Monday, 11 September 2017

Economic Myths: The BBC's brief history of paper money

It's all fine and dandy until this bit:

But the government soon moved stealthily to a fiat system, maintaining the principle but abandoning the practice of redeeming jiaozi for metal. Bring an old jiaozi in to the government treasury to be redeemed, and you would receive a crisp new jiaozi.

That was a very modern step. The money we use today all over the world is created by central banks and it's backed by nothing in particular except the promises to replace old notes with fresh ones.


Rather counter-intuitively, government issued 'money' does not require any asset-backing whatsoever, all the government needs is a system of whereby people HAVE TO hand those notes back to the government which effectively 'unprints' them again. The mistake that the Weimar Republic et al made was not taxing enough.

This is most easily explained with rationing vouchers. The vouchers had virtually zero cost of production to the government, were handed out as a kind of universal welfare entitlement and people HAD TO hand them over when they bought food or petrol. The government played little or no part in supplying food or petrol so they were not 'asset backed'.

Some people did not use all their vouchers and other people wanted to buy more food or petrol than their official ration, so would pay for them. That's where the value comes from.

On the day rationing was abolished, all the spare vouchers people had accumulated became worthless. Similarly, if the government had printed far more vouchers than there was food or petrol available, the vouchers would have significantly fallen in value.

It's the same with governments printing money (or its electronic equivalent). For every 'real £' of value you create, collect or spend, the government demands that you also pay X% of that value in 'government £' to the government.

Everybody needs to earn (by producing or collecting rent) and to consume goods and services. So you HAVE TO somehow obtain the permission slips to do in 'government £' from the government (or from beneficiaries of government spending). That's what gives them their value.

So the real economy works backwards from the answer and for convenience, denominates its transactions in whatever the national currency is. It wouldn't matter what 'currency' is used in the real economy (like BitCoin), the government simply converts your BitCoin earnings/spending to its 'government £' equivalent and charges you tax accordingly.

The thought experiment works just as well with any tax, including Land Value Tax. It's basic Modern Monetary Theory.


Dinero said...

Its not taxation that gives Sterling its value . If there was no taxation, £s would still be used and Sterling would still have value. What gives Sterling its value is the fact that Bank deposits are backed by borrowers obligations to supply goods and services to deposit holders. And similar with BoE notes , backed by BoE assets, either a government enterprise provides goods or services ,or someone who pays tax does the same to fund the Treasury bonds held by the BoE.

Mark Wadsworth said...

Din, that's almost completely wrong but I can't possibly make it any simpler than it is.

Curtis said...

Its not taxation that gives Sterling its value . If there was no taxation, £s would still be used and Sterling would still have value.

This part is correct though, at least in terms of paper money - the Iraqi Swiss dinar and Somali shilling retained value despite the lack of a government and in the case of Iraq, so much so that the Americans (despite having no obligation to do so) bought the Swiss dinar notes from the public (at least with new notes)

Mark Wadsworth said...

C, two weird outliers of physical paper of a defunct govt being accepted as money, for pragmatic reasons dies not disprove the point. Try paying in Germany with old Ostmark, they'll laugh at you.

Dinero said...

As "loans create deposits" and the value of a loan contact is defined by the asset side of the balance sheet it follows that the value of being the beneficiary of a banks liability is defined by the banks assets. The assets are loan contracts, which are undertakings to supply goods, land, services to deposit holders. The viability of the obligation overseen by a bank loan officer. The article refers to "paper money" being a receipt for an asset of gold and silver, well in that context it still is, but the definition of the asset is expanded to include all things valued by deposit holders.

Lola said...

ASAIAC MMT proves that nationalised money is a Very Bad Idea. If money values depend on government then governments will bugger it up by over production. But it is well known that I trust governments as far as I can spit a rat.

Mark Wadsworth said...

Din, bank issued money is backed by other people HAVING TO pay mortgages (a kind of privately collected tax).

Government issued money is backed by people HAVING TO pay tax.

Can you please not jumble the two topics?

L, government deficits are very naughty indeed and I am against (it goes into rent), but in practice it doesn't work out as badly as in theory.

Lola said...

MW. I wasn't talking about deficits, and they aren't 'government' ones' they are taxpayer ones incurred irresponsibly by government to buy our votes, I was talking about currency or money debasement. they just cannot themselves. It is after all what funds the welfare warfare state.

Mike W said...

Curtis, I too saw a programme which I think was the Somali 'shilling' or some such ex currency. The tribesman/bankers even sat at their 'benches' and were clearly trading in old plastic bags of the dusty stuff.I did notice too tribesmen with AK47's at the market.Mmmm.

So, If after the collapse of the old 'state' leading War Lords divy up the remaining (never increasing) notes and now use them for trading goats, boys and heroin internally(within a tribal structure). Are you really suggesting this knocks a hole in MMT? I agree with Mark this is really not a good example. I assumed folks would be giving Bit Coin as the great 'market' counter.(Which, I think is more like the example above as it happens):)

Your other example is actually what you would expect with MMT it seems to me. The Americans injecting US dollars, so Iraq's can start to pay their 'hut tax' in their new master's chosen currency. There was no 'market' exchange rate between old and new notes. If true these warlords handed over their old currency (for dollarization) and the Americans simply burned it!

Bayard said...

For a currency to have value, it simply has to be generally accepted for the payment of debts. The government doesn't have to be involved. There are loads of examples of this: cowrie shells, cigarettes, Maria Theresa dollars, LETS, C18th private currencies, the ones previously mentioned, etc etc.

Derek said...

Mark is absolutely correct on this. The only reason that the Somali shilling retained value was because local landlords/warlords continued issuing it as payment for goods and accepting it as payment for rent. Thus demonstrating that a government is nothing more than a collection of landlords and that taxation is nothing more than a form of rent.

Mark Wadsworth said...

B, it is very strange. You are trying to prove me wrong by pointing out that people use other things as money. Of course people have used lots of different things as money, I never said they didn't.Cigarettes aren't money, they are a commodity, a real thing with real value (to smokers at least), so strike those off the list.

All I said was: tax collecting powers give government issued non-asset backed paper money its value. I did not say that people buying and selling have to use their national currency as money either, people in the UK can use what they like to denominate indebtedness and prices.

I fail to see why people using cowrie shells negates that.

D, aha, thanks for back up.

Piotr Wasik said...

MW, if you are still reading this, why "government deficits are very naughty indeed and I am against (it goes into rent)" - interesting and puzzling. Initially I found Steve Keen and MMT counterintuitive - I wanted everybody to "live with means" therefore everybody to keep surpluses. And my understanding now of what they call "accounting identity" (sum of all money is zero, as money is counted as positive amount or negative amount) is that if govt has no deficit, members of public cannot have monetary savings. Do you prefer people's savings to be balanced by other people's mortgages? Again, my understanding is that under 100% LVT, land selling price would fall to zero, making all the cost of house or flat purchase the value of the building only, so mortgages would be much smaller, e.g. 80k regardless of the location. And why govt deficit goes into a rent? Which rent please?

Bayard said...

"I fail to see why people using cowrie shells negates that."

It doesn't and that wasn't my intention. I was responding to the statement "If there was no taxation, £s would still be used and Sterling would still have value." which formed part of a comment that you said was "almost completely wrong".