Friday, November 25, 2016

In the Land of the Color Blind, Neither a Borrower Nor a Lender Be: Part 1

(Yet another comment that became a full blog post. Actually two. Or three. Perhaps a book? This is a reply to Nick Rowe and JKH.)

JKH and Nick are creating a real challenge to anyone who wants to question the theoretical plausibility of Nick's red money construction, especially when it comes to symmetry between red and green money. Two beautiful minds put together create a real monster?

In what follows, I'll take out my two red pennies' worth.

Here JKH repeats one of Nick's key assumptions in red-only world, namely that you cannot sell if you don't possess red money:
He wants to sell something for $ 1,000 so he requires a red money balance to sell it.
So customer X borrows $ 1,000 in red money.

But why doesn't X just buy something for $1,000, receive $1,000 in red money from the seller, and then sell himself? Why would he want to borrow red money?

I see two options (if first is true, then the second kind of follows; but the second can exist independently of the first). To keep this post from becoming way too long, I'll leave the second option for another post. Here's the first one:

  1. X is credit-constrained, which means that he cannot buy first and thus acquire a liability (red money).


Credit constraints

If you are totally unworthy of credit, you cannot incur financial liabilities. This is true both in green-only and red-only world. For you to incur a financial liability, there has to exist someone who considers you creditworthy and this someone has to be in a position where he can make it possible for you to complete the transaction – usually a purchase of goods/assets – as part of which you acquire the financial liability.

Red money, unlike green money, cannot be a (broadly defined) bearer instrument. A record has to be kept of the owner of the underlying liability, and the transactions involving transfer of liability. If I remember correctly, Nick has tried to justify "red paper money" (cash) by a garbage metaphor, where red cash is like garbage. But it seems hard to come up with a system which could help enforce the rule that you cannot dispose of the red cash other than by selling goods.

I see no reason why we shouldn't avoid this control/enforcement problem by assuming that there is no (physical) red paper money in existence; all we have is a more or less centralized record-keeping system run by a bank or banks. That system is the easiest way to establish the control required.

If red money is a record of a liability, then what is its holder liable to do and how did the first piece of red money come to exist? Remember that we are still in red-only world.

Red money is a liability to sell goods. (Green money gives a right to buy goods.) One acquires red money – once there is some in existence – by buying goods.

For the "origin myth", it seems we need to turn to Nick's garbage metaphor. As Nick says, garbage is a bad, not a good. The first red money must have come into existence through a sale of a bad. Perhaps like this:

There's a public disposal facility for radioactive waste (DFRW). The private producers of radioactive waste are under government surveillance, and they must deliver the waste they produce to the DFRW. How are the private waste producers made to pay for this public service? Remember that there is no money in existence. One option would be to make them pay in kind, by delivering goods to the government (for public use). But that's not convenient.

Let's assume that a standardized sack of wheat (WS) functions as a numeraire and a unit of account (see my first post for an explanation) in the economy under study. To avoid the inconvenience of payments in kind, the DFRW, our proto-central-bank, comes up with an ingenious record-keeping system:

It creates a ledger which includes "checking accounts" for all the radioactive waste producers – all these are trusted corporate citizens. The DFRW sets a fixed price, expressed in WS, on radioactive waste. When a waste producer delivers (ie. sells) waste, the DFRW makes, say, WS10,000 debit entry on the customer's checking account. Following the principle of double-entry bookkeeping, the DFRW makes a WS10,000 credit entry on its own account called "Waste stock". In conventional accounting language, the waste stock is a liability of DFRW (we find it on the RHS of balance sheet). Likewise, the customer's debit balance – only debit or zero balance is allowed – on a checking account is said to be an asset of the DFRW (LHS of balance sheet).

Before the customer leaves the premises, the DFRW and the customer together set a payment schedule. This schedule defines when the debit balance on the checking account is going to be reduced, and finally closed, by the customer. How can the customer, the waste producer, reduce its debit balance? By selling goods ("earning credits").

We have just witnessed the birth of red money.

But how does it become a medium of exchange? I see at least two ways to make it such (and these can be combined):

1. The State Theory of (Red) Money

The government establishes a special negative tax, in the form of lottery (positive taxes are already paid in kind, so I will call the recipient of this negative tax a taxpayee; it could be understood as "payer of red money"). To be eligible to receive this tax, a taxpayee has to be creditworthy enough so that the DFRW agrees to open a checking account in his name. Having opened an account with the DFRW, the taxpayee can buy goods from the waste producers by accepting "red money": his account is debited, the waste producer's account is credited. His purchases are limited by the "max debit" limit (conventional language: overdraft limit) connected to the account. Just like the waste producers, he has to agree on a payment schedule with the DFRW. Just like the waste producers, he reduces his debit balance by selling goods (incl. services, incl. labor).

It's time for the negative tax lottery. The government will select at random, say, 1000 checking accounts which it will credit with a random sum between WS10 and WS1000 – but only if the account has a debit balance that covers the credit entry.

OK. You probably get the idea. (If you don't, we can continue in the comments. This post is too long already.)

2. The Debt Binge Theory of (Red) Money

Who wouldn't want to buy stuff first, pay only later? Now it's made easy – for all creditworthy agents. Just open a checking account at DFRW and start accumulating debits. Perhaps you're a large scale user of electricity? Now you can buy it from your local nuclear plant by accepting red money from it. And you can rest assured that your customers are happy to buy goods from you in the same way, by accepting your red money.

Read my lips: This red money thing is going to snowball into a widely accepted medium of exchange!

OK. In this post we have dealt with some fundamentals of a red-only economy. In the next post we will get to look at the interesting stuff Nick and JKH are discussing, like the red money loans which I already mentioned.


As you might have already realized, if X in JKH's example is severely credit-constrained (totally unworthy of credit in the eyes of the DFRW) he can neither buy first nor take out a loan of red money (from a non-bank). The latter would involve a debit balance on his checking account, and the DFRW wouldn't approve of it. From this it follows that collateral must play a decisive role in a red-only world. Logically, one must be able to sell first even if one's promises are valued at zero.

More on this in the next post!


  1. Antti: Perhaps I am just dense, but Nick's description of red money is completely illogical to me. Unfortunately, the lack of logic (for me) continues into this post. I am not understanding this.

    Perhaps it would help to describe how red money can exist and then be loaned from a bank.

  2. I have not read this in detail but have a couple of general points.

    JKH is very intelligent and he likes thinking about this stuff as a mental challenge, so you need to be very clear at any point whether JKH is saying

    “this is how the real world works”


    “this is the implication of thinking through the logic of a world that Nick has made up but which does not exist in the real world”.

    Nick’s red world does not exist, so JKH’s views on the red world fall into the latter category above. That is also why Roger gets impatient and why I only skim read this post.

    If we are modelling different worlds at the same time, it is essential to explicitly say what world we are talking about at any point and the reason for exploring that world. It’s normally best to stick to the real world though as that has more than enough difficulties.

    One of my first thoughts on reading about Nick’s multiple worlds was that only one of the worlds could be real, so why did Nick think that he needed to create multiple worlds? That thought, on its own, suggested to me that Nick had made an error in his thinking even before I read the detail of his models.

  3. Jamie: You're right, one has to be careful with JKH. I'm trying to be careful.

    It might be that you and Roger "just don't get" how Nick or I see the world (or we don't get how you see this thought-experiment), and why we see that this kind of thought-experiment is useful not only as a mental challenge (like Sudoku?), but because it can teach us something important about the real world (I don't think this is just "Sudoku" to JKH, and perhaps you don't either).

    All Nick's worlds, even the combined one, are imaginary (even if he says that he finds the combined one to be a model of the real world). How I see this is that Nick wants to discuss the combined red/green world as a (simple) model of the real economy, but wanted to build that world by first introducing the green-only and red-only worlds, so that we can see what he means by "red money" being a medium of exchange.

    What I'm trying to argue in my latest discussion with JKH (in Nick's blog) is that "green money" is not a medium of exchange either, not in Nick's red/green world nor in the real world -- here I seem to agree with Nick that his red/green world might work as a model of the real world. It is obvious to me that "red money" is not a medium of exchange.