Friday, January 6, 2017

A New Monetary System From Scratch, Part 6: Credit Limits

Within an 8-hour journey (in a mountainous terrain) from our town community with a new monetary system, there's an off-the-grid village. There's been small-scale trade between the village and our town as long as anyone remembers.

The trade has mainly taken the form of a few village merchants and tradespeople descending into the town once a month to attend a monthly market. At the market, they barter their wares for goods they either need themselves or know are in demand back home. In addition to barter, some credit has been involved, in form of bilateral debts between certain villagers and townspeople who know and trust each other. The debts have often been skilo-denominated (see Part 1), but in the absence of a medium of exchange, all the debts have been eventually settled by delivery of goods ("in-kind"), usually at the following month's market.

With the advent of the new monetary system, the villagers trading with townspeople became disadvantaged. The townspeople, having gradually got used to the new monetary system, and the related electronic trade reporting system (ETRS; see Part 4), found bartering with the villagers inconvenient.

It didn't take long before the central-banker agreed to open an account for any villager at request, on one condition: no negative balances were allowed. (He didn't know the villagers and no creditworthy townsperson was yet willing to step in as a guarantor.)

An account with the central bank, and the "ETRS gadget" that accompanied it, gave the villagers a chance to participate in "gift exchange" at the local market, on the condition that they gave up (sold) goods before accepting (buying) goods.[1]

Two questions:

Did the central-banker impose a Clower-constraint (cash-in-advance constraint) on the villagers?

Does money, after all, exist in our economy?


[1]  Of course, they could make a sale first while promising to deliver the goods later, assuming the buyer was willing to extend personal credit to them. From that, there was only a short step to no (physical) delivery of goods at all; the two parties could agree on a re-purchase of the sold goods, by the villager, later on. This would be like a "money loan", if money existed in our model economy.


  1. I will comment by taking the perspective of an older, experienced villager.

    This villager has traded in the past, given and been granted credit, and has taken credit losses. He is an experienced trader.

    He was there when the new "ETRS gadget" first was used. (Demand should have increased, assuming that the availability of credit increased.)

    Now he is offered his own "ETRS gadget", on the condition that no automatic credit will be available. What might he consider as he weighs the "opportunity"?

    First, the temptation to make an easy sale. Using the gadget, he can sell to someone that has nothing to offer in return. The downside of this trade is that he is dependent upon someone else, in the future, trading the credit given by the central bank.

    Second, this credit will be of no value back in his home, off-grid village. To the extent that he needs hard currency to build his next trade good, he will need to rely on other resources.

    Third, he must make an "investment" to begin using this gadget. His first trade must be to a townsman, who is not expected to trade something in return (at least not immediately). (Townsman gives nothing, villager receives a credit mark, central bank provides credit). (The villager may receive guffaws when returning home with nothing but a new trade gadget with a mark on the screen.)

    Now I will try to answer the questions.

    Is there a cash-in-advance constraint on the villagers? Yes in the sense that the villagers must invest in the gift-economy project before they can participate.

    Does money, after all, exist in our economy? Yes, in the sense that a mark (a substitute) is taking the place of physical goods for a period of time. The gadget represents a method of physical substitution identical to the normal function of money.

  2. Thanks, Roger!

    You say that in a sense money exists. Does that mean that you are willing to agree that in another sense it doesn't?

    I don't find it hard to imagine that there is money. But I find it hard to fit money into the narrative, or description, I'm presenting.

  3. Hi Antti: " another sense it doesn't...."

    The longer I blog, the more careful I become to describe the perspective from which I write. I try to understand more than one perspective, realizing that my reader may not agree that I am understanding his perspective in any part.

    I am willing to consider evidence that money does not exist. It is easy to see that money, especially fiat money, is so easily created that an easy course of explanation is that money does not exist at all. The thought that banks create money (nearly like a counterfeiter) is simply unreal to our legally disciplined minds. The unreality of spontaneous creation coerces us into alternative explanations.

    The village trader I described is thinking of trading physical-objects because that is the mechanism of trade previously in vogue. He has received credit (and issued credit) so, in a sense, he has used money (that is, if we allow that credit can be considered as being money). He would readily accept that a written credit commitment could be traded, allowing that verbal agreements are hard to enforce or trade.

    To me, the key is that money should be considered as a physical substitute for the object traded. My village trader has no problem with this. The townsmen will complain.

    If money is a physical trade, then a monetary exchange should not be money-for-goods; a monetary exchange should be money-traded-for-money. A money-traded-for-goods exchange should be a "semi-barter" exchange. (So you see that I am arguing even with the language of economics.)

    So far, I find it easy to fit physical money into monetary explanations. The difficult part is in finding reader acceptance. :-)

  4. Roger said: "To me, the key is that money should be considered as a physical substitute for the object traded. My village trader has no problem with this. The townsmen will complain."

    Do you mean that the townsmen don't see the credit balance (a record of cumulative market value of goods given exceeding cumulative market value of goods received) as a physical substitute for goods, while the villagers could see it as such?

    One of the main points I wanted to make with this post is this:

    For villagers, the cumulative market value of goods they have received from others (as "gifts") must never exceed the cumulative market value of goods they have given to others. This is the rule, articulated in the language adopted by the townsmen. The rule is enforced by limiting villagers' account balances to non-negative.

    For the villagers, it would make no difference if we stated the rule otherwise, by relating it to the record-keeping directly. We could tell the villagers that a credit balance is 'money', and they have to give up 'money' if they are to buy goods. This means that first they have to get 'money' by selling goods. So the actual rule would be stated in terms of record-keeping.

    Both ways to articulate the rule, or to describe the situation, seem valid? I think they are both valid.

    But once we add that "the buyer needs to transfer money to the seller", then we have a problem. No transfer takes place in reality (as any townsman can attest). If we nevertheless choose to desribe the phenomena related to record-keeping using language like "money transfers", then we introduce an artificial layer on top of the accounting.

    With my theory, I'm saying that we don't need that artificial layer. We can talk about the record-keeping as record-keeping. This removes all the mystic from banking, as it means that no money is created (ex nihilo or otherwise); instead, accounting entries are made, and there is nothing mystical about that.

  5. A quick one before I think about it some more. My first reaction to your post was that the village was like a dollarised nation that had given up ist own currency and had limited access to forex borrowing. Such a nation would be forced to run current account surpluses / always have positive forex reserves. Currency board regimes like Hong Kong are in a similar situation, although they are probably credit worthy enough to bridge short periods in which reserves run dry.

    I've always been on board your 'nothing is transferred' train. In fact, I've never been on any other train. So I actually have trouble seeing the 'money as a thing' perspective. As a convert, you're at an advantage :-).

    1. Actually, I suppose the constraint could apply to nations that still have their own currencies, too, as long as these aren't accepted in foreign trade. As is the case with many smaller nations.

  6. Antti: You ask: "Do you mean that the townsmen don't see .........villagers could see it as such?" Yes. The townsmen think more like you when you write "No transfer takes place in reality (as any townsman can attest)."

    Are you familiar with algebra? One of the fundamental axioms of algebra is that symbols can represent physical objects. It follows that money (in electronic form) can be considered as a algebraic symbol representing a physical object.

    Next we have an accountant recording a transaction, using algebraic symbols (numbers at this moment). The entry(s) should record a real transaction where physical goods change ownership. If one of those goods is money, are we supposed to apply a unique rule that causes money to become ghost-like, transferring from one account to the other without physical existence during the act of transfer?

    I think you would answer "yes".

    I think I would answer "no, the money is in existence before, during, and after the act of transfer".

    You will probably observe that the accountant is only recording whatever the two traders are reporting. If that is all the recording represents, why should we attach future significance to the record? It is because we DO think that something important has been traded that we bother to create a record.

    You will probably also observe that no money existed before the trade, the accountant supplied all the symbols. This observation is correct and brings to light the reality that our accountant has the power to create money. The entries made are expected to be transferred in the future and may detail future obligations. These entries have more than a ghost-like future reality.

    So rather than adding a layer of complexity to the accounting, a layer of physical money transfer carries important information about the reality of underlying events. Discarding the physical layer detaches the ledger entries from the physical realities that are the reason for recording.

    What sort of physical realities might be lost? One that comes immediately to mind is the event of death of an account holder. What should the accountant due with the symbols no longer linked to an entity? It is logical to look at the underlying physical relationships to find an answer.

    :-) MONEY!!! :-)

  7. I agree with this:

    If we nevertheless choose to describe the phenomena related to record-keeping using language like "money transfers", then we introduce an artificial layer on top of the accounting.

    With my theory, I'm saying that we don't need that artificial layer. We can talk about the record-keeping as record-keeping.

    You have the choice between the convenience of using existing terms at the risk of being misunderstood and not being understood at all if you invent your own terms. Damned if you do, damned if you don't :-).

  8. Roger said: "It follows that money (in electronic form) can be considered as a algebraic symbol representing a physical object."

    What is the physical object the symbols represent? Currency?

    Earlier I've given an example of warehouse bookkeeping. I'm fine with (inventory) balances representing physical goods that actually are in a warehouse. Likewise, credit and debit entries made on the inventory accounts represent goods moving into, and out of, the warehouse. There are real goods which either are in a warehouse or are being transferred into and out of the warehouse, and there is bookkeeping reflecting these real goods and their movement.

    That logic doesn't apply to money. Physical money, currency, is part of bookkeeping. The question we should first ask ourselves, and then answer, is: What is being recorded? It is not "money holdings" and "money transfers", like it would be if we were talking about real goods.

    I have answered that question already.

  9. Oliver: I know I'm damned :-) I would just add that it's not just the terms that I've changed, but the concepts, too. If my theory doesn't have the concept of "medium of exchange", then I find it best not to use the word 'money' at all. If a balance can never be transferred but disappears with every entry made, then we shouldn't give it a name which, for most of us, suggests it can be transferred.

    Yes, I can see the link to a dollarised economy. In my next post I will actually "dollarise" the village even more :-) I also agree that converts usually have an advantage! But I'd like to understand a bit better how you are used to view these things.

    Are you saying that you haven't been thinking in terms of "money transfers" or "money flows" or "flows of funds"? You haven't even in your mind seen those flows, while knowing that they are strictly speaking just metaphors?

    I'm asking because I tend to get misunderstood on this point. Why I'm arguing that those flows don't exist in reality is not because I want people to accept that fact, per se, but because I want to justify my building a theory/framework within which it doesn't make sense to talk about that kind of metaphorical flows.

  10. Antti writes "What is the physical object the symbols represent? Currency?"

    Good question.

    Ask yourself this question: If I gained control of a block of money, let's say $100,000,000, what have I gained control of? It does not matter if the money is borrowed, inherited, or saved.

    I would suggest that you have control of a lot more than a single object, a group of inventory items or a substantial block of property. You have control of a substantial undivided portion of the economy. You could say then, that money represents physical control of the economy.

    My description of money as being a "National Gift Certificate" is an attempt to illustrate this expansive comprehensive role by making an analogy to a commonly used retailing tool. Physical money needs to be understood as an undivided share of the entire economy, controlling those parts of the economy potentially available for "semi-barter" exchange.

    I don't see that the concept of physical money conflicts with your gift-economy theory. Instead, the concept forces us to think that the accountant is creating money as he makes his entries. In turn, this forces us to consider what limits the accountant must apply (if any) as he records. :-)

  11. Roger: I think I follow your thought.

    But how does the control you talk about differ from the control someone with a zero balance (no "money") but, say, SK10,000 credit limit has?

  12. Antti: Having a credit line still requires some kind of creditability—as in 'ability' to get credit (money). Such condition is not completely irrelevant to the institutional context where payments are conducted. Money, in general, does not acquire its features as means of payment via the credibility of the holder, but rather via the issuer. With a credit line you already assume creditability on the part of the holder, which, in many circumstances, however, may or may not exist.

    Here's an interesting definition of money from an old common law case by Justice Darling in [Moss v Hancock (1899)]: "Money ... (is) that which passes freely from hand to hand throughout the community in final discharge of debts and full payment for commodities, being accepted equally without reference to the character or credit of the person who offers it and without the intention of the person who receives it to consume it or apply it to any other use than in turn to tender it to others in discharge of debts or payment of commodities."

  13. Antti: The term "credit limit" describes an ownership control mechanism.

    Any borrower can potentially borrow without limit.

    Can the lender supply physical money without limit? If the answer is "no", then the lender may place a "credit limit" on the borrower to encapsulate the transfer of money into borrower control.

  14. Johan: I don't think I disagree with you.

    Looking at Justice Darling's definition of 'money', you might find my latest post (just published) interesting? The central bank credit notes are very much like the 'money' he talks about -- with the exception that the person who receives it probably wants to tender it to the central-banker not in discharge of debts or in payment of commodities, but in order to get his or her account credited?

  15. Roger: You didn't answer my question? :-)

    If you look at my just published post, you see how I don't agree with your calling the bank a 'lender'.

  16. Antti: Sorry, I guess I do not understand what the question is. Could you rephrase it?

  17. Roger, perhaps I wasn't clear enough. You talked about "control of money", but you also seemed to imply that money gives to its holder control of something else? It's the latter I referred to. You said:

    "Physical money needs to be understood as an undivided share of the entire economy, controlling those parts of the economy potentially available for "semi-barter" exchange."

    I took you to mean that money gives its holder (potential) control over real resources (should he want to buy those), as is often said. I wanted to understand if a holder of money has somehow different control over resources than someone with no money but an unused overdraft.

  18. Antti: Ah, now I get get the question!

    You correctly quoted my caveat "controlling those parts of the economy potentially available for "semi-barter" exchange."

    In my view, money does not control the entire economy. Money only offers control over " those parts of the economy potentially available for "semi-barter" exchange." (In bartering tinged words, money is a "chameleon object", representing whatever physical object the viewer wishes to see.)

    "... I wanted to understand if a holder of money has somehow different control over resources than someone with no money but an unused overdraft"

    Your question seeks to explore the blurred line between "complete control" and "qualified control". A person with an unused overdraft potential would (should) see himself as having the "opportunity to reach a purchase goal at the cost of incurring a credit obligation". (This person has a pleasure-pain decision opportunity.)