvious: banks actually would issue their own notes. You might have “Wells Fargo dollars.” In more recent times, this sort of money is created by banks and hedge funds issuing derivative securities or exotic bonds, either backed by nothing, or backed by other securities; securities for which there may or may not be a market, and which may or may not have actual value. The use of credit money seems to help more than it hurts, as it allows private entities to create money when liquidity is needed by the economy to do things like, say, buy lots of stupid houses in the suburbs. Credit money is no different in principle than the government selling “war bonds.” You’re just funding different kinds of activity. Is it a bubble? Not a bubble? The way to answer the question is, is the credit money used for something worth investing in.

One of the little appreciated facts of American history: the Westward expansion was funded mostly by credit money. Banks and companies would set up shop with tiny gold reserves, people would use their money as currency, and the banks would regularly explode, making the issued money worthless paper. Why on earth would anyone back such a hare brained scheme? Simple, really: there was no other form of money available, because the government removed vast amounts of money from circulation in the form of greenbacks (fiat money which funded the Civil War) and silver notes. That, combined with the very real economic expansion brought on by new technologies and exploitation of new resources in the American West required much more money than was available. So, seemingly silly monopoly money was the only game in town. This caused problems to the people who held a lot of cash backed by an exploding bank, but it solved more problems than it caused, as it enabled markets, trade and economic growth at an important time in American history. You think derivatives are complicated? At the outbreak of civil war, there were over 7000 different kinds of Bank issued credit money in circulation in America; and there were no computers to sort this all out. Yet, America in that era was a Capitalist marvel; one of the greatest economic and industrial expansions of human history was funded on credit money. Sure, we were in the Long Depression but it was also the gilded age. “Funny money” works just fine, if your purpose is to get people to do useful work. The point of money isn’t to keep something in the bank like most people think: the purpose of money is to circulate. The “funny money” was used directly for what it is good for: people worked for it, and the fruits of their labor continued to exist after the money disappeared: aka, all of America West of the Mississippi. All the rail lines, mines, buildings, plumbing: they’re mostly still there. Sort of like all the houses, fabs and facebooks which were built in the 00’s, when that pile of credit money disappeared.

So, history indicates money is a measure of economic output backed by social agreement, which is used to create liquidity in markets. This sort of historical definition probably implies all kinds of other interesting questions, like what is a market, a bank, economic output, liquidity and so on. I’m not real interested in creating a school of economics, but it’s good to get to some kind of basic understanding of this sort of thing without looking through someone else’s blinders.

For a view into current events, I think Krugman is uncharacteristically spot on:
http://krugman.blogs.nytimes.com/2009/10/19/americas-chinese-disease-not-quite-what-you-think/

And on a lighter note:

34 Responses

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  1. eminence_gris said, on December 1, 2009 at 10:24 pm

    Terry Pratchett has a great take on this in Making Money, where his protagonist invents fiat money based on the economic output of golems.

    It is important to note that the protagonist, prior to his career in civil service, had been a con man. As always, the right man for the right job.

    • Scott Locklin said, on December 2, 2009 at 4:06 am

      Har, got to love the protagonist name, ” Moist von Lipwig.”

  2. Marci said, on December 1, 2009 at 10:37 pm

    I’ve never studied computer science. What I have read of computer science appears to be programming combined with bad math. (See what you did there?)

    Honestly, economics is a pretty wide field to dismiss with platitudes. Whereas in econometrics and game theory you get no ideology and hard math (and “good” math because results are verifiable), in macroeconomics you get few results that can be properly falsified, and thus few ideology-free policy prescriptions. (Few experimental macroeconomists are as daring and reckless as Mugabe…)

    On your essay on “funny money” — I don’t think it would be particularly controversial or novel for most economists or economic history students. The only ones who would disagree are “Austrian” economists, a (very vocal) fringe group among economic professionals. Mainstream economic theory, be it of Keynesian, Monetarist or Neoclassic origin, would very much agree with your assessment of fiat money.

    • Scott Locklin said, on December 1, 2009 at 10:58 pm

      Well, I wouldn’t disagree with you at all that computer science is programming combined with bad math. I’d also say computer science is ideology and bad habits combined with bad math. I think that’s a fair and honest outsider’s view, and I’m trying real hard to be fair and honest about economics.

      You can see my dilemma with the different schools of economics. Here you are, telling me I am somewhat in agreement with various ancient and accepted orders of economic theory, and the other guy who posted below tells me I’m full of beans because I haven’t considered them Austrians. Who am I to believe? You both have read more economics than I have.

      I don’t think I need to believe in any of them, as I think they’re all full of baloney. I want to puzzle things out on my own without accepting anyone’s ideology, because “ideology is bad, m’kay?” This is a humble attempt to do so.

    • jz said, on December 4, 2009 at 6:21 pm

      Its a mistake to think that writing off CS as a wreck to a programmer is going to make them defensive. You’re going to get: AND HOW!

      • Scott Locklin said, on December 4, 2009 at 8:53 pm

        Man, that’s a timely remark for this morning. Try saying something bad about an open source package in a public forum.

  3. kkrev said, on December 1, 2009 at 10:37 pm

    Any writing on the subject of money and banking that doesn’t address Austrian business cycle theory is pretty silly. Fiat manipulations of the money supply clearly produce booms and busts. If one doesn’t understand the depression as a consequence of earlier manipulations one develops wrongheaded ideas about deflation. In any case, reluctance to spend during the depression had as much to do with the New Deal as anything else. The government was doing progressively more crazy things that crippled the economy, which induced rational panic and hoarding of cash.

    Much of this essay seems to conflate fractional reserve banking and gold convertibility with commodity money. With true commodity money one ounce of gold is “enough” to run the world economy forever, no matter the growth rate or population.

    I don’t follow your claim that volatile “funny money” worked fine just because plenty of it was in use during a large economic expansion. It’s just as valid to claim the expansion would have been greater and with fewer hiccups had currency been more sound.

    Click to access historyofmoney.pdf

    • Scott Locklin said, on December 1, 2009 at 10:49 pm

      Maybe that’s true. Anyway, I like to try to figure things out without other people’s ideas influencing me. Maybe I’ll read ole von Mises one of these days, but I don’t care to right now.

      I’m pretty sure the long depression could have been avoided with different monetary policy. The thing is, during that era, the official money was completely “sound.” It was so sound, there wasn’t enough of it to do all that needed to get done, and people had to invent new kinds of money which were not necessarily sound.

      • Keely said, on December 2, 2009 at 12:42 am

        I don’t consider myself an “Austrian” and frankly consider many of the contemporary adherents to “Austrian” economics to be religious fanatics. And I generally steer clear of their giant online circle jerk over at Mises.org.

        But Ludwig von Mises’ The Theory of Money and Credit is definitely worth reading, especially if you’re interested on the nature of money. Some of the other major “Austrian” works are well worth reading as well.

        • Scott Locklin said, on December 2, 2009 at 12:57 am

          Thanks, as I said, I’ll likely get to it one of these days.

  4. hegemonicon said, on December 2, 2009 at 1:41 am

    Scott-

    Thanks for this piece – it’s nice to see some writings on economics laying out some basic principles and not wielding some ideology like a sword (comment section notwithstanding.)

    It seems to me that the problem with macro-economics is a combination of the fact that economies are big, complex, and not amenable to running experiments (meaning that it’s very hard to ever be proven right or wrong) and that it’s closely tied to politics (meaning people’s political views and biases easily get dragged into it.)

    There’s something wrong with a field where your views make it more clear who you voted for in the last election than what your actual predictions are.

    • Scott Locklin said, on December 2, 2009 at 2:03 am

      Well, I’m glad someone didn’t take this as a grand pronunciamento on The Economic Truth -honestly, I just want to figure stuff out. Maybe I’m being dumb in all kinds of places; just don’t tell me I’m dumb because of what some dead guru says. Argumentum ad verecundiam is weak sauce; give me a juicy ad hominem over it any day.

      Sticking emotional politics in where clear thinking belongs is dreadful and unfortunately very common. I think there are whole intellectual movements based on making excuses for this bad habit which amount to, “I know you are, but what am I?” I’m trying not to do this. Perhaps that’s unmodern, and hence political, but whaddevs; that’s how I try to roll.

  5. sharpend said, on December 2, 2009 at 10:45 pm

    Scott,

    I am just rereading Poker Face of Wall Street just to get at the Soft Bank Credit Money story. You are right one use of money is to get people to do useful work. It is a technology to efficiently and quickly organize labor. I supposed that was its primary purpose in the Western expansion where much of the wealth was created through labor/effort. Money has all sorts of attributes: a store of value, a method of exchange, its potential velocity. Velocity is just the technology of money.

    My take is that Economics a like a science with a big footnote “If:” It reminds me of Feynman knocking social sciences for not knowing what it means to know something. In economic theory there is nothing to know since it is all predicated on an ideal world. It is math applied to a role playing game where the agents are rational optimizers.

    Unfortunately, many economists are such babies that have to talk past each other. No one can even agree which data to use. So you have one guy says the Taylor rule implies Fed Funds and -6 and another saying it implies Fed Funds at 0. So even if they did know the rules of the game, they won’t agree on prediction or prescription. But I don’t really think rules of the game (law and politics) and basic or dominant strategy are static.

    • Scott Locklin said, on December 2, 2009 at 11:50 pm

      I confess that book gave me a lot of ideas as to what money is, and why it’s not a terrible thing when you lose money. Aaron is an original thinker. I don’t think his ideas are 100% spot on or anything, but I don’t think mine are either.

      I think a lot of economist ideas about how individuals act is a sort of giant solipsism. Economists probably are something like rational utility optimizers of yore, or at least they think of themselves in that way. The economists I have known do things like split dinner checks to the penny. Real human beings reach for the bill. I suppose we’re getting things like behavioral economics now, but I haven’t heard of any economic schools trying to fit their ideas to such data. Really, “behavioral economics” looks like a lot like stuff marketers already know.
      I’m a fan of some of the econophysics stuff, at least as a way of putting sense to complex systems rather than just waving words at them, and plan on blabbering about Bouchaud and Sornette at some point. Sadly, I can’t get Sornette’s form of TA to do anything.

      • sharpend said, on December 3, 2009 at 12:59 am

        I think I am a fan of that stuff too. I haven’t spent enough time with it but some of the output jibes with my thinking. J. Doyne Farmer, who is at the Santa Fe Institute and founded the prediction company has some interesting papers.

  6. CWE said, on December 4, 2009 at 2:15 am

    If you do not like ideology mixed with bad math, Paul Krugman is about the worst choice you could make.

    http://finance.chyden.net/?p=1934

    He talks out both sides of his mouth, letting his political leanings color his analyses.

    Not that he is unique in this regard.

    http://www.huffingtonpost.com/2009/09/07/priceless-how-the-federal_n_278805.html

    I earned my MA in Economics and I am working on my PhD in Finance. You are right to stick to history. Me? I read sociology.

    Keep up the good fight.

    • Scott Locklin said, on December 4, 2009 at 3:25 am

      Oh yes, I agree with you, and have mentioned in other posts that I find Krugman to be a silly ding dong most of the time, but I did like that particular post of his. It describes the money flow in ways which make sense to me from a trading perspective. Maybe he is full of baloney there too or has some wacky political axe he’s grinding, but if so, he managed to fool me.

      Thanks for the kind words and encouragement: I’ll take them to heart. Best of luck in your studies!

  7. Daily Links #132 | CloudKnow said, on December 6, 2009 at 3:23 am

    […] Scott Locklin: A peregrination on the nature of money […]

    • maggette said, on December 12, 2009 at 6:59 pm

      Hey, again great stuff.

      The bad thing (for you) is that I will dircet every “…let’s assume the world is one village with 100 people and one bank…the bank now lends 10 bucks to each peson. After one year they want to earn 5% interest rate…where does the money come from, its still only 100 bucks” “back to gold standard” idiot to your article:).

      I had a lot of econimic training during my education….and it is a really weird disciplin. I also am a huge fan of Bouchaud, Sornette, Farmer adn Cont.

      I had to discuss and implement a “financial econometrics” micro market model during a seminar work. I mentioned some of the Bouchaud and Farmer papers on micro market theory……: the econometrics professor didn’t even know them ….
      Keep up the good work

      • Scott Locklin said, on December 13, 2009 at 1:30 am

        Thanks for the kind words.
        I don’t think Farmer’s artificial stock markets ever amounted to much of anything. I’m beginning to suspect Sornette’s crazy log price thing might be baloney also. On the other hand, I recently looked at one of Sornette’s lectures on economics, and think everyone else should be fired, and he should be put in charge. Even if his crazy models turn out to be baloney, they’ve helped him achieve a deep understanding of what really goes on.

        • maggette said, on December 13, 2009 at 12:05 pm

          And again I 100% agree;
          I’ve read Sornette’s “Why Stock Markets Crash” and I liked it. The “log pattern” stuff is in my opinion the least interesting part of the book. I don’t know if this has any predctive power at all. But I like his whole approacht to look at data. I will start to read his “Critical Phenomena in natural science ” over christmas.

          I also agree that Farmer’s artificial market stuff is interesting but may not be of any practical use anytime soon, but I was referring to his micro market empirical work like:

          Click to access MarketImpact.pdf

          If you want to read the “anti christ” of economic literature, read Joseph McCauley’s book. I think he really hate economics. Really.
          Keep up the good work.

  8. Mac said, on January 10, 2010 at 11:57 pm

    Have you read Nial Ferguson’s “The Ascent of Money”. If not it’s quick read on the subject.

  9. Yonemoto said, on October 4, 2010 at 8:45 am

    Hey, I know this is long after the fact, but you’d better look back into some of your statements.

    “Why buy anything when your money is a better investment than the economy itself?”

    Uhm, because you need to eat, and cloth yourself, and shelter, and entertain yourself. A deflationary contraction can be thought of a reaction to overexuberance in terms of debt-spending… In those situations, you would *want* people to be more austere and careful with how they spend their money, with the possible exception of charity – and responsible charities should be accumulating rainy day funds and hedging against lowered donations by betting on negative economic indicators (never mind that regulation makes that extremely difficult).

    “Another way to think of it: imagine your society has one hundred people with X pounds of gold. Now imagine hundreds more goldless people start to move in. Your gold becomes more valuable, so you’re less inclined to spend it as long as people keep moving in. That’s deflation.”

    I’m pretty sure that population increases are typically inflationary. To put it succinctly, you have the same amount of money chasing after increasing demand (versus increasing supply). If you doubt this, I would recommend reading “the great wave: price revolutions and the ebb and flow of history” which is very entertaining and extremely informative.

    As for the Great (deflationary) Depression. A lot of what made that horrible were huge fluctuations in commodity and debt markets and the utterly devastating effect that had on farming, and all the flailing about that the government tried to do to preserve farmers (like burning food to bring prices back up). As much as I lament big-box farming – subsidiziation aside modernity really has enabled farmers to do things like hedge against drops in grain prices which makes the supply stream more reliable. Luckily, the Great recession seems to have hit farmers less hard than, say, manufacturing, which while it has a similarly powerful lobby causing us to do incredibly stupid central-control to try to ‘fix’ the problem, at least they’re not messing with our food supply (in any magnitude directly, anyways).

    Also, it’s not like inflation doesn’t have more severe effects. I see inflation as the big bad wolf because 1) persistent inflation requires exponential growth, which may not necessarily be possible on a finite earth. 2) it steals money from the poor and gives to the wealthy (monetarist) or wealthy and politically connected (keynesian). The mechanism by which it does that compounds, too, so I don’t find it surprising that the wedge between the rich and the poor keeps broadening no matter how hard we try to redistribute wealth via taxation and social programs. But then again, not screwing the poor is an arbitrary moral position of mine.

    Finally, one big difference of the (certainly inflationary) micro-credit expansions that led the westward expansion – and what we’re doing now, was that because of the restraint of the gold standard, when a bank bubble burst, there were defaults and the lenders got themselves screwed. A default, of course is a deflationary event, and so the general, net effect was nil. The damage was local. Sure, people got hurt, but it didn’t screw over society. Instead now we are unrestrained by a commodity standard and we choose to bail out institutions. That, of course favors lenders, i.e. banks, and leaves the silent tab to the poor who get hit hardest by the devaluation of their salary. But then again, I don’t like screwing over the poor.

    • Scott Locklin said, on October 4, 2010 at 2:59 pm

      Most American’s use of money for the basic staples is pretty limited. How much of the economy is involved in this? I’d be surprised if it is anywhere past 10%. Probably more like 2%. I know that “consumerism” which is basically just “buying junk” makes up about half the US economy. Why should I buy some plastic tchotchkes now, when my dollar will buy 2 times as many later? If I’m a mormon with a year’s worth of food in my house (I’m not, but I do have … supplies), why should I buy more for now?
      Population expansion the old fashioned way (birth) is probably inflationary. Immigration? It depends. If an immigrant shows up on my one man island with nothing… is my bar of gold worth more or less? Now, two immigrants: seems to me my gold is worth more when two poor people show up than when only one does. If there are two million immigrants, and still only one bar of gold to go around: I’m freaking rich. Mind you; I’m attempting to think this through on my own -maybe I’m better off listening to an economist here, but I’d be hard pressed to pick one.
      I was thinking about the American economy the other day in terms of immigration. Really, you could look at the economic expansion of 2001-2007 as floating a debt bubble to house 20 million new immigrants. One of the simplest ways to expand the economy is to grow the working population. Even if all that population does is, like, build houses for itself: the economy grows. Unless, of course, the debt float collapses and everyone goes home, or goes on the dole.
      Funny: I see inflation as stealing from the rich and giving to the poor (as long as the poor’s salaries go up with inflation). Worked that way in the 1970s I think. At least the rates of divergence between rich and poor were not so radical then. I think there is quite a lot of social utility in keeping society, well, a little less Pareto distributed than it presently is. Though I have absolutely no idea as to how to prevent this. I found it really striking that the CIA world factbook listed this as one of the most significant problems facing America, way back 10-15 years ago when it first came online.
      I agree with you that extreme uncertainty is probably the greatest cause of financial unrest; both now and in 1930. I wrote as much in some other blog entries. I also like the idea of local money versus what we do now. Pretty nifty of late 1800s Americans to invent new kinds of money, wouldn’t you say?
      Thanks for your thoughtful comments!

      • Yonemoto said, on October 4, 2010 at 4:39 pm

        I fail to see how inflation transfers money from the rich to the poor.

        let’s compare a rich person, who spends, say 20% of income on day to day expenses (still pretty high) versus a poor person, who spends, say 90% of income on day too day expenses. 10% inflation pushes the rich person to spend 22% of income on day to day expenses and the poor person to spend 99% of income on day to day expenses.

        For the rich person that is a 2.5% decrease in spending power, for the poor person that is a 90% decrease in spending power. That’s nothing compared to any benefit to the poor given by bet relief through devaluation (parked at 10%). Yes, the presumptive assumption here is that wage inflation (I dislike this abuse of the term inflation) doesn’t happen, but wage inflation certainly lags behind commodity inflation. I suppose if you could find a case when wage inflation preceded commodity inflation you would find a case where inflation helped the poor, but that wasn’t the case in the 70s.

        The reason why it gives to the rich is that the mechanism, credit expansion, (or in the olden days, adulteration of the gold) gives first access to the funds to bankers (politicians, during the era of gold). They get to make the first, and therefore biggest margins off of interest on the newly available funds in the money supply, and bankers typically aren’t poor.

        I don’t know when in history inflation has ever helped the poor. again, I’d refer you to “The Great Wave” – it’s really a great perspective on this stuff, and it’s written by a really fantastic author. I don’t like reading books anymore (not enough attention span) but I tore through the 500-odd page book in a week.

        I guess the immigrant argument doesn’t really make sense to me because if you hoard the gold bar and there’s a million immigrants coming in, they aren’t gonna be accepting gold as the medium of exchange unless you are spending it on them. That’s kind of the fallacy of the ‘paradox of thrift’ in general. Eventually you have to spend what you hoard, because if you keep hoarding, economic activity drops and having the same amount of money chasing less productivity is inflationary.

        • Scott Locklin said, on October 4, 2010 at 8:37 pm

          You’re failing to see, as we are differing in what the definition of a rich person is. To me, someone with a large income is not rich. Someone with vast savings is someone who is rich. In an inflationary environment, if you’re a Keynsian, you’re printing so much money, Mr. Rich guy’s stack of dollars is worth less. Some of those dollars get handed out to poor folks. You’re effectively taxing savings. If you look at the proportion of rich to poor, you will see it dramatically increased once we got rid of inflation. One of the interesting things about the last 30 years is the Fed managed to sort of securitize inflation away into … investments and house prices.

          OK, in my immigrant example: pass out half the bar to “fund economic activity.” Half the bar is circulating, but the number of people is increasing. Is your other half bar worth more or less as N_immigrants grows? Of course it’s worth more: there’s more potential work chasing the same amount of commodity money.

          I’ll check out the Great Wave one of these days; it’s in the queue … though behind a lot of other stuff.

          • Yonemoto said, on October 4, 2010 at 8:47 pm

            The inflation tax doesn’t really hurt the rich people in the way that you claim that it does, because rich people (as I see the rich) are typically reinvesting their ‘savings’ in mechanisms that are designed to bring a greater-than-inflation return, such as the stock market, hedge funds, etc. And when these mechanisms fail, it’s typically the people at the poorer end of the ‘rich’ spectrum (that are locked in by institutional mechanisms such as 401ks, IRAs) that get burned. Or alternatively, the wealthy store their assets in things like land and gold.

            Inflation forces individuals to invest to protect their wealth – and It’s not so easy for the poor to participate in that sort of investment, because they are living on the margins as i explained above. As real loanable funds dries up in the face of increased pressure to invest in stupider and stupider things – because there is a limited capacity for social investment (considering your perspective on science I think you’d agree that it holds true across society and finance), the people caught in the tail end of the bubble are often those who are putting less of their money in investments (and therefore less of a personal commitment to monitoring them) – which is why the middle class keeps getting raked in by inflationary pressure.

            • Scott Locklin said, on October 4, 2010 at 9:03 pm

              Go back and look at what Market returns versus inflation was in the 1970s: it didn’t work, at all. Didn’t work in bonds either, though debt was a better investment than equities. Them rich guys lost their capital, and poor people remained, well, about the same as a proportion of the nation’s wealth. It’s fairly well known that this happened. FWIIW, if you store your value in land in such an environment, you also lose money: high inflation should correspond to higher interest rates, which are what you use to fund the land. Gold did OK in them days, but, well, you get the picture.

              As long as poor people’s wages lead inflation, they more or less stay the same, while rich guys get more poor. Back in the day when the Steel Industry drove the entire rest of the economy, and when union politics was important, crap like the Steel Unions wanting another buck an hour would actually drive inflation. This is an entirely non-controversial statement no matter which school of economics you hail from, and was more or less done on purpose for the reason stated above. In those days, too, the government would attempt to fix prices on commodities to prevent the voters from suffering too much. So, inflation benefitted poor wage earning folks in two ways in the 70s. None of these are in play now, however, and it’s not real clear what will eventually happen if the dollar inflates.

              We’re in a crazy situation, as world economies are far more linked than they were, and *everybody* is printing money in hopes of getting some mild inflation going. And, there is a huge demographic overhang of rich/old people who continue to buy central bank notes, even at effectively 0% interest.

              • Yonemoto said, on October 4, 2010 at 9:10 pm

                “As long as poor people’s wages lead inflation, they more or less stay the same, while rich guys get more poor. Back in the day when the Steel Industry drove the entire rest of the economy, and when union politics was important, crap like the Steel Unions wanting another buck an hour would actually drive inflation. This is an entirely non-controversial statement no matter which school of economics you hail from, and was more or less done on purpose for the reason stated above.”

                I don’t find this to be controversial. But the cases where poor people’s wages lead inflation are few and far between over the course of history. And whereas unions might be great for collective bargaining, they also can be a serious a drag on innovation – imagine if we had horse and buggy unions pushing for legislation favoring animal coaches over the internal combustion engine.

                Plus, that inflation might have been great for the steel unions, but what about everyone else who wasn’t part of that? So, my modified statement that it benefits the poor *and politically connected* stands.

                • Yonemoto said, on October 4, 2010 at 9:11 pm

                  excuse me, *rich* and politically connected.

              • Yonemoto said, on December 23, 2010 at 2:27 am

                “As long as poor people’s wages lead inflation, they more or less stay the same, while rich guys get more poor.”

                Maybe i should put it this way. Among the liberal punditry, anyways, part of the goal of inflation is to marginally decrease the real cost of labor. Quote: “I would add, however, that there’s another case for a higher inflation rate — an argument made most forcefully by Akerlof, Dickens, and Perry. It goes like this: even in the long run, it’s really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts. So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis.”

                http://krugman.blogs.nytimes.com/2010/02/13/the-case-for-higher-inflation/

                you cannot have your cake and eat it too. If your goal is to create higher inflation to depress the cost of labor, and preserve a high employment rates – on a sustained basis… Then the wages of the poor cannot lead inflation.

  10. Jim Baird said, on December 17, 2010 at 9:58 pm

    This is an old post, but I just came across it (I originally found your blog because I saw a video in which Nassim Taleb was saying stupid things and searched for other people who noticed he tends to do that a lot).

    You are mistaken about the origin and nature of money. Commodity money actually came long after credit and fiat money. Here are some links that describe the history:

    http://www.ces.org.za/docs/what%20is%20money.htm

    http://www.cfeps.org/pubs/wp/wp45.htm

    And as for how this relates to our current predicament, check out this:

    http://www.netrootsmass.net/fiscal-sustainability-teach-in-and-counter-conference/stephanie-kelton-are-there-spending-constraints-on-governments-sovereign-in-their-currency/

    • Yonemoto said, on December 23, 2010 at 2:50 am

      Haha… Well, she says that the “only constraints on government spending are self-imposed”. That’s mostly true, but not quite – if the government overspends and the populace suffers too much, there’s always the possibility of revolt (or in democratic societies, hopefully, mass “no confidence”). It’s happened before in the past, and I would hardly call that a “self-imposed” constraint, or if, it is, it’s a self-imposed constraint that is highly aware of a powerful indirect, “external” force.

  11. BTC bubbles | Locklin on science said, on April 17, 2013 at 3:20 am

    […] about using BTC as a currency. I think most enthusiasts for it are naive and do not understand the nature of money and what it is good for. I do think it would work a lot better as a store of value with a properly […]


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