Re: Backed money/Mike Sproul

[Warren Mosler <mosler@xxxxxxxx>]

>

>
> Let me see if I can put our agreements/disagreements into a simple
> example. A US government bank issues 100 paper dollars in exchange for
> 100 oz. of gold. It then issues 100 more paper dollars, which it
> accepts for taxes in lieu of gold.

ok, but let me know what can be meant by 'issue.'  Do you mean 'spend,'
'lend' or something else?

> At this point the bank's balance
> sheet looks like this:
>
>    ASSETS                       LIABILITIES
> 1) 100 oz. gold                 $100 notes
> 2) Ability to collect
>    100 oz in taxes              $100 notes
>
> I think we would both agree that these notes are fully backed, either
> by gold or by taxes? and that each note will be worth 1 oz, regardless
> of how many are issued (and backed) by the bank?
>

OK, If the notes were 'spent' it might look like this:



assets                       Liabilities

gold- $100                Notes issues $200

Receivables- $100


But let me digress again on 'backed.'   With today's floating
rate policy, govt spending and lending and member bank
lending can be considered 'backed' at the point of issue.  That
is, issuance is required to be collateralized for banks, and govt
lending is always collateralized, and of course spending is
in exchange for collateral (by definition).  So you could say
the government and its banks demand collateral in return for
spending/lending and in that sense the currency is 'backed.'
However, once issued, bank deposits and Fed notes are not
convertible at the Fed as they may be under a gold standard, for example.


>
> I think we differ regarding the effect of derivative moneys issued
> by other banks. You would say, would you not, that if a French bank
> started issuing eurodollars, and if the US tax man accepted those
> eurodollars in payment of taxes, and if, furthermore, the French bank
> held no reserves of US dollars, then that would reduce the value of
> the paper dollars?

Not necessarily.

>
> (The french bank could get away with holding no dollar reserves simply
> by paying out a "dollar's worth" of francs every time someone presented
> a eurodollar for payment.)

And not for this reason, either.

If you do pay taxes with $ drawn on a French bank's account,
the Fed will clear that check via a member bank and debit
that member bank's account at the Fed, etc. leading to some
form of collateralized lending by the Fed to the banking system,
the same as if the check was drawn against a member bank in
the first place.

There was a concern about 20 years ago about euro deposits
'counting' as 'money supply' and somehow being a potential source
of inflation.  However, going back to my analogy with other commodities,
which is the same point you make below,
it is the same as being concerned that a new offshore commodity exchange, with
its likely increase in total world open interest, would drive up the price
of the underlying commodities.  Maybe and maybe not, of course.  Same
with measures of bank deposit $, domestic or offshore.

>
> I would say that the issue of eurodollars would not affect the value
> of the paper dollars. A stock market analogy explains why: If a french
> stockbroker issues derivative shares of GM stock, then that issue
> clearly does not affect the value of the base GM stock. The reason
> is that GM stock is valued only because of its backing--not because
> of how many derivative shares are issued (and backed) by other parties.
> If the paper dollar is really backed--just like GM stock--then the
> issue of eurodollars, or any other kind of derivative money, cannot
> affect its value.

Yes, as above.

To sum up and go way back a few posts, the value of units of a currency
is a function of prices paid (at the margin) at the point of issue.
This is the same as saying the value of the currency is a function of the
collateral demanded at the point of issue.  So if I had to use the term
'backing' I could also say the value is 'backed' by what is demanded at
the point of issue.  And I think that is the point I read into your paper,
for if 'money' is issued without 'backing' (demanding collateral, including
services, etc.) in unlimited quantities hyper inflation is likely.

That being said, however, if collateral is demanded, the currency will retain
value regardless of the quantity spent.  For example, paying $35 for an
oz of gold in unlimited quantities is not by definition inflationary, if the
value of the unit of currency is defined as how much gold it can buy.
Buying at fixed prices can keep prices from falling but not cause that
price to rise beyond that level.  Particularly if the same issuer is willing
to sell that commodity at the same price.  In that case buying adds to the
buffer stock and cushions future price rises.  Yes, the relative price of
that commodity can change due to a bufferstock policy, but that is a
different point.

So is 'quantity' 'important'?  Yes, but in a very different way than most
quantity theory is presented with todays floating exchange rates.
Is a floating exchange rate currency 'backed'?  Yes, in the sense that
collateral must be demanded at the point of issue.

And, without tax liabilities and without convertibility, the issuer can demand
what ever it wants in exchange for its currency but the market won't sell it
anything at any price.

With convertibility (present or presumed future), and 'credible' reserve
availability, the currency will have value without tax liabilities (to the extent
of the reserves).


Best,

Warren







>
> Best,
> Mike Sproul
>
>
> Warren Mosler wrote:
> >
> > Mike,
> >
> > I just started rereading your paper and much I had forgotten
> > immediately came back to me.  For example, I think I now
> > understand what you call 'backing' and I agree with its
> > importance concerning the price level.
> >
> > In fact, I have always made the point myself that central bank
> > lending is always secured, and, if the CB lent unsecured in unlimited
> > quantities to member banks the currency would likely soon be
> > worthless.  Likewise, the CB controls the definition of bank capital
> > via its classification of bank assets, thereby regulating bank loans/deposit
> >
> > money creation.  I now recognize this as what you call 'backing.'
> >
> > It seems a lot like what I call 'exogenous pricing.'  I have
> > stated the price level is a function of what the govt. demands in
> > return for that which is necessary to pay taxes when it spends/lends.
> > I think we may be saying the same thing?  In your terms, there is no
> > market force that determines the 'backing.'  It is 'arbitrarily' determined
> > by the government as issuer of the currency.  The non government sector
> > needs the govt.'s spending/lending to comply with tax liabilities, and
> > the govt. 'sets' the terms of exchange via that provision of the needed
> > units
> > of the currency, whether it knows it or not.  If it does not 'back'
> > sufficient
> > quantities of the units of currency it or its agents (including banks)
> > provide by demanding collateral in exchange for spending/lending inflation
> > is likely to follow.  This applies both to govt spending and lending by its
> > banks whose deposits  can be used for tax payment.  Further, the govt.
> > 'backs' its loans to member  banks via the collateral it demands in addition
> > to its bank capital requirements. I think your 'backed' is my
> > 'collateralized?'
> >
> > Given that, various non banks sell their liabilities such as commercial
> > paper, notes, and bonds and may lend unsecured or with less than
> > '100%' collateral.  In the short run, that could drive up the price level
> > and spending/lending could migrate away from the banking system.
> > But if the govt. 'sticks to its guns' and refuses to pay the higher prices
> > or alter the collateral it demands prices will eventually be 'forced' to
> > deflate to the point where the govt. is again spending/lending on its
> > terms.
> >
> > And, to illustrate another point with a simple example, if the govt. had a
> > head tax of a total of 100 units, and gave away more than that, the currency
> > would have no value.  However, it could give away 99 and then demand
> > something
> > in exchange for that last unit which would determine the value of a unit
> > of that currency.
> >
> > Warren