Tuesday, February 26, 2013

Mike Sproul

I still remember figuring out that Milton Friedman's phrase "money relative to output" is a way of saying scarcity makes things valuable: It is a way of saying the idea that "scarcity makes things valuable" applies to money just as much as it does to the things we buy with money.

Friedman's ideas went up a few notches for me that day. The more so because economics, according to the textbook, is the study of scarcity.

Friedman's idea became one of my fundamental building-blocks of thought, as much as the line from Keynes that the engine which drives enterprise is not thrift, but profit. What I'm saying is, Friedman's idea is embedded in the very foundation of everything I think about the economy.

So every time I run into comments from this guy Mike Sproul on blogs and stuff, he stops me dead in my tracks. Sproul says, if I have it right, that money gets its value not from scarcity, but from the assets that back money. It's the old idea that paper money backed by gold was valuable because of the gold backing: Not a difficult idea to accept, in its own right, but as unlike Friedman's as demand deposits are from Krugerrand.

Ran into Sproul recently in comments at Free Banking: Drawing the line:

First, there's gold. Then there are paper claims to gold, then there are bookkeeping entries that are claims to those paper claims, and so on. All those claims have varying degrees of liquidity, so we draw arbitrary lines where nature did not put any lines, and start talking about M1, M2, etc. The whole exercise is a classic case of asking the wrong questions.

Here's the right question: Whose liability are those claims? Paper dollars issued by the Fed are the Fed's liability, and their value is determined by the Fed's assets. Checking account dollars issued by Chase bank are Chase's liability, and their value is determined by Chase's assets. Credit card dollars issues by Visa are Visa's liability, and their value is determined by Visa's assets. Those various kinds of dollars have varying degrees of liquidity, but when it comes to the question of what determines the value of those dollars, asset backing counts for almost everything, while liquidity counts for almost nothing. It is therefore a huge mistake to divide various kinds of money according to their liquidity, while paying no attention to asset backing.

Even the first time I ran into Sproul, he was talking about the value of money in relation to assets and liabilities:

the quantity of checking account dollars does not affect the value of green paper dollars, since the Fed's assets and liabilities are unaffected by the actions of private banks.

Now, that one I have trouble with. I can always fall back on the notion that I'm an idiot, a mere hobbyist trying to make sense of the world. I've been "taught" almost nothing about the economy, and maybe my understanding of things is like a river that took a wrong turn when a trickle of a tributary of my thought went the wrong way around a pebble, once upon a time. But I cannot see how the value of the dollar is "unaffected" by the actions of private banks.

Banks and borrowers create money that is indistinguishable from and interchangeable with the green paper dollars issued by the Federal Reserve. Is there a pebble here?

Certainly, most of the U.S. trade deficit is created by private spending of bank-created money. And certainly, the trade deficit affects the value of the dollar. Is there a pebble in this?

At the root of Arthurian economics is the view that most of the increase of prices in my lifetime has been caused by the expansion of credit, not by running the printing press. This view is confirmed by the fact that after the crisis the Fed's main focus was to prevent the deflation that would come from the collapse of credit. Is there a pebble?

So, I have trouble sometimes with things Mike Sproul says.

In the Free Banking comments, he said something I liked:

Back in 1840, when checking accounts were relatively new, people denied that checking account dollars were money, on the grounds that checking account dollars ultimately had to be paid in paper or coin. In 1710, people denied that the new-fangled paper notes were money, since paper notes were ultimately paid in coin. Today, people deny that credit card dollars are money, since they are ultimately paid with a check, a paper bill, or in coin. In every case, it has taken people a while to realize that there is a permanent float of dollars (paper, checking account, or credit card) that is never paid down, and that permanent float should be counted as part of the money supply. Credit cards were introduced in 1950, so if past history is any guide, it will be about the year 2080 before economics textbooks count credit card dollars as part of the money supply. By then, of course, there will be some new kind of money, and economists will deny that it is money.

His opening thought here, in 1840 people denied that checking account dollars were money, I like that. I said something similar myself on this blog one time, and I'm happy to accept Sproul's thought as confirmation of my thought. The right side of the pebble, and all that. I'm okay with his 1710 thought, too.

But I'm not okay with his view that "credit card dollars are money". Oh yeah yeah yeah, we use credit for money, definitely, and that is definitely the problem. It's a problem because credit isn't money. Credit isn't money, because after I pay for something with credit, I still have to pay for it with money. Credit doesn't discharge the debt.

The use of credit is qualitatively different from the use of checking account dollars and "new-fangled paper" notes. Pay for something with gold, or with new-fangled notes, or pay by check, and you have no further obligation to pay for the thing you bought. The debt is discharged. This is not the case if you use credit to pay for something. Pay with credit, and the debt remains. Paying with credit is not the same as paying with money. Sproul is wrong about this.

In my comment at that Free Banking post, I linked to a PDF (6-page article in a 12-page PDF) on the "True Money Supply" (TMS) by Joseph T. Salerno. Salerno writes:

... money serves as the final means of payment in all transactions. For instance, credit cards are not counted as part of the TMS, because use of a credit card in the purchase of a good does not finally discharge the debt created in the current transaction.

That's right. In 1840, checking account dollars were money because you could use them to "discharge the debt". In 1710 the new-fangled paper notes were money, because you could use them to discharge a debt. But today, if you use a credit card to pay for something, you add to your debt. You don't discharge it. Credit cards are not money. Credit is not money. This is why using credit for money is a problem.


Mike Sproul said...

You should have emailed me when you first posted this, and I could have responded in a timely manner. My email is sproulmike, and it's a yahoo.com address (Hope that will throw the spam-bots off my scent.)

1) I have been a big admirer of Friedman since 1976 when I took my first econ class at UCLA. But I came to recognize that he was wrong about money. A quantity theorist would believe, for example, that if I borrow $100 from my bank while offering an IOU promising to pay $105 in 1 year, and if my bank issues that $100 by crediting that amount to my checking account, then M1 has just risen by $100, and the price of groceries will rise, just as if a counterfeiter has issued a fake $100. This leads to the very unlibertarian proposition that willing banks should be restricted from issuing new money to willing customers. The real bills doctrine contains no such unlibertarian strictures against banking. It is the natural rule that free banks would (and did) follow.

2) About my proposition that the value of the dollar is unaffected by the activities of private banks: Think of an analogy to GM stock. GM's assets (including future earnings) are worth $60 billion. GM has issued 1 billion shares, so each share is worth $60. Now Merrill Lynch issues 1 billion IOU's, each promising to deliver 1 genuine share of GM (or cash equivalent) on demand. GM's assets are still $60 billion, and there are still just 1 billion genuine shares laying claim to that $60 billion, so each GM share is still worth $60, regardless of what Merrill Lynch does. Merrill Lynch's IOU's are a claim only against Merrill Lynch, and GM shares are a claim only against GM.

3) About credit cards: Say I borrow $100 from my bank and put it in my checking account, then immediately spend that $100 at the grocery store. At the end of the month I pay back the $100 to my bank using paper dollars. I do the same thing every month, so you'll find a permanent float of $100 in my checking account, which is never really paid off. That $100 is counted as part of M1. The next day I charge $100 at the same store, meaning that I just borrowed $100 from the credit card company, handed it to the grocer, and paid back $100 to the credit card company after 1 month. I do the same thing every month, so there is a permanent float of $100, never really paid off. This $100 has as much right to be counted as part of the money supply as the $100 in my checking account.

The Arthurian said...

Mike, thanks for your comments. I meant to respond sooner... Dunno where the time went.

I'm having some difficulty addressing the specifics in your remarks.

RE #2: If the new Merrill Lynch issue causes them to increase their holdings of GM stock, then it seems to me that the demand for GM stock has increased and the price of GM stock will rise as a result.

RE #3: The $100 you borrow from the bank counts as M1 when deposited in your account, yes. I always figured that the $100 you spend on a credit card counts as M1 when the seller is paid by the credit card company. Is this not true? (If the adjustment to M1 occurs after the transaction as opposed to before it, to me the difference is not very significant.)

In your example #3 you begin by borrowing from the bank: You begin by *adding* to the quantity of money.
It clarifies things for me to think of being paid for work done, so that the money I receive can be considered money that was already existing in the economy.

For me, then, the difference between money and creditmoney is whether I have to pay interest (and repay principal).

If I buy something on credit today, I still have to pay for it tomorrow. Yes, the increased demand today is one of the effects of money, the expansionary effect. But the payment tomorrow is the constraining effect.

You want to count as money the things which have expansionary effects. Joseph Salerno's TMS counts as money the things which have constraining effects.

For me, it is the excessive separation of expansionary and constraining transactions that creates problems, for the gap between them is filled with debt.