All Life Is Problem Solving

At the very end of the Seminal/FireDogLake discussion of my last post, “How Are You Going To Pay For It”, two commenters, ironymeter and konst, offered some comments about the idea in Modern Monetary Theory (MMT) that fiat currency is, to a great extent, accepted, because the Government mandates its status as sole legal tender which can be used for paying taxes imposed by the Government. Let’s begin with a reply to ironymeter; who says:

At the heart of MMT is the idea that people will value the currency and accept it as the medium of exchange. If people no longer need it to pay taxes, the willingness to do this will decline.

The heart of MMT is a conjecture that people won’t value currency if they don’t need it to pay Federal taxes?

At the heart of every economic theory based on government issued currency (backed or fiat) is the idea that people will accept it as a medium of exchange, otherwise it’s worthless. Could you explain the reasoning behind your “reasonable conjecture” that in the absence of Federal taxes people will be less willing to accept government issued currency as a medium of exchange? Roughly 80% of what we use money for is not Federal Taxes: it hardly seems reasonable to conjecture that in the absence of federal taxes people will stop using money…

I think what we’re talking about here is the legitimacy of money, and not just any money, but Federal Government money that has no backing from a commodity like silver or gold. People might accept that kind of money as a means of exchange in the abstract, because they need some medium of exchange, but why would they accept it in preference to a commodity or something commodity-backed, that someone else began to circulate, if they were not required to accept it? And if they were “required” to accept it in law, why would they more or less willingly do so, if they did not “need” that money for some requirement they could not avoid, imposed by the Government, such as paying taxes with that money?

At the recent Fiscal Sustainability Teach-In Counter-Conference, Stephanie Kelton provided a very good narrative comparing the MMT point of view on the currency with the conventional textbook view found in economics. Here’s what she had to say on the subject.

When you open up an economics textbook, and you turn to the page that begins to talk about money, inevitably you find a story that begins with something about barter; and ‘once upon a time’ man trucked his wares to the local trading venue because he’s pre-programmed to truck barter in exchange, as Adam Smith told us, and there was no currency around. So you had to lug your clay pots and your shoes and your fish and whatever else you may have specialized in the production of, down to some local trading venue, where the only way the exchange could take place is if you happen to come upon the person who not only had what you wanted, but wanted what you had.

Economists refer to that as the double coincidence of wants. And so, barter is this clumsy system for conducting exchange and, so the story goes, man suddenly decided – hey there must be a better way to organize – we should really think about finding some Thing that would be universally accepted. And, lo and behold, they hit on money, primitive forms of money first. The textbooks tell stories of things like pebbles and shells and feathers and beads and all of that, and later discovering money things like precious metals, which had nice properties that fish and other commodity monies didn’t have, in that they would serve as a good store of value, they were easily divisible, they were portable – you put your coins in your pocket and go conduct your exchange.

But, the story is always told that this somehow happened spontaneously. The private sector figures out that there’s a more efficient way to conduct exchange. They choose to use money. They decide what money is. And this all happens without imposition from any authority, no state, nothing like that. So the money is stateless. And, then of course, over time, money evolves (I’m still in the textbook story) from things like primitive money to gold and then to paper with gold backing. People take paper in exchange for real goods and services and the argument is – well, but at the end of the day, it’s as good as gold. So they continue to accept the paper.

Then the story gets more difficult to explain, for this group. Sometimes we call them the Metalists because, when you have a pure fiat money system, why do people accept currency, that is intrinsically worthless, backed by nothing of value, and yet people will beg, borrow, steal, toil away the day, in order to get these otherwise worthless pieces of paper?

And so, what we like, what we prefer, is the story that’s been dubbed, or the approach that’s been dubbed Modern Money Theory, which traces the nature and origin of money to the early authorities. Randy has written a lot about this in his, ‘Understanding Modern Money’ book, from the early temples and later to the nation states and we could go on and on about this, but that’s not what I want to do. But, it does trace the origin and nature of money to some power authority; that is, the money does not emerge spontaneously by the will of the people, but it is imposed on them.

How is it imposed on them? It is dictated by the authority. It is chosen. The authority establishes that you all must pay something to me. I define the unit of account. In the United States, the unit of account is the dollar. So I say in what unit you must pay obligations to me and then I tell you what you have to do to eliminate those debts. And so, I impose a tax liability on you. I make you indebted to me. Now you need to do something to eliminate your obligation to me. And I tell you how you can do that. In the United States, you can earn dollars. You pay your tax obligation to the state in U.S. dollars. That gives value to the government’s otherwise worthless pieces of paper, and allows them to move real resources from the private to the public domain.

So we have a very clear way to answer the question ‘Why is fiat money accepted?’, whereas our textbook counterparts have some difficulty with that. If you push them too hard, they say, ‘Well, Pavlina accepts dollars from me when I go into her shop because she knows that she can pay Warren her rent with those dollars’. And then you say, ’Well, why does Warren take them?’ ‘Well, Warren knows that he can pay Marshall when he rents a car from him’. ‘Well, why does Marshall take them?’ ‘Well, Marshall knows that Randy will take them.’ And you get into this infinite regress problem. They really have no answer, is the problem in that theory.

So the Modern Money approach accepts that the currency derives its value from the state’s willingness to accept it in payment to the state, to eliminate obligations to the state. Now there are lots of things that obviously circulate as money things. The government’s money is not the only thing out there. And there is some ordering, or hierarchy of money things. Some are more generally accepted than others.

And so here I have a quote from James Tobin just to give this some credibility because we pull out the Nobel Prize winner when we want to convince you that these ideas are not crazy and fringe, and James Tobin said in a book in 1998, “In advanced societies the central government is in a strong position to make certain assets generally acceptable media by its willingness to accept a designated asset in settlement of taxes and other obligations. The government makes that asset acceptable to any who have such obligations and in turn to them and to others and so on.”

So Pavlina takes it because she has obligations to the state. If she herself doesn’t, she knows she can find someone who does. That’s why this thing is special and that’s why the government’s IOU is special and those of us that have done some work in this area, in talking about a hierarchy of money would argue that the reason that the state’s IOU, the state’s money sits at the top of the hierarchy is because it is the most generally accepted and it gains its acceptability by virtue of the state’s proclamation that we all need it in order to eliminate our tax liability.

So, Modern Money Theory stresses the relationship between the government’s ability to make and enforce tax laws on the one hand, and its power to create or destroy money by fiat on the other. I would define as a sovereign government, a government that retains these powers, that they are sovereign in their own currencies. Among others, examples of governments with sovereign currency, the United States, Canada, UK, Japan and Australia, all sovereign in this regard, by this definition.

I think the MMT view on the origin of money, as stated by Stephanie Kelton, above, and Randy Wray, in his book Understanding Modern Money, is much more realistic than the view that money is stateless. And I also think that the day-to-day role of the possibility of the State’s using coercion to force payment of taxes, is vital for establishing that the State’s money, which is needed to pay imposed taxes, is valuable at least for that purpose, and that since it is, and since everyone must have access to it anyway, they may as well also use it a general medium of exchange for all transactions public and private. So, to go further, it also seems very reasonable to me to expect that if people no longer needed Federal currency to pay Federal taxes, then the bonds between Federal currency and transactions would be loosened, and that people would find ways to do without Federal money altogether. Barter after all is not illegal, and would rise in frequency if people did not have a legal requirement to gather money to pay taxes. Also, various types of private, some backed by commodities would, no doubt, also begin to emerge.

In addition to ironymeter’s comment, konst also had some on the role of state authority/coercion in making fiat money valuable. In reply to a comment by Warren Mosler on making litter into currency, konst said:

From your example it seems MMT/Neo-Chartalists idea of what our world should be is the government as a sociopath which threatens you with a gun saying “your money or your life” like the kleptocracy we have now.

That is so wrong on many levels. The Soviet Union tried that in the 20th century. Where are they now?

P.S. Mr. Mossler nothing personal. I have seen MMT theorists using that argument before. I just wanted to make a point. It’s a road to totalitarianism.

This, of course, is just a lot of name-calling. The Government, according to the Constitution, has the authority to create and destroy money. There is nothing kleptocratic, or immoral, or sociopathic about using this authority. It’s an authority that the Government of the United States has used since the Continental Congresses, even prior to the drafting and ratification of the Constitution, and it is an authority used by every Administration since that time, and in a very effective way under our greatest Presidents, Washington, Lincoln, and FDR. It is ridiculous to associate creating and destroying currency specifically with the Soviet Union and totalitarianism. It is nothing more than a power associated with national sovereignty, and with the presence of a Government that has the authority to be effective in promoting the general welfare if it wants to be. And it has no more connection with totalitarianism than any other necessary power of a national Government has.

In a later comment, konst went on to say:

We know from historical examples that Governments have imposed fiat currencies before on populations that have had no desire for them, and that the currencies became the medium of exchange because people needed it to pay taxes.

Where in the history of the world has a government imposed a fiat currency in a society where a real money-medium-of-exchange has not already existed?

If there really was such a case in history it’s likely the people on which it was imposed were slaves to begin with.

There’s plenty of evidence that it’s the Governments imposing the money in ancient history. Randy Wray reviews a lot of it here, and references historical sources. There’s also Chapter 3 from his book Understanding Modern Money. Both references provide plenty of evidence to prove that Governments decide on the currency, whether or not the people on which “it is imposed” are slaves or not.

Summing up, the idea that “legitimate physical coercion,” the basis of Governmental authority is, equally, the foundation of the value of money, is an idea that is profoundly opposed to neo-liberal economics and also to the Austrian School. In these approaches the market is king, and to function properly the economic system must be autonomous relative to the political system. But MMT recognizes that political and economic factors are closely coupled in modern societies and that many supposedly economic issues are really just as much political or ideological ones. That’s one of the reasons why I like the MMT approach so much. Another, is that it tells us that there are no mere accounting or solvency limitations on the actions we ought to be taking to re-make American society into something better. The limitations we face are real issues like full employment, inflation, and economic inequality, and, more generally, the consequences, including sustainability consequences, of our economic policies

Finally, a word, on another issue raised by ironymeter:

there’s nothing in MMT that requires Federal income taxes

Whew! I finally got an answer to the question I asked in #29. So, may I assume that MMT supporters are in favor of abolishing existing Federal taxes, save in times of full production capacity, and (possibly replacing) them with a straightforward wealth redistribution tax?

Sorry. Different, people using an MMT-based approach may well have different tax policies. Some will favor more re-distributive taxation, others not. Some will be partial to income taxes, others to progressive real estate taxation. MMT is an approach, and a paradigm, that allows for alternative theories and policies based on political and ideological differences. It does however exclude certain alternatives, such as the complete elimination of Federal taxes.

(Cross-posted at Correntewire and Fiscal Sustainability)