Saturday, January 22, 2011

Is a newly minted coin money?

In comments, someone asked if a newly minted coin was a financial asset or not.

Here is my response -- it is not a financial asset, it is a real asset. A financial asset is an asset that has a corresponding non-equity liability. A real asset has no corresponding non-equity liability, and therefore get some nominal value associated with it and booked as equity. The details of how the nominal value get assigned can be important, but not in the context of this discussion (financial vs real assets).

A newly minted coin has no liability associated with it, and is therefore not a financial asset. If the coin belongs to the Mint that produced it, then it's nominal value would be booked as equity to that Government entity. The difference between its production cost and its nominal value would be true seignorage.

If the coin left the Mint and went into general circulation, it may not be counted as Government spending depending on how exactly the transfer happened. When the coin was deposited at a bank, then it would enter (for the first time) the reserve system as it would be booked as a deposit in the creditors account (credit bank liability), which would credit the banks reserve account (asset), which in turn would credit the reserve account (liability) held at the Fed, which would debit its (negative) equity entry. At this point, the coin has become a financial asset.

A far deeper discussion of this is at Mosler's.


Friday, January 14, 2011

Why the Government must run the right size deficit

A commenter brought up this quote, which I think illustrates the mechanics of how vertical money works rather nicely:
No, money is neither of neither of these.... In an economy without capital (a technology that transfers forgone consumption today into increased POTENTIAL output tomorrow) there simply is no saving.

Take... an economy that produces only back scratching services where nobody can scratch their own back. Suppose there are 100 people in the economy and suppose that everyone only has the strength to provide one back scratch per day. Thus, daily potential output is 100 backscratches, the money supply is $100 distributed uniformly in the population so each backscratch costs a dollar.

Now, suppose one person (only one) decides he'd like to save. He wants to forgoe todays scratch but get two tomorrow. Thus, he provides a backscratch and gets paid a dollar for it which is added to the dollar he already had. However, someone else was unable to sell a backscratch but still consumed his and now has no money. Today output fell to 99 backscratches.

Now, tomorrow the guy with the extra money gets 2 backscratches and still provides one, the guy with no money gets none but still provides a backscratch. Output is back to 100 and the money is back to its uniform distribution. Furthermore, because potential output is capped at 100 total backscratches printing an extra dollar and giving it to the guy who was unemployed on day 1 just causes inflation, no increase in aggregate output. (Although it does have a welfare effect by allowing the unlucky guy to get a fraction of a backscratch.)

So, no net savings, just forgone ouput. Without capital, a way that forgone consumption today is transformed into increased potential outupt tomorrow there will always be zero net savings and any attempt on the part of agents to save in real terms will only result in an output loss. Money in no sense represents past savings here, only productive capital can do that.
I think the comment was meant to refute MMT, but instead it just illustrates the critical role the Government uniquely plays, as currency issuer, to create net financial assets (equity) for the private sector to store.

In the toy economy setup in the quote, there is no source of net financial assets. The economy is endowed with $100 net financial assets at the start. Somewhere, therefore, there must be an entity that has -$100 net financial assets, but stands outside the economy. In our world, the currency issuer (ie. US Fed for the US $) carries a negative net equity balance, and currency users (ie. everyone else) carry, overall, a positive financial asset (equity) balance.

In the example, when one backscratcher wants to save, he just reduces the real output (backscratches) and deprives someone else of income. This is exactly what can happen in the real world in paradox of thrift conditions. There is no way for the economy to increase its net financial assets (equity), all it can do is shuffle around the allocation. This shuffling may or may not result in full output.

In the example, the next period, the backscratcher who had hoarded the extra dollar got an extra backscratch, and everyone was fully employed again. Great! But suppose that the other backscratchers saw that one of their own was idle, and decided they might need some extra money stashed away as well to carry them through lean periods. Well, some of them might try to hoard a dollar too, and now real output is depressed further.

The simple solution to this is for the endogenous currency issuer to simply issue more currency that the backscratchers can happily hoard. This way, you maintain full employment, everyone has their nest egg, and all is well. If the currency issuer over does it, then it can simply tax away some of that extra money so the price of back-scratches remains $1.

Wednesday, January 12, 2011

Real vs Nominal

Lots of activity in recent comments about the distinction between "real" vs "nominal". Here's my take:

Short version: "Real" equals atoms and/or sweat. "Nominal" equals a number in a spreadsheet.

Longer version: Real pertains to real goods and services produced by an economy. If the goods are available in a future period, they are termed "investment" in the prior period when they are produced. Nominal equals a number in a spreadsheet. When comparing numbers in a spreadsheet, you must be scrupulous to compare apples to apples, so book value to book value, or market value to market value as an example.

An inflation adjusted nominal term is not "real", because it is still a number in a spreadsheet. It is worth inflation adjust nominal values so you can account for inflation and compare nominal values meaningfully across time. Nevertheless, inflation adjusting a nominal value does not give you a real value, it just gives you an inflation adjusted nominal value. You do not need to inflation adjust real goods or services -- a chair is always a chair, a haircut is always a haircut.

"Real" also does not mean "material" or "significant".

The connection between real and nominal is subjective and contingent, and it can change. If you create a painting and sell it for $1M, then it can be booked for $1M, but $1M may be worth anything (or nothing) in the future. Moreover, if you create a painting that you think you might be able to sell for $1M, but decide to keep, it may or may not be booked at $1M depending on how accurate your perception of its market value really is. Or whatever.

Either way, the painting is "real" and its nominal value can be booked a number of different ways, but the link between them can change and is contingent.

At an economy wide level, if nominal incomes increase faster than real production, there is a risk of inflation (unless that extra income is "saved" and becomes, essentially, dead money).

Friday, January 07, 2011

Macroeconomists do not understand debt

Big thanks and welcome to Andy Harless, who appears in the comments of a recent post on savings putting the orthodox macroeconomist position in plain English. Once again -- you all be the judge of what makes sense to you. First, Andy:
The crisis occurred because people (mostly in Asia) earned too much income and didn't spend enough. The crisis wouldn't have happened if they had chosen not to earn that income, and it wouldn't have happened if they had chosen to spend more. The financial and housing sectors over-expanded because Y-C was too high in the rest of the economy. You can't blame them for the minus sign, but you can blame them for choosing the values of Y and C. I say again, saving caused the crisis.
This is the old "savings glut" idea put in plain english. To buy it, you need to believe that a Chinese man, who made a VCR and sold it for Yankee dollars, and then put those dollars under his mattress and lived off rice and gruel, is responsible for Angelo Mozilo giving a $1M loan to an unemployed gardener, and then having that loan rated AAA by Moodys and sold via Lloyd Blankfein. Maybe the Chinese factory worker went to college with Geithner and therefore has an inside track to Wall Street?

According to Andy, households are flush with cash and are just not spending because the Government isn't threatening their savings enough. Thus our high unemployment. The data, and common sense, suggests that households are up to their eyeballs in debt, and are not spending because they don't have enough money.

You can see the twisted logic by which orthodox macro believes that the more money you borrow, the less money you need. Those of us with experience in reality might hold a more nuanced view. Again -- make up your own mind.

Mosler recently had a piece that tracks the non-Fed sector's fiscal position clearly from the late 90s to today.

Sunday, January 02, 2011

Tron: Legacy -- the rewrite

Forgive me this indulgence.

This is what the film should have done:

Overarching theme: "Man is machine". What does this mean? Does not matter.

Key elements: Clue and Flynn Jr. are mirrors of each other. Clue runs the operation, but it keeps glitching. Flynn Jr. avoids the responsibility of running the operation, but is the glitch himself. Flynn is both of their father.

Flynn Sr. is beyond human, but not quite machine. He is a wild messiah, only barely still in touch with the digital and analog world. He appears randomly, being Gnostic.

Clue and Flynn Jr finally embrace each other. The integrate, becoming a partial man/machine hybrid.

Flynn Sr embraces them both, completing the Trinity. He achieves enlightenment.

We have a 15 minute 2001-esque 3D visual light show extravaganze, while Daft Punk goes nutso.

Roll final credits.

Saturday, January 01, 2011

Happy New Year!

Best to all for 2011