In my previous post I first assumed that someone might borrow red money because he was credit-constrained (and thus couldn't buy goods without selling goods first). Then I proceeded to prove my assumption wrong, without even initially realizing what I had done (I woke up 6am this morning, and still lying in bed I realized my mistake).
By borrowing red money you receive red money, and buy buying goods you receive red money. If you borrow red money from a non-bank, and if red money can exist only as a debit balance on a checking account (which, I argue, must be the case), then the bank cannot differentiate between you buying goods or borrowing red money; the accounting entries are identical. (The same is true for selling goods and borrowing green money from a non-bank.)
I just wrote a short story about the need for collateral in the absence of trust, even when one only wants to sell goods. You find it here (Nick's blog).
So, let's forget the credit-constraint reason. The reason (for borrowing red money) I initially had in my mind when I started to write the previous post was the second one. It's this:
X wants to make a financial investment.
Financial investments in red-only world
In a green-only world, X would first sell goods and then make a loan of $1,000 to someone. In red-only world, the only way he can make a similar investment is for him to first take out a loan of $1,000 and then sell goods.
If X would take a loan of $1,000 but only sell goods for, say, $100, his investment would be 90 % debt-financed ("liability-financed" for Nick?), 10 % equity-financed. After first taking the loan, he can build his equity share by selling goods, which will be mirrored in his red money stock (a liability for him).
In red-only world, one builds a financial fortune by getting rid of borrowed red money -- while remaining a (big) borrower all along. Financial assets are red money loan contracts seen from the borrower's perspective, and holding this kind of asset is closest one can get to holding green money in red-only world.[1]
In green-only world, when the loan expires, the lender first receives money from the borrower, and then he can buy goods with the money. In red-only world, the borrower, having earlier "spent" the borrowed money by selling goods, must first buy goods to get red money (back), and when the loan expires he delivers the red money to the lender.
Is red money borrowing equivalent to green money lending, as JKH says?
In a way it is, but in another way it isn't. What happens when a loan is made?
A green money borrower acquires both an asset (the money) and a liability (the loan).
A red money borrower acquires both an asset (the loan) and a liability (the money).
A green money lender gives up an asset (the money) and acquires another asset (the loan).
A red money lender gives up a liability (the money) and acquires another liability (the loan).
Initially, I find no symmetry between the positions of a red money borrower and a green money lender. (Instead, there is clear symmetry between the positions of borrowers and between the positions of lenders.)
The position of a red money borrower is comparable to the position of a green money lender only after the former has sold goods and got rid of the liability (red money) he acquired. That's probably the equivalence JKH talks about.
We see that one can neither sell nor make a financial investment in the red-only world without first incurring a liability. And to be able to incur that liability, one has to have a checking account and either be considered creditworthy by the bank, or be able to post collateral.[2] For someone coming from the real world, this doesn't make any sense.
But I believe this is a feature, not a bug, in Nick's system. When he talks about red-only world, "Red Nick" is equivalent to "Green Clower". The requirement that one can only sell goods if one has red money is a "cash-in-advance constraint". Clower's requirement that one has to possess green money if one is to buy goods is silly, too. It doesn't make sense.
When we put the silly red-only and the silly green-only world together, we get the (slightly less silly) real world. When describing that world, we have two options:
- We can suggest that both green money and red money are media of exchange.
- We can suggest that green money is not a medium of exchange; that there is no medium of exchange, other than the record-keeping system as a whole.
Nick has chosen option 1. I have chosen option 2.
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[1] Assuming "shadow banks" are forbidden. If not, then I would establish a money market fund which would buy (investment grade) red money loans from borrowers by issuing deposit-like shares to them. These shares would probably become the green medium of exchange.
[2] My "creditworthy" is more or less the same as trustworthy. Having eligible collateral probably makes one creditworthy, in another sense of the word.
or 3. We can suggest that for any closed system there is an equivalence of red and green money in that all transactions are recorded pairwise per party involved. So, if one does insist on using the term money, the only consistent way to do so is by either following the asset (green) side or the liability (red) side of transactions or, and this would be my favourite, insisting that the term is actually short hand for both red and green sides of any transaction viewed together. In other words, the only thing that is NOT consistent is insisting that red and green BOTH be counted separately, as Nick is doing. To be clear, I don't think defining a stock of money is a particularly sensible thing to do anyway. And if anything it must include the sum of all unused overdrafts, too.
ReplyDeleteAntti: Sorry, but I still fail to understand your version of red money. And I still don't understand Nick's version.
ReplyDeleteLet's try an example: A young person with talent wants to draw a picture and sell the picture for food. He first needs a canvas and paints. With canvas and paints, the artist can draw a picture and sell it.
Two red world problems:
1. What does the artist need to buy canvas and paints? My guess: (removed due to lack of logic)
2. With the painting completed, what value of red money will be given with the sale? My guess: The value of the claimed time-used-to-paint added to the cost of canvas and paints.
In the green world, I would understand this situation and offer an opinion. In the red world, I feel lost, without a common point of reference.
Oliver said: "I don't think defining a stock of money is a particularly sensible thing to do anyway"
ReplyDeleteI fully agree. If you're still thinking about Nick doubling Gross money, forget it :-) It's not stocks, but flows, that are interesting. And I'm saying that flows don't exist. They are just part of the conventional way of thinking about the accounting, but there's another way -- my way (no link to a song, sorry) -- to think about this that doesn't include "money flows".
You said: "So, if one does insist on using the term money, the only consistent way to do so is by either following the asset (green) side or the liability (red) side of transactions or, and this would be my favourite, insisting that the term is actually short hand for both red and green sides of any transaction viewed together."
It sounds like you're talking about Jamie's world, not Nick's? But not really, because he didn't talk about the two sides of a transaction, but the two sides of a record (credit/debit balance)?
I think I know what you mean, and I think I agree with you. It's just that in Nick's world, red is red (a liability) because there is no green on the other side of it (no one's asset). And the same goes for green. So Nick has just
(1) taken the view shared by Friedman, Pesek, Saving, Eric Lonergan, etc, which says that "fiat money" is an asset to its holder but no one's liability ("part of net wealth of the community"), and
(2) applied that view to overdrafts in central bank ledger.
I see much sense in what he has done. I think it's quite logical. If you have an overdraft, you just sell goods to get rid of it. You don't deliver money to the (central) bank. You deliver money to no one. You deliver goods to someone, but that someone wasn't your creditor. That's why Nick says that it's your liability but no one's asset.
I don't agree with the people who say that "fiat money" is net wealth. But I do agree that money itself is no one's liability. It is not net wealth because there exists "unilateral liabilities" for all these "unilateral assets". Everything in a central bank ledger is either a an asset without a liability (RHS) or a liability without an asset (LHS). When the CB purchases a bond, that bond ceases to be someone's asset.
Doesn't make much sense -- or does it? :-)
Roger: I understand your pain :-)
ReplyDeletePerhaps I partly answered you in my answer to Oliver above?
You said: "1. What does the artist need to buy canvas and paints? My guess: (removed due to lack of logic)"
If the artist is going to buy something without having yet sold anything, he naturally needs credit. His bank has to be OK with his account balance going negative (an overdraft). He doesn't need money to buy things, but neither do we need it in the real world -- we can use an overdraft facility.
"2. With the painting completed, what value of red money will be given with the sale? My guess: The value of the claimed time-used-to-paint added to the cost of canvas and paints."
The artist will try to set a dollar price on the painting just like he'd do in the real world. If the price he gets covers only the cost of canvas and paints (this is a realistic assumption -- ask artists), his account balance returns to zero. If he gets more for the painting, then he has to borrow red money from someone, bank or non-bank, prior to the sale -- which sounds silly. Is it this last part you don't get it? Or?
It makes sense to the extent that I agree that all bank accounting entries sever the ties between borrower and lender (I've never thought of the monetarist story in that way . interesting). Nevertheless, all entries are born in pairs and die as such, too. That is the point that quantum economists make. To them money only exists in the instant of transactions (quantums), it is never a stock measure.
ReplyDeleteAntti: Thanks for the reply. My world is simple (at least to me) and does not fit at all with the green/red world. Here is why:
ReplyDeleteMy mechanical world has an economic machine where positive parts are connected to positive parts. These parts all move in the present time frame--together. Negative parts would be part of a FUTURE time frame, and by definition are not part of the present.
Turning to the artist, he wants to work in the present. He needs canvas and paint. He needs something real (and existing) to trade for those items. Credit is a good solution (like you suggested) BUT is this credit issued by the seller or a bank? If the bank, then the bank MUST make available a real, existing tradable product. You seem to agree here, with the bank SUPPLYING A PRODUCT (maybe red?). In the green world, the tradable product is green money.
The fact that the bank trades green money for a promise to repay the money in the future does not make a loan document part of the present macro economy. Instead, the loan document becomes a fixed asset which will have an impact on the FUTURE economy when the loan is repaid.
I think this is standard green money theory. Maybe the sharp distinction of assets-present and assets-future is unusual.
Turning to the second part
"2. With the painting completed, what value of red money will be given with the sale? My guess: The value of the claimed time-used-to-paint added to the cost of canvas and paints."
I think you agree that in the red world, we have a very difficult time combining positive parts (new labor and existing canvas and paint) and then finding red money to deliver with the completed painting. We are trying add positives to find negatives. I don't find this logical.
We all know what to do in the green world.
I am about ready to give up on this green/red comparison. How about you?
Oliver said: "Nevertheless, all entries are born in pairs and die as such, too."
ReplyDeleteExactly. No wonder people mention Quantum Economics when they hear what I'm saying. But as I said, I believe I differ from QuantumE in a substantive way. We'll have to find out how :-)
Roger said: "BUT is this credit issued by the seller or a bank? If the bank, then the bank MUST make available a real, existing tradable product."
ReplyDeleteHere's where we differ. I don't view green "account money" or "book money" (that is, positive balance on a checking account) issued by a bank an "existing tradable product" either. (TMF and I have argued about this perhaps for a month now...)
What the bank does it allows the artist's balance to go negative. Nick would put it like this: The bank allows the artist to receive a "tradable product", red money, from the seller of the canvas and paints. The bank trusts that the artist is able, at one point, to get rid of the negative balance by selling his painting. That's how credit, trust, is involved.
You said: "I am about ready to give up on this green/red comparison. How about you?"
I don't give up on it, because it has a clear connection to what I'm arguing in my "gift theory". But I believe I can make these things more understandable to you and others than Nick can. I don't use green and red, so you get rid of that kind of thinking if you choose to follow my path ;-)
Antti: Your comment showed much insight. Thanks for that.
ReplyDeleteIn fact, I wonder if it provides the bridge that we need to tie gifts to money?
Roger said: "BUT is this credit issued by the seller or a bank? If the bank, then the bank MUST make available a real, existing tradable product."
The distinction between the seller and bank is important. The seller can make a gift which may fit into your theory. On the other hand, the bank is a third party. It is not making a gift, not receiving a gift. The bank is a cooperating third party that has been brought into the (otherwise) two party transaction.
Now, let's look at the results of "artist failure" by contrasting the two methods of obtaining canvas and paint. If the seller gives the canvas and paint, "artist failure" results in the seller never receiving anything in return. The transaction stops right there, with no echos except bad memories.
Now consider if "artist failure" results in no bank repayment. Well, this is more complicated. The artist was given money. The seller received money. The seller presumably passed on the money to additional sellers. Maybe sellers to sellers to sellers. There is no end to sellers selling.
BUT THE BANK ITSELF, if the bank was never repaid, could never re-loan that particular block of money again. That makes the bank a loser if we have "artist failure".
Does this distinction between gift and money make sense to you?
It is the enduring nature of money that forces me to consider it as a product with physical life (and makes me suspicious of how gifts could replace real physical money).
There is a second important point concealed in this example. It's a concealed point so you need to look deeply into reality. Consider that money is a human invention that can be created. Here is the concealed point: if money can be created, it must be possible to "un-create" it.
OK, we will look at the creation and un-creation of money. Most people agree that banks can create money. Money was created when the artist accepted money from the bank. It is easy to see that the created block would be un-created when the bank was repaid.
What happens when there is "artist failure"? The bank is never repaid and the money is alive with possible infinite existence. The money now appears to be a permanent physical object.
Hold on--the "artist failure" story does not end yet. We said that money is a human creation, yet we also said that the money the bank created can live forever when we have "artist failure". We made this block of money into a real physical object--out of nothing! (Is this what is bothering you?)
There is a logical explanation for this reality. The bank is lending money created by another bank. It's that simple. The bank loan of green money that the bank gave to the artist was green money created by another bank. We can extend that thought to the creation of fiat money by government. The explanation ends with the realization that base money is money that has been provided by government.
We close the loop completely by recognizing that base money can be destroyed by government collecting taxes and paying down it's own debt. If government completely paid down all government debt-in-the-form-of-bonds, all the existing fiat money should disappear. Banks would have no fiat money to lend.
Wow, there is a lot of concealed logic in the "artist failure" story ;-)
Does this do anything to bridge the gaps between your gift theory and my view of money? I guess if this stuff was easy, it would have been solved long ago :-)