Sunday, March 25, 2012

A Letter To A Friend

The division of labor is indeed a wonderful thing. For it to work however a sizable suite of liberal infrastructures must first be in place. One of the most important and least understood is the money system itself. It is an infrastructure, no mere thing, and it has important counterintuitive properties that cause its human inventors to consistently and systematically abuse themselves with its operation. I’ll address the nature and cause of this self abuse below, for now suffice to note that money is an artifact of man created to solve a particular set of problems, which it does. But aspects of the system are profoundly different from anything found in nature and can confuse us with an artificial logic that, while of our own creation, wreaks havoc on our evolved heuristics. Keynes would have been, and any real Keynesian will be the first to suggest the function money was invented to fill was efficient exchange for the purpose of strengthening the community, the state and its people. And his work centered on the all too human reasons why it periodically fails. 

I think we can agree the world, no less the subset of human institutions, is far too complex for anyone to fully understand. A result of this recognition was the invention of science, a vast set of institutions built around the need to codify what can be measured in a testable and document-able way so that functional generalizations to be universally depended upon can be drawn. The study of economics from Petty forward has been driven by a scientism seeking to document the underlying principles of economic activity in such a form. Like money, however, this scientism reduces understanding to mathematics which by nature excludes most of what is valuable in lived human experience. The scientism imposes a form that makes it easy to forget economics is the study of a subset of human behavior, it is a sociology of that human behavior engaged with the system of money. From its founding until Keynes economics assumed an identity between the math and the behavior it represented, he rejected this. 

While the best practitioners never lost their humane grounding, heirs as they all were to the enlightenment, Petty, Cantellon, Qesney, Ricardo, Smith, Malthus, Marx and Marshal all grounded their work in deeply moral frameworks. But the accumulated canon made of their work took the form of the mathematical contributions each made and the concepts they built around the variables in their equations. Keynes contribution was to point out that in fact human impulse drives money and generates whatever real value money actually has. This means that human action, human motivation (and behind that emotion), governs the laws, such as they are, of economics. 

He insisted the math was nothing more than representations of sterile theories that must be held mutable in the face real human agency. This had been latent in Adam Smith’s moral philosophy as well, which he developed only latter into an economics, but Smith was blinded by the progressivism of his own historical moment into believing improving and expanding human freedoms adjudicated by democratic process were, to use a Marxist anachronism, historical inevitabilities. But the invisible hand is no such thing, it is the consequence, the end point of hard fought battles for equal protection and equal standing in the eyes of the law, which is to say the view of governments. Markets are an emergent property of well formed social, political and economic institutions and their scale is limited by that of these supporting institutions in which they are embedded and on which they depend.

In the Innes essay at Mosler’s site, and in “Debt, the First 5000 Years” by David Graber these authors look in as much detail as one could wish for, and with most engaging styles, at the question of what money is. Short of  full book reports, in summary, proto-money was independently invented across a range of cultures as a legal or communal fiction to allow immeasurable grievances to be adjudicated for the mutual benefit of society at large. Once extant this symbolic money became a social currency used to rank position, to regulate marriage, to settle intractable disputes and to bind individuals to obligations to their community or specified members of their community. Urbanism concentrated and centralized this function and added the final layer of individual compulsion by the state which made proto-money, money, as we know it now. In this way, with this compulsion, it became the states creature for the first time we know of some 5,000 years ago. 

Money as proto-money, began with an obligation to our fellow citizens and has ended up as an obligation to the state which with the evolution of liberal democracy has transubstantiated back to where we began with our fellow citizens. One circle is complete (at least while democratic legitimacy prevails). Restoring our shared humanity back to the center of the system remains to be done. 


Now to the problem with money in our primate minds. Money functions mathematically. Our minds can function this way but they inherently prefer not to. It’s a popular posture to say people are lazy. I propose instead, our minds are predisposed to what was evolutionarily efficient. In the ancient savannahs of our genetic proving grounds doing math didn't make you fitter, it made you cat food. Daniel Kahenman’s “Thinking Fast and Slow” is a Nobel Laureate’s summary of his findings on the nature of our evolved noodle. The titular fast and slow refer respectively to heuristic thinking and computational thinking, each supported by unique and independent brain structures. Quick thought processes essential for survival on the savannah evolved into powerful heuristics. For example, reflexes, language, generalizing spatial perception, face recognition and the genetic arms race of non verbal communication. These are things we do effortlessly that computer science can’t come close to replicating. 

Heuristics work with incredible speed and efficiency and most of our direct interpersonal relations are driven by them. We've inherited a package of emotions and behavioral templates driven by emotions that regulate our immediate short term behavior. In important ways these heuristics act on us as much or more than through us. And so long as we are dealing with other people, with animals or the natural environment, these heuristics arm us with the wisdom of our ancestors including our deep and powerful moral instincts. It is at the level of heuristics modern people struggle with the world they live in most deeply: the modern human habitat is man made and it is made in response to our conscious desires in almost total ignorance of the heuristics that determine the workings of our minds prior to consciousness. Confronted with this environment, one designed to suit our conscious and aesthetic intellectual predilections, our heuristics frequently trip, fumble or make giant unwarranted leaps giving behaviors the appearance of stupidity, folly or sloth. 

This is the same terrain where money twists our morality. Money takes a set of linguistic concepts, freighted with judgmental moral weight, and subtly distorts them. We say diamonds or gold are valuable because in money terms they are. But air and water, which we think of as free, are incontrovertibly more valuable. So what Marx called “surplus value”, what had been concentrated social currency, turns when monetized into capital and inverts the meaning of value (gold up, air down) relative to the natural, scientific reality. Then, when debts that had been born in a social currency, in which form their accrual drew society closer together through the mutuality of obligations, were monetized they suddenly tore societies apart through the inherent asymmetry of debtor/creditor relationships. The moral failure of not living up to ones obligations gained the tyrannical power, once money gave debts precise measure and external form, to reduce one to slavery. It seems intuitively fair (obligations are obligations right?) when it engages our moral heuristic, but at the computational level the fairness vanishes when you factor in a Minsky cycle, which though only named in the 1970s has been around since the creation of the interest bearing loan, and pinpoints the inherent injustice in this relationship. 

In the “hedge” phase of the cycle, loans are made at a customary rate and commerce is stable and predictable. After a while, creditors discover they can make riskier loans and make better returns despite the greater risk. As this recognition spreads lending standards deteriorate further and returns improve. Each successive loan gives another person access to the fixed money supply within any accounting period expanding the effective money supply by increasing the speed of its exchange pressing prices upward even for folks who neither borrow nor lend: injustice is seeping in. As losses mount in the speculative phase, losers are incentivized to double down both by the penalties of default, often liberty itself, and the easy money consequent to declining credit standards: injustice is now taunting us to excess. Notice the process begins with decisions by creditors with debtors drawn in by the result of the prior act: this is the original sin of credit born of the monetization of obligation. 

In the ponzi phase losses are mounting so fast that loans are taken to replace deteriorating capital positions and cover prior interest obligations. When the bubble bursts, the functional money supply is reduced to the original base stock, wherever it happens to be at that random moment. All exchange is deprived of monetary float including commerce that had been wholly independent from credit and debt relationships. In antiquity when this happened the final creditors, whoever they randomly happened to be, would loan back what was necessary to survive making the entire society debt peons securing through money power their own dominance. The Old Testament has multiple references to and rules for Debt Jubilee’s to address this cyclical recurrence.

Creditor greed causes monetary phenomena where both positive and negative incentives engage with our heuristics for optimism and trust, decisively advantageous evolved traits, to convert these positive impulses to tyranny by the precise, unalterable and external measure money puts on obligation. Unfairness inherent in the credit squeeze of banking collapses has always been apparent though few could distinguish where and how injustice first enter the transactions. Our heuristics for obligation and justice are not structured to sort out the confounding logic of these artificial relationships so they naturally elide obligations into debt and burden them with a perception of justice that is in no real way present. 

Central Banks were invented to solve the liquidity problem natural to the credit cycle to ameliorate the knock on effects to the larger economy and bankruptcy laws were devised to assuage the obvious injustices money systems periodically impose on those drawn in by poor underwriting or simple bad luck. But Bagehot's essential rule for central banks in a credit squeeze, to lend generously, against good collateral, at painful rates has been forgotten which entirely robs the resulting system of any justice. Creditors who's greed inflated the bubble get both their profits from the bubble and rents from a new informal debt peonage for all those who's un-payable debts remain on the books, debts who's value was set at the height of the bubble that must be repaid from the desiccated float of post-bubble deflation. 


Lerner's American peers ran the US economy in the Truman to Nixon administrations along Keynesian lines. Although we were on a gold standard then, the functional effect of the spending decisions of the monopoly issuer of the currency were put to good use and worked exceedingly well between 1946 and about 1970. In fact it worked so well it created the American, European and Japanese middle classes in that short span of years. When Nixon abandoned gold he did it to strengthen our nations control of the dollar denominated economy including that portion engaging our trading partners, particularly the petro-states that were putting our gold reserves in a bind: they needed our market much more than they needed our gold and embargoed in a fit of pique when we denied them the gold. Of all the world's economies, ours is the most energy intensive so this embargo triggered an inflation that was only ended, but ended quite promptly when the domestic natural gas market was freed to float ending the constraint on real capacity. Conceding they needed our market more than our gold, OPEC relented and continues to supply us oil.

This incident was abused in domestic politics to make the argument that unions and workers caused the inflation. If you look at productivity growth and wage growth, they were married from 1946 to around 1980. No later than 1982 they divorced. Until Reagan, if you worked harder and increased your productivity you were rewarded with growing income. Since Reagan you have not been (except maybe those in finance where all the money gains from increased productivity have ended up in the last thirty years). The preceding boom era, the one that created middle classes in the American sphere of influence, was defined by anti-trust policies that ensured competition, a patent and copyright regime that prevented rent seeking and labor policy that aggressively pursued full employment. 

In “Debt, the First 5000 Years” you will find numerous examples of fiat money economies that survive and prosper for centuries and they are always run on the same principles described in Lerner’s essay: taxes drive money and spending steers the economy drawing resources, including people, into productive use. China had two multi-century eras of fiat money. The US fought the Revolution, the War of 1812, the Civil War and the Second World War with fiat money. Fiat money’s occasionally fail but they fail as a symptom of political failure, not the other way around, primarily they fail when for whatever reason states loose the ability to tax effectively. 

Hard money, throughout recorded history has always been prone to seizures, dependent as it is on finite stocks that can be concentrated and hoarded. When economies were primarily agrarian this mattered only to privileged minorities in cities and in trade. In industrialized civilizations where the vast preponderance of the population is urban these seizures have led to state failures, to wars and to the conversion to fiat money. The aggregation of ever larger populations in industrial nations has brought with it an exponential increase in measurable standards of living. But at the same time it has brought an equally necessary expansion of political structures as the technoligies supporting those standards of living are themselves complex with significant maintenance and upgrade costs. 

Even more significant to government is the replacement cost of obsolete infrastructures. The preservation of obsolete systems because of money cost confuses the value measure function of money with real value in the real economy. This confusion has immeasurable real and human cost as population pressure builds against standards of living constrained by obsolete systems. Decisions about money costs and real costs are intrinsically political as money is a political infrastructure and how it is used is an expression of the dominant political values of the society using it. At present we use a buffer stock of the unemployed to guarantee the relative money value of completely non-productive asset hoards around the world and because we rely on that buffer stock we are afraid to employ it to replace our obsolete infrastructures. We are sacrificing the future to conserve our money: this is insane.

As Keynes observed, the single largest loss of wealth in a recessed economy is the wealth that is simply never created by idle workers and stocks of capital. Real wealth only exists in the real economy and every day we insist that educated young people do nothing economically productive is a day we pinch the real future carrying capacity of the US economy. Everything we need for the future of our civilization we have in our capital stocks, our people and our creativity. Every day we waste these things with disuse because “we can’t afford them” we steal from our own and our children’s future. We confuse money with value. Our “deficit attention disorder” has our political leadership convinced that if we somehow starve ourselves enough right now, dismantling our productive capacity and disemploying our youth and much of our working population, we will somehow be enriching our future. As Keynes said in 1929: 

“The Conservative belief that there is some law of nature which prevents men from being employed, that it is ‘rash’ to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years.” 

The role of policy in the Keynesian era was to put the nations resources to the best use as determined by the market forces that resulted from the freely made spending decisions of free people working for wages that reflected their effort, knowledge and skills. The Reagan Revolution ended that. Since 1980 all of the gains have gone to capital and what had been the workers share of productivity gains has been loaned back to them converting their income into rents for finance. It is not sustainable as we are seeing now because it concentrates all the money in non-productive hoards that starve the float of commerce as more and more of worker's earnings are diverted to interest payments, a non-productive rent. The good old fashioned gold standard solution to the inevitable desiccating concentrations of money after financial bubbles burst is what the Regent did in France after John Law’s attempt to convert that nation to fiat money failed in 1720: a third of the nations gold stocks were expropriated at bayonet point by the the Royal Guard. 

Personally, I think it would be great fun to debate such a policy now, though I’d not support it in the end because I’m a chartilist and it seems to me there are much better tools at our disposal, fiat money in particular. Any state that chooses to make the most of its resources, including its people, with this tool can. The degree to which a state chooses to not look after the best interests of the majority of its people is the measure of that states corruption and by this measure ours is almost hopelessly corrupt. 

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