Wednesday, January 8, 2014

Here's a difference

Following up on yesterday's post... or, actually, gathering notes for yesterday's post, I came across the following remarks from Steve Waldman, here:
You won't get an argument from me re the debilitating role of expanding finance. But I think that's complimentary to, rather than an alternative to, the inequality and demand story. Because you have to explain, so, suppose thieves in bankers' suits suddenly steal 5% of the money. That's going to be bad for the economy somehow, but how? You could argue a supply-side explanation: productive people are demoralized, the fruits of their labor are worth less, so they choose to produce less. But then you wouldn't expect to see disinflation and involuntary unemployment. After all, the money the bankers steal isn't burned, but it should be burning a hole in their pockets, they should be converting it into real goods and services and bidding up the prices of things, if people aren't producing as much. That's not what we see -- we see involuntary unemployment and sluggish prices. Somehow all of this thieving has not (just) interfered with supply, but it has diminished demand! But why should bankers not buy as much as whoever else might have had that money? They've no need to hide the loot in mattresses; their theft was perfectly legal. The cops guard their moneybags.

My explanation is that it's because the bankers are rich already. They don't use their marginal dollar to buy goods and services, they hold the income for the status and safety they experience by being rich. The channel by which finance diminishes rather than merely redistributing demand is, I claim, inequality. Income to the already rich is a drag on demand.

Suppose instead of finance, a reinvigorated union movement were to effectively organize, or from an economist's perspective cartelize, labor, such that ordinary workers all received raises and labor's take was an extra 5% of GDP. Would that "cost" translate to a collapse of demand the way that finance's vig has? Obviously not, I say, but what say you?

I agree.

Waldman's remarks concern the Marginal Propensity to Consume, a Keynesian concept that makes good sense to me: As income increases, people tend to save an increasing portion of it.

In the quoted text, Steve applies the high income share to "bankers" and the low income share to ordinary workers. But it is still the Marginal Propensity to Consume (MPC) that he is describing. Why does demand diminish, he asks, when bankers make lots of money?

"My explanation is that it's because the bankers are rich already," he writes. Demand diminishes because they spend less, because they save more, because they are rich already, he says. That's the MPC.

I also agree with Thomas Philippon that the "sum of all profits and wages paid to financial intermediaries" is unduly large. And with Simon Johnson, who says "I know of no evidence that says you are better off with a financial sector at 8% rather than, say, 4% of GDP."

But I'm pretty sure that cutting in half the wages and profits of the financial sector, cutting in half the number of banks and bankers, does go hand in hand with cutting in half our reliance on credit.

The bankers' take, the wages and profits of the financial sector, the size of that sector as a share of GDP, this is not what I mean by "finance".

If you look at things the way Adam Smith did, bankers' income is wages. Bankers go to work in the morning. They go home at night. They work for a living. And they get paid for working, just like the rest of us.

Okay, maybe they get paid better.

Still, the money they get paid for their work is wages. If they also own the company, or part of it, then they get profit, too. Profit, that's another of Adam Smith's cost categories. I wrote of this before:

By contrast, credit or bank money does involve real factors of production. Those are the factors Thomas Philippon has in mind when he says, "The sum of all profits and wages paid to financial intermediaries represents the cost of financial intermediation."

But wages are wages, and profits are profits. Completely separate from those payments to labor and capital, there is the payment to finance: interest.

Wages is wages. Profit is profit. Finance is finance. A person of high income is liable to save more than a person of low income, yes. But even a person of low income may be able to save. In both cases, the income-earner takes money received in exchange for his contribution to production, takes some of it out of the productive sector, and deposits it into the financial sector.

By contrast, income from finance arises in the financial sector.1  And, unless you take some of that money and dis-save -- take it out of the financial sector and spend it into the productive sector -- unless you dis-save, that money stays in finance. This is a massively different circumstance than applies to wages and profit.

The difference, then, when income is received, is whether it is received into circulation or received into savings.

My paycheck comes to me by way of circulation. By definition, my paycheck is M1 money, circulating money:

M1 includes funds that are readily accessible for spending. M1 consists of: (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) traveler's checks of nonbank issuers; (3) demand deposits; and (4) other checkable deposits ...

By way of contrast, the interest on my savings is credited to my savings account. It is part of M2 (circulating money plus savings), but not part of M1 (circulating) money.

So it seems that both kinds of money circulate, the kind that is received into circulation, and the kind that is received into savings.

Both types circulate, but have exceedingly different personalities of circulation. It occurs to me that money received into circulation is "medium of exchange" money; and money received into savings is "medium of account" money.


1. "The income from finance arises in the financial sector." But it is still a cost to the productive sector. The quoted sentence here is a description of how the saver receives the interest he earns. It doesn't come to you as a check, which would be M1 money. It is deposited (or credited) directly to your savings.


geerussell said...

So I get what "unit of account" is as analogous to an inch or an ounce. A unit that serves as measure of value.

I get what "medium of exchange" is, a specific money-thing denominated in the unit of account, a financial asset exchanged in a transaction.

Where I stumble is "medium of account" which as far as I can tell it's something Sumner invented in a fugue state.

The Arthurian said...

"... in a fugue state."

I did a number of posts on it some time back, mostly trying to figure out what Sumner might possibly be talking about. With not really much success.

But in the above post I am realizing for the first time that *maybe* we can have monetary exchanges with financial accounts, where perhaps the whole transaction takes place within the financial sector and even within accounts other than transaction accounts.

I doubt that banks keep funds in a checking account the way I do. They probably "sweep" their money just as they do ours, only moreso. And (being a bank) they can probably transfer money directly from their savings account to my savings account in order to pay me interest.

So much or most of what I define as the cost of finance can be transacted without showing up in M1 money at all.

M1 being "funds that are readily accessible for spending", it is what I spend for sure. But banks and, probably, high finance people in general can mostly avoid M1... can mostly avoid our "medium of exchange" and instead use snob money, Sumner's "medium of account".

Discussing Sumner's view, Marcus Nunes wrote:

The good kind is “whole money”. That is, it is both the MoE and MoA. Bad money loses its MoA property, but keeps its MoE property.

I'm saying, people with money can keep it in interest-earning accounts, and still spend it if they want to. Their money has BOTH the MoE (spendability) and the MoA (interest-earning) properties. Their money is whole money. My money is incomplete, "bad" money according to Marcus.

Dunno, it was just an accidental connection my mind made without my help. Maybe it's off the wall. Maybe there's something to it.

shtove said...

I suppose Smith would have allocated a chunk of bank profits/wages to rent seeking.

Steve Roth said...

Hi Arthur:

I think a better way to think about it:

There is a stock of financial assets (claims on real capital or future production which are somewhat roughly the same thing).

If a lot of that stock circulates, there's more GDP, more production, more income, more surplus, blah, blah, blah.

When more of the stock is held by rich people, it reduces circulation. A pretty straightforward velocity argument. (Though you also have to think about how that stock increases and decreases in toto -- another, related subject.)

So rather than saying that rich people "remove" that money (how could they?), it's that they sit on it, rather than spending it on.

Key (modeling) concept: "marginal propensity to spend out of wealth." It's generally discussed vis a vis income. That's very Keynesian -- his consumption function was a function of income only, not wealth. Fatal flaw IMO. Need both in the function.

Stopping now...

Jazzbumpa said...

I think there is yet another aspect of finance, possibly outside the arena of banking, per se. That is the weird world of obscure financial instruments. The last time I looked the estimated notional value of these things is somewhere between 6 and 20 times cumulative global GDP.

These things are also highly leveraged [I think] so the actual amount of money involved might only be in the same approximate range as global GDP.

But this is pure rentier activity and contributes nothing to real investment, production or consumption.

It's a massive misallocation of resources that has to have a significant negative effect on the real world economy.