Friday, February 14, 2014

It's always on the house at Mason's Bar and Grill

At the Slack Wire: JW Mason's Don't Start from the Coin. Mason writes:

To understand the monetary nature of modern economies, you need to begin with the credit system, that is, the network of money obligations. Where we want to start from is a world of IOUs. Suppose the only means of payment is a promise to pay. Suppose it's not only possible for me to tell the bartender at the end of the night, I'll pay you later, suppose there's nothing else I can tell him -- there's no cash register at the bar, just a box where my tab goes. Money still exists in this system, but it is only a money of account... If you give something to me, or do something for me, the only thing I can pay you with now is a promise to pay you later.

That's a little weird, isn't it? Every day at opening I tell the buxom barkeep, "Put it on my tab." And every night, stumbling out, I tell her "I'll pay you tomorrow." [1]

Let's take Mason's "bartender" example as a starting point in his "begin with the credit system" approach. Let's see what we have to add to it, so it makes sense.

There is no settlement of money obligations in Mason's Bar. Right off the top, I'd say we have to add the cash register and some means of actual payment. But hey, let's see where Mason takes us.

"Debts in this system are eventually settled," he writes. "As Schumpeter says, they're settled by netting my IOUs to you from your IOUs to me." Reminds me of the story about the $100 bill.

By the end of that paragraph, JW Mason is reiterating the "clearinghouse" function of today's central bank:

The longer the chain [of IOUs], the more important it is for their to be some setting where all the various debts are toted up and canceled out.

Mason points out that this same function was served by the great fairs of Medieval Europe:

During their normal dealings, merchants paid each other with bills of exchange, essentially IOUs that could be transferred to third parties. Merchants would pay suppliers by transferring (with their own endorsement) bills from their customers. Then periodically, merchant houses would send representatives to Champagne or wherever, where the various bills could be presented for payment. Almost all the obligations would end up being offsetting.

During their normal dealings, merchants accumulated IOUs. At the fairs, they settled them. Okay, I can see that. Mason quotes Fernand Braudel:

The fairs were effectively a settling of accounts, in which debts met and cancelled each other out, melting like snow in the sun: such were the miracles of scontro, compensation. A hundred thousand or so "ecus d'or en or" - that is real coins - might at the clearing-house of Lyons settle business worth millions; all the more so as a good part of the remaining debts would be settled either by a promise of payment on another exchange (a bill of exchange) or by carrying over payment until the next fair: this was the deposito which was usually paid for at 10% a year (2.5% for three months).

Mason likes this. He emphasizes that

a "good part" of the net obligations remaining at the end of the fair were simply carried over to the next fair.

And he moves to conclusion:

I think it would be helpful if we replaced truck-and-barter with something like these medieval fairs, when we imagine the original economic situation.

I don't understand. What does Mason mean, when we imagine the original economic situation? He seems to be suggesting that how we think about money today depends on how we think about money in "the original economic situation". That's absurd. It's more like the other way around.

Apart from that conclusion, Mason emphasizes the importance of settlement of money obligations. It seems to be the mutual swap of IOUs that satisfies his desire to understand "the monetary nature of modern economies".

And the way things are yet today, with still so many IOU dollars per settlement dollar, Mason's focus on IOUs is understandable. But then, with so many IOU dollars per settlement dollar, it is quite clearly not true that "As Schumpeter says, they're settled by netting my IOUs to you from your IOUs to me." Our world is more like Mason's Bar, where settlement never happens.

I have a different conclusion.

I think it's intuitive that, if we owe each other $100, it should be quite easy to cancel those debts. I don't think this is any great insight. I think a focus on the "settlement" service provided by fairs (or by central banks) is like blinders that keep us from seeing more significant details.

In the Middle Ages, millions of dollars of debts could be settled by a hundred thousand ecus d'or. Today, millions of dollars in promises to pay can be settled by a hundred thousand in settlement money. It's the same story as in the Middle Ages.

The story is that, while much of our debt can be settled by mutual swap and the "melting like snow", not all of it can be settled that way.

Anyway, it's important to note that it took real money to settle things, even in the Middle Ages. Mason wants us to start at the bar that has no cash register and no way to pay for our drinks. But at the end of the day, at the end of the fair, when Judgement Day comes, when it's time to settle up, you need more than just a box where your tab goes. You need the cash register. And you need something more than a promise to pay your bill later. You need money to pay your bill. You need money for settlement.

Mason says "a 'good part' of the net obligations remaining at the end of the fair were simply carried over to the next fair." But those obligations were not "simply" carried over. They were carried at 10%.

And that's just one year. Imagine a society where policy tells us it is okay to accumulate our carried-over obligations. Then most of this year's carry-over is still with us when we add next year's carry. And the year after that, and the year after that, and the year after that. Keep it up for sixty years, and this is what you get:

Graph #1: How much debt we have, per dollar of settlement money we have

Mason wants us to think not in terms of truck-and-barter, but in terms of the Medieval fair. I want us to think in terms of the ultimate settlement medium. If most of our debt melts away like snow, great. But what about the rest? It takes money to settle that debt. If not settled, it still takes ten percent.

The IOUs that easily melt away by mutual swap are not the problem. The unsettled debts that accumulate are the problem. Thinking of the economy in terms of "melt like snow" doesn't deal with the problem. To deal with the problem, we need money for settlement.

I followed Mason's Braudel link. Braudel writes of "the old fairs at Champagne" at their peak, around 1260. And of later fairs at Piacenza, and the Genoese clearing-house. Braudel writes:

All good things come to an end however, even the ingenious and profitable Genoese clearing-house. It could only function if sufficient quantities of American silver reached Genoa. When the silver supplies began to dry up in 1610 or so, the whole structure was threatened.

The clearing-house could only function if there were sufficient quantities of silver, Braudel says.

Our debt, the whole house of cards, rests on a little bit of settlement money. It's this settlement money we have to add so Mason's story can make sense. But settlement money is the part JW Mason seems to want to do without.

Try to make sense of things without that money, and you're back at Mason's Bar.

JW Mason wants to replace "truck-and-barter" with "medieval fairs". Fine. But Braudel says medieval fairs only work if there is sufficient settlement money. Even if you "begin with the credit system" you have to end by assuring there is sufficient settlement money, or "the whole structure" is threatened.


1. I'm pretty sure Mason doesn't really mean it's always on the house at the bar he describes. He means my tab will come due sooner or later, when they open the box and tally it up and hold me accountable (i.e. "money of account"). And then I'll be stuck doing something to pay off the tab, and the question of what I won't do for money comes up for negotiation. That's probably what Mason means. But then, maybe when the time comes to pay my tab, I can just say, "the only thing I can pay you with now is a promise to pay you later."

2. Mason and Schumpeter object to "building up the analysis of money, currency, and banking" by beginning with "an analysis of a state of things in which legal-tender ‘money’ is the only means of paying and lending." Both Mason and Schumpeter prefer "to begin with the credit system".

But focusing on the one or on the other is the wrong focus. What's important is to maintain a viable balance between the quantity of credit and the quantity of the legal-tender money -- between the debt arising from credit use, and the money we use for settlement of that debt.

3. Happy Valentine's Day.

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