Re: Backed money (reply to Mosler)

[Warren Mosler <mosler@xxxxxxxx>]

mike sproul wrote:

> Warren:
> > > If we view money as being backed,
> >
> > What does 'backed' mean with a floating exchange rate/ non convertible currency?
> > Doesn't 'backing' imply convertibility at 'fixed terms' by the issuer?
> >
>
> There is a non-trivial distinction between "backed money" and
> "convertible money". If a banker has issued paper notes and promised
> to convert them on demand into one ounce of gold, then during
> business hours those notes are both backed and convertible. Over
> the weekend, the notes are inconvertible, but still backed.

Backed by a promise of future conversion.

> When the
> Bank of England suspended convertibility from 1797 to 1821, it still
> recognized paper pounds as its liability, and still held gold and
> bonds as assets against those paper pounds. During the suspension
> period, the paper pound was backed but inconvertible. The bank was able
> to restore convertibility in 1821 because it had kept its assets--in
> other words, because the pound had been backed all along.

Yes.  The key word being 'suspended' which promised future convertibility,
presumably at the same conversion rate.

> The paper
> pound was simply valued in the same way as any inconvertible
> financial security is valued--according to its backing. That is what it
> means for money to be 'backed' in a world of floating exchange rates.

But that exchange rate was not floating.  It was fixed via promised
conversion at a future date.  Conversion is generally promised for the
future.  The terms are not usually 'convert today or risk losing the
conversion feature?'


> If you can think of a meaningful difference between the Bank of
> England's suspension (24 years) and the fed's suspension (38 years
> and counting) I'd like to hear it.
>

The US policy was permanent termination.  There was no explicit or implicit promise to offer conversion at some future time at $35 per
oz or any other rate that I know of.


>
> > > then money issued by the fed has value because of the backing (t-securities, gold, etc.) held by the fed.
> >
> > Gold?  Yes, there is gold, but there is no conversion feature to the $US.   And let's look closely at
> > the 'money.'  Reserves and Tsy secs are accounts at the Federal reserve bank.
>
> We must have some kind of language barrier here. Treasury securities
> are not an account at the fed. You must mean in some non-standard sense.
>

Last I knew tsy sec were all 'book entry' at the Fed which means they
merely account for them.  Isn't that what an 'account' is?  They are
accounting data.  That's all.  An interest bearing time deposit (Federal
Reserve) bank account, to be more precise.

>
>  Checking accounts
> > and certificates of deposit are accounts at commercial banks.   As a point of logic, being able to exchange one account for another account has value only if at least one of those accounts has further value?
> >
>
> As above, convertibility is not necessary in order for backing to have
> meaning and to give real value to something.
>
> > But I suppose we are too far apart on this issue to really connect. Just to clarify my original assertion: Money issued by the fed has value because of the backing held by the fed.
> >
> > This would be true if there was legal convertibility at the fed- that is, backed by something with intrinsic value.
> >
> > Derivative money issued by private banks  (and individuals) has value because of the backing (mortgages, cash, etc.) held by those banks.
> >
> > Or federal deposit insurance.  But again, only if there is some further value to the unit of account.
> >
> > This at least agrees with your statement that the quantity of (base plus derivative) money does not affect its value.
> > Not exactly my statement.
> >
> > > > The issuer of the currency (government) is the single supplier of that which
> > > > it demands for payment of taxes and other debts to the government.  Single
> > > > suppliers are 'price setters.'
> > > >
> > > > >
> > > Are you actually saying that money has value because the government
> > > accepts it for taxes?
> >
> > Yes.  With a floating exchange rate this is the case.
>
> Well, I can see where tax acceptability can give value in particular
> cases; for example, when the colony of New York issued paper shillings
> and declared them acceptable for taxes at the rate of 8 NY shillings
> per ounce of silver, but I don't see the validity of this point for the
> modern dollar, especially when the government rarely takes actual
> currency in payment of taxes. It prefers private bank liabilities.

Demanding units of a currency with a floating exchange rate for payment
of taxes must be a source of value unless there are 'issuers' with
'no cost of production' other than the government.  Yes, we say
banks create 'money,' yet we know they can not simply use ATM
machines that actually take a roll of paper and print it, and book
the 'sale' of $ customers take out as profit.  We know that would
mean instant hyperinflation.  So clearly there is a constraint of some
kind on the money creating activity of banks that preserves value?

The answer does include, as you mentioned, the idea that bank liabilites are 'backed' by the bank's assets, which could be sold.  But this is still a 'non starter,'
as it can explain relative value but not 'absolute' nominal value.

And, as you stated, government can function solely like the rest of us,
using only commercial bank accounts if it wished, as I believe Germany
has done for quite a while.  But even then, the act of taxing in the
unit of account and accepting 'inside' bank deposits 'works' only with
the government, at the end of the day, being the single supplier of that
which it demands for tax payment.

First note that the origin of such a system has to be either convertible
currency or a system that began with 'outside' money from the government.
'Inside' purely notional money has no way of 'springing up' without outside
money, any more than there would be corn futures is there was no such
thing as corn.  How would banks develop using a particular notional
(floating exchange rate) currency purely on their own?

Let me get back to the mechanics of a floating exchange rate currency and
a governemt that has a Central Bank but subsequently choses to use the
commercial banks for its operating accounts (to reduce the need to constantly offset operating factors).  Now let's assume the governement levies a tax.
Since the payment of that tax always winds up in a government account in
the banking system, you might say that therefore the 'money' is always
there to be borrowed.  This is true, but the government also sets bank
capital requirements and lending standards.  Governments (particularly
those offering deposit insurance) have learned to set these requirements to prevent the moral hazard issue from raising its ugly head and inflating the currency.

Anyway, with tax liabilities due, the non government sector has the
choice of borrowing the units of currency or selling real goods and
services to the government to get the needed means of payment.
And borrowing requires collateral as demanded by the banks under
govt regulation plus, in most cases, an interest rate.  So 'taxpayers'
have the choice of continually going into debt and mortgaging their
assets to the banks or selling to the government at the prices the government
is willing to pay.  And, if they chose the borrowing route, they are
losing their net nominal wealth and getting more and more 'leveraged'
against the currency.  This is not sustainable if the government holds
the line on the prices it will pay, and the amount of collateral it demands
vs a notional amount of lending, and the allowable debt to income levels
that qualify for a bank loan.

Let me again
bring in Innes' What is Money, 1913, from http://www.warrenmosler.com

"But a government produces nothing for sale, and owns little or no property;
        of what value, then, are these tallies to the creditors of the government?
        They acquire their value in this way. The government by law obliges certain
        selected persons to become its debtors. It declares that so-and-so, who
        imports goods from abroad, shall owe the government so much on all that her
        imports, or that so-and-so, who owns land, shall owe to the government so
        much per acre. This procedure is called levying a tax, and the persons thus
        forced into the position of debtors to the government must in theory seek
        out the holders of the tallies or other instrument acknowledging a debt due
        by the government, and acquire from them the tallies by selling to them
        some commodity or in doing them some service, in exchange for which they
        may be induced to part with their tallies. When these are returned to the
        government treasury, the taxes are paid. How literally true this is can be
        seen by examining the accounts of the sheriffs in England in olden days.
        They were the collectors of inland taxes, and had to bring their revenues
        to London periodically. The bulk of their collections always consisted of
        exchequer tallies, and though, of course, there was often a certain
        quantity of coin, just as often there was one at all, the whole consisting
        of tallies."

This makes perfect sense to me.  And the rest of the article make
fascinating reading as well.

Best,

Warren

>
> Best,
> Mike Sproul