Re: Backed money (reply to Davidson)

["John O'Donnell" <jackodonnell@xxxxxxxx>]

mike sproul wrote:
>
> >
> > Valuing money on the basis of its backing has a very
> > significant flaw. That is the ability, and it most cases
> > actuality, of the issuer to buy or sell the backing
> > commodity at will. That is, because the "price" of the
> > backing commodity can be set by the money issuer at any
> > amount between that which results in the issuer buying all
> > that is and the market doing likewise the actual value being
> > set is the price of the commodity, not that of the money.
> > The price of money remains its value in purchasing all the
> > goods and services relevant to a market.
>
> But every private bank backs its checking accounts in precisely this
> way. They issue a $1 checking account that is convertible on demand
> into a $1 bill. They can, of course, set the price of a checking
> account dollar at $1.01 paper dollars--but they'd get no customers.

Not quite. Banks offer a set of services for the use of
customers idle cash. A very different thing from "backing"
deposits with a promise to pay. The reality is that the
value earned on the use of depositor's money is either
sufficiently greater than the costs of the services provided
or the bank will institute charges for some or all of the
services.

I think I have seen on this list some discussions about the
present circumstances in Japan whereby banks are charging
customers for maintaining deposits. In any case, deposits
are not a simple conversion of one form of money into
another, they are services provided in exchange for the
interest that banks earn on the money deposited.

> If they instead set it at $.99, they'd be killed by arbitragers. Banks
> don't buy "all that is" and the market doesn't do likewise, but
> nevertheless, checking account dollars are backed by their issuers.

Actually, sometimes they do pay directly for deposits. They
pay interest for checkable deposits such as NOW accounts and
when there is a significant shortage of lendable deposits
they even "give away" toasters and other enticements to
attract depositors.

> The same reasoning applies to any kind of backing (gold, land, etc.)

Yes, the same reasoning applies but the conclusions you draw
from that reasoning do not.

> > However, it is also true that simply calling the issue of a
> > government "money" does not make it so. To have value the
> > issue must have a use. It does not matter if that use is
> > purchase of a commodity or the payment of obligations
> > dictated by government or both. But only one such ultimate
> > use is needed to give the "money" value. If the payments of
> > obligations to government as in present day organization of
> > society are unavoidable, the use of backing for money
> > becomes superfluous.
> >
> > The choice of a market to avoid a poorly managed money stock
> > by resort to barter or standardized barter [i.e. -- A single
> > commodity such as gold as an intermediate trading
> > substance.] is just as likely to occur with a "backed" money
> > as with a fiat currency.
> >
> An old-fashioned banker that has issued $100 in checking account
> dollars cannot back them unless he has assets worth at least $100.

Assets yes, money no. And even if the bank is technically
bankrupt [i.e. -- It's assets marked to market are less than
its liabilities.] it can continue functioning so long as the
rules of banking do not require marking to market. Again,
the present Japanese experience as discussed on this list
includes the circumstance that many banks are carrying real
estate loans at values exceeding the value of the underlying
real estate. If not the Japanese circumstance, consider the
U.S. Savings and Loan industry just before the collapse of
many of these institutions. They kept up the charade for
quite a while by paying high interest rates to attract
deposits so they could disguise their true circumstances
while hoping that their assets would recover enough value to
save them.

> If he has only $99 worth of backing he will face a run and will
> collapse.

Actually, most bank runs have occurred with banks well
supported by assets but because of the lack of liquidity
were unable to meet demands for cash. However, banks that
were technically bankrupt often continue to operate in the
hopes that the assets they hold rise in value before their
true condition becomes obvious.

> It is also true that if the banker has no assets in his
> vault, but nevertheless has the ability to take away (i.e., tax)
> $100 from people, then his money is still fully backed.

IF banks could tax they would be governments, not banks.

> If, however,
> he only has the ability to take away $99 from people, his money
> must lose value.

I'll address this as if it were speaking to a government
that can tax and not a bank that cannot.

The quantity of tax collections does not and should not
equal the quantity of money in existence. The reality is
that most currency issued by governments is used to conduct
trade and much of it is lost temporarily while it visits
foreign locations and some is lost forever by fire, burial,
etc. Taxes payable in a currency creates the fact that it
has value; that use and whatever other uses made of the
currency relative to the quantity in existence determines
the amount of that value.

> Your statement that money has to have "a use" is
> not a strong enough condition. Money must be fully backed either
> by explicit assets held by its issuer, or, what is the same thing,
> obligations owed to its issuer.

Exchangeability for an asset less convenient to hold or
satisfaction of obligations are both uses that are the
condition needed for money to have value. Seems plenty
strong enough to me.

--
			-- jbod

		Tax Privilege, Not People
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