Wednesday, 16 September 2015

Chartalism

It turns out from the various comments to my recent banking post that Modern Monetary Theory is just Chartalism repackaged.

And what the heck is Chartalsim, you ask. It is, again, stating the blindingly obvious, from Wiki:

A prince, who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money; even though the term of its final discharge and redemption should depend altogether on the will of the prince.

— Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations


To give a folksy example, as a matter of fact, the wife and I don't give our children cash rewards for helping round the house and neither do we charge them rent.

But we could give them coloured plastic tokens for helping round the house ('government spending'). Those tokens are of course worthless UNLESS we demand that our children hand back a certain number of those tokens in rent each week and a certain number each mealtime ('paying tax') so that the budget balances. It is the 'taxing' which gives the tokens their value, not the spending.

So, for example, if one child has a shortfall because he or she hasn't helped round the house much, faced with eviction or going hungry, they would have to buy tokens from the other child, either for cash or in exchange for a favour (or just try stealing them). So the tokens clearly have value.

With modern currencies, society has organised itself so that the value of most transactions is measured in terms of the government-issued unit of currency for convenience.

This is not actually essential, we could do all our private trading in terms of dollars or bitcoins or gold or anything else, the government can (and does) collect taxes in sterling (by converting your dollar or bitcoin profits to its sterling equivalent and charging tax on that). The theory works much better if the government collects user charges like LVT rather than taxing income and profits, but that is a separate topic.

While this is all a bit counter-intuitive, it's not difficult to grasp. Think about it, if you go and pay your taxes in cash, the tax officer could chuck those bank notes straight on a bonfire without this affecting anything*; if the government needs more bank notes, it can just print up fresh ones at minimal cost. It's exactly the same with our hypothetical plastic tokens, my wife could collect X tokens each meal time and then put them through a shredder. Those tokens have served their purpose.

* The same as the Bank of England chucking all the UK government bonds it holds onto a bonfire; the government can't owe itself money. Despite what people say.

31 comments:

Dinero said...

Here's clear and concise example that shows that what the government taxes and spends is bank deposits.

A small country has 1 million in reserves . The income tax is 20% . The employers in that country borrow $ 1 Billion and pay it to the employees. The government revenue and spending is $200 Million.


The following year the amount of reserves is still 1 Million. The income tax is still 20%. and the employers borrow $2 Billion., and pay that to the employees. the government revenue and spending is now doubled due to the private sector creation of deposits.

That is a clear example that the thing that government taxes , is deposits.

If the 400 million had not been created the government would not have been able to tax and spend it.

Mark Wadsworth said...

Din, the word "reserves" is meaningless in that context so your whole explanation is meaningless. The government can start the year with nothing but paper and ink, chartalism or mmt still works exactly the same. Deposits and physical notes are conceptually exactly the same.

Dinero said...

The point is the Government taxes and spends bank deposits , and they are created by commercial banks and their customers. If they, the commercial banks and their customers, had not created the $400 million, the government would not have been able to tax and spend it, and so it is shown that what the government taxes and spends is bank deposits and they are created by commercial banks and their customers.

Ben Jamin' said...

All a very nice way of looking at things, but what are the concrete policy implications?

Also, I think the World would be a better place if I could pay for goods, services and taxes in any form of legal tender I choose. Like dollars or bitcoin for example.

Choice is a good thing isn't it?

Mark Wadsworth said...

Din, would you like me to explain it again in words of one syllable?

Your explanation is very superficial and you singularly fail to realise that for convenience, governments don't bother printing notes any more, they do it with bookkeeping, but the logic is exactly the same. Bank notes and fiat currencies are a relatively new idea and I'm just saying how it actually works in practice and why people are prepared to accept payment in bits of paper of no intrinsic value.

Nowhere ever in the history of the world has there not been a fiat currency that was not kick started by the government, in most places people fall into line and use it as a unit of currency for convenience. Fiat currencies do not and cannot come into existence spontaneously (which is why people used to denominate everything in gold, which has real intrinsic value).

BJ, that's the beauty of it. It is not "a way of looking at things" it is "how things actually work" and to be honest, has no policy implications whatsoever. It gives us no clue as to how much the government should be spending on what or what sort of taxes it should be raising. It doesn't even tell us that deficits or surpluses are necessarily a good thing or a bad thing.

Dinero said...
This comment has been removed by the author.
Dinero said...

What you are saying is certainly not "how it works in practice" as you say , because as I illustrated the government doesn't create the money.

20 % of 1 Billion = 200 million
20 % of 2 Billion= 400 million

And bank deposits have an intrinsic value because the borrower who creates them has an obligation and commitment to supply economic resources in the future in the course of repaying the loan that created the deposit.

Lola said...

Hmm. The Bard. "put not your trust in Princes". Ditto Lola end of MMT/chartism.

Mark Wadsworth said...

Din, why would there be a fiat currency system in the absence of a government? It has never happened. But as per usual I am wasting my time and I give in.

L, chartalism is not an -ism like Communism or Environmentalism or Home-Owner-Ism. It is just a way of explaining why fiat currencies "work". Like "capitalism" is not a belief system, it is just a word for something that pre-exists, like the weather.

And as as long as govt spending and taxation is denominated in the same thing and there are no big surpluses or deficits, it works fine, be that gold or bits of paper or entries in a government electronic ledger.

But clearly no, don't put your trust in princes. They are politicians, rent seekers, criminals and Home-Owner-ists.

Bayard said...

Lola, it's the Bible, Psalm 146:3

"why would there be a fiat currency system in the absence of a government? It has never happened."

ISTR there being generated a lot of column-inches talking about C18th/19th companies creating their own fiat currencies in the form of tokens a few posts ago.

Mark Wadsworth said...

B, and many shops still sell "gift vouchers" which is the same sort of thing. That is not a fiat currency. That is payment in advance.

Mike W said...

Yep,

I read that a company in the USA makes a good living turning tax dollars into house insulation material.
MMT, as I understand it is a factual explanation of how a fiat system works despite what our leaders may say about tax and budgets. It is not an ideology as MW explains. It, MMT, stands in contrast to a state that is on a gold standard or currency peg. For example, it does not help to explain Greece or any other Euro zone country can or cannot do in a crisis. It does however, explain what we, the USA and Denmark can do.So I think that counts as real policy stuff in anyone's book! Greece is/was in the same boat as me, Lola, your company and your local council and the county council. We are all constrained by the fact we cannot create currency that will pay tax or bank debt, bonds etc. We have to go out and work, or steal for it.But our government is not.All budget ceilings in the end are purely self imposed or imposed by the fear of real inflation

DBC Reed said...

I would have thought that fiat currencies developed in a laissez faire manner or "naturally" as that grand Romantic Adam Smith is always saying about everything he approves of.You know: Lombard Banks sold promissory notes to travelling merchants to pick up the same amount of gold from the bankers' brothers in other city states to guard against banditti, shipwreck etc Then these notes started changing hands at full face value as the bankers kept less and less gold in reserve. The same old story.I cannot see any place for government edict: Italy didn't have an National Government till the nineteenth century. Governments only appear to have given approval when they started "borrowing" off the banks.e.g. William of Orange and Dutch banking.

Mark Wadsworth said...

DBC, that is like a John Lewis voucher. Its value is derived from what you (think) you can get for it. The gold or goods have to be there first before people will pay for it. It is not s fiat currency.

Ricky said...

The plastic token analogy in which the worthless tokens are valuable only depends on the fact that the children can be evicted or go hungry.
In which case the tokens are only valuable via the fact that force can be used if the tokens aren't returned to the issuer.
Another comparison would be the tokens used in POW camps which were used by prisoners to exchange for small items such as shoe polish, razor blades etc)
We in modern society use the camp money equivalent (apart from commodity-trading on a small scale which is against the rules and called "crime") but - outside the camp - those who actually run it are trading in gold or some other material of intrinsic value.
As you say they can print it at will then lend it to us but the catch is that they confiscate tangible assets if we fail to return it.

Mark Wadsworth said...

Ricky, exactly. Either the goverent gets them back by making threats (taxation) or it gets them back with user charges (land value tax).

Mike W said...

Things move very quickly here,I still need to thank Lola, Derek and DBC Reed for the heads up about Gesell from the previous thread. He is now on my reading list with the Keynes essays.

DBC I agree with the idea that Bankers exchange notes internationally. Isn't this why the Rothschild family/dynasty did so well after 1800? They could be trusted to honour each brothers notes no matter the country.So I take it this is what you mean by organic 'market' growth in currency notes.
How about this for state growth. I am thinking of Wellington's army in the Peninsular War in the first instance. While the French military gave the local folks no choice, they simply plundered the villages and took want they needed, an age old strategy.Wellington resisted plunder and issued notes to exchange supplies for goods at his magazines. So cattle, wheat, women and men in exchange for whisky, rum, opium, blankets and guns. This is stage 1. Stage two, general point. After a war a state says that it will exchange back the magazine notes for whatever, pounds, Dollars, Francs the winner has. It also now tells the locals who survived the conflict they are part of Empire A or B and that they will also have to pay in these currencies a tax on the huts/hovels/ homes that they thought they once owned. They had better get working in the fields or they they face the full might of the law (as Ricky suggests above)!
MMT accounts for the first issuing of paper by the military authorities for goods and services in the model above.So Wellington (the state) and the Rothschild's (the bank) hand in hand?

DBC Reed said...

To be "current" you would have to be able to go into any shop and use a John Lewis voucher there. Please video yourself getting what "you think you can get" for one in a tobacconist, as I obviously live a very restricted life in Northampton. You might also go into a bank and present a £20 note and ask them to make good on the "promise to pay the bearer £20" whereupon they will hand the same note back saying " Piss off, that only applied when this was a commodity based currency:it changed into a fiat currency when the promise to pay was repudiated" When was that BTW?My contention is that this was the moment when commodity voucher money became fiat not through the dreaded government action but financial sleight of hand or bona fide laissez faire/laissez passer.

DBC Reed said...

Richard Lipsey says 1931 was the date that notes were no longer redeemable at banks in gold (or silver?).Wonder what was the significance of that date?

Bayard said...

DBCR, I have always thought that bank notes are simply that, notes from a bank (as they still are in Scotland) and the promise to pay was a promise to exchange these notes for coinage, which is the property of and only issued by the state.

Mark Wadsworth said...

DBC, who said government action was "dreaded" or that banking is not "sleight of hand"? I was just explaining how things work without any sort of judgmental overtone.

Fact is, bank notes were originally a voucher for gold. You said yourself (17 Sept 10.01) that you could only exchange these vouchers at their "banker's brother's". Not my fault if banks started trusting each other and then other businesses started trusted banks. That's still not a fiat currency, it is a voucher entitled you to X amount of gold.

DBC Reed said...

@MW
I am also explaining how things worked and the fact is we ended up with a fiat currency after the banks started issuing more notes/ vouchers than they had gold (Fraud! Swindle! Counterfeiting! squeals Rothbard this time quite correctly); the convention then persisted that you could exchange your notes for gold if you wished; as soon as the Banking system created too much money and the bubbles in share and other asset values collapsed big time circa 1931, they cancelled the voucher agreement leaving the fiat system as now.Very little government imposition; very much the banks suiting themselves.
You suggested that government action was dreaded when you said that governments only create fiat arrangements.
You also jib at the government resuming the right to create money which would solve the other half of the money/land nexus.You have constructed a viable Citizens Dividend around land taxation when the original National Dividend simply created new money (rather than the banks) to pay for the economy working at full capacity by distributing it to people equally.( A Gesellian stamp money system might ensure it was immediately spent.)
I agree that action simply to control land price inflation should be tried first.On the face of it, it should work on its own which would save an awful lot of bovver.

Mark Wadsworth said...

DBC, what the private banks do is not fiat currency, originally it was gold backed and nowadays it is splitting the zero, and the transition was very gradual.

"You suggested that government action was dreaded when you said that governments only create fiat arrangements."

You are quite tiresome.

In this post, i merely explained how and why fiat currencies actually work in practice. I think I made it abundantly clear that I see this neither as a good thing nor a bad thing, the post is entirely value neutral.

When i explain how banks split the zero - in a similarly value neutral fashion - people like you and Robin 'madman' Smith accuse me of justifying their behaviour.

So please stop accusing me of saying things I never said, that is behaviour for little girls' and Home-Owner-ists, not serious chaps who like discussing stuff.

DBC Reed said...

@MW
I suppose I feel, quite reasonably all things considered, that a system where banks create money and all of kinds of Tory wankers run round saying Where's the money coming from? all the time is not something you can be "value neutral" about.
"Splitting the zero" is a value neutral way of saying that banks create sums of money which they split into two accounts .So that's supposed to neutralise the Rothbard accusations?
Do bear in mind that I think that action on land price inflation could do a great deal to sort out problems with the channelling of newly created money before resort to monetary reform.

Bayard said...

"That's still not a fiat currency, it is a voucher entitled you to X amount of gold."

WTF's a fiat currency then?

Random said...

It doesn't entitle you to anything. It is a promise convertible to gold.
If the gold vaults were robbed you would not be able to exchange for gold for instance.
Money is always IOUs. In the past it was convertable go gold? Yeah well so what?

Mark Wadsworth said...

DBC, if I explain how a gun and a bullet works, that does not mean i condone murder; if I explain how a car engine works, that does not mean I condone speeding.

It is first important to understand splitting the zero. Then we realise, this can lead to better outcomes (encouraging investment and smoothing spending patterns) or for bad things (credit and land price bubbles, speculation generally).

So as you say, absent land price bubbles and speculation thereon, the splitting the zero in isolation would lead to better outcomes.

B, for these purposes, a "fiat currency" is exactly what the post explains. The £ issued by the government is not backed by anything but has value because you need it to pay taxes with.

R, yes, if the gold vaults are robbed, your voucher becomes worthless. But as long as the government has the power to tax (i.e. the tacit acceptance by the population, however grudging) then the £ issued by the government will always have value. There are no vaults to rob, which means that the £ in your pocket always has value. In that sense it is safer than gold backed vouchers.

Random said...

"turns out from the various comments to my recent banking post that Modern Monetary Theory is just Chartalism repackaged."
MMT is sometimes referred to as neochartalism. It takes insights from other heterodox theories and intergrates bank lending into the model.
MMT is an econ theory about how the best achieve Full Employment and Price Stability.

Bayard said...

Mark, sorry, should have looked it up. Of course a currency "which derives its value from government regulation or law" (Wikipedia) cannot exist without a government, by definition. However a currency unbacked by anything of intrinsic value, which has value because it is said to have value, can. It was you that said Dinero was talking about a fiat currency, when in fact he wasn't, and put us all on the wrong scent.

"It doesn't entitle you to anything. It is a promise convertible to gold."

R, can you give a reference for that? I would think that the "sum of one pound" in the promise is much more likely to be one pound's worth of coin of the realm, in gold, silver or copper.

Random said...

I don't know, Bayard. But it is just a promise. There is no guarantee the state will live up to the promise.

Bayard said...

Well, of course, nowadays the promise is much easier to keep, since the coin of the realm is no longer made from valuable metals and is intrinsically pretty worthless. Even the "copper" coinage is made from steel.