Italy is once
again making political and economic waves, with much of the trouble stemming
from the Euro. The currency question is
now becoming one that decides the fate of nations. Ironically, all of this was avoidable had the
Euro been established and maintained in a manner consistent with sound monetary
theory.
 |
| Georg Friedrich Knapp |
Unfortunately,
the Euro was established firmly on the foundation of “Modern Monetary Theory”
(MMT), which is based on Keynesian economics, which is in turn derived from the
“chartalism” of Georg Friedrich Knapp, also known as “the State Theory of
Money.” The essential principles of MMT
are:
·
Money is a creature of law rather than a
commodity.
·
The State can create “pure” money by emitting
bills of credit (issuing debt), making it exchangeable by recognizing it as legal
tender.
·
Money is not a medium of exchange, but a standard
of deferred payment. Government money is
debt the government may reclaim through taxation.
Making matters
difficult is the fact that the first principle, that money is a creature of law
and not a commodity, is exactly right . . . but they understand it incorrectly.
We agree fully
with the statement that money is not a commodity. It is not.
It is a means of exchanging commodities or, more accurately,
productions. Money is the means by which
I exchange what I produce for what you produce.
Unfortunately,
MMT, while it accepts the principle that money is not a commodity, proceeds to
treat it as if it were. It is assigned a
price (interest), and the quantity of money is treated as if it determined
other factors, such as the velocity of money, the price level, and the number
of transactions.
In other words,
in the equation,
M x V = P x Q
where M is the quantity of money, V
is the velocity of money (the average number of times each unit of currency is
spent during a period, P is the price level, and Q is the number of
transactions, M is the “independent variable” and V, P. and Q are the dependent
variables. V, P, and Q are determined by
M, not the other way around.
 |
| John Maynard Keynes |
That is mathematical
nonsense. One of the things we learned
in high school algebra is that you can’t have one equation and three dependent
variables. It is mathematical
gibberish. You can’t make V, P, or Q,
the dependent variables, give desired results because the only relationship you
know is defined in terms of M, the independent variable.
The only thing
you can do in that case is create the amount of money you think is needed or
wanted, cross your fingers, and hope for the best. Or (more likely) the worst.
Now, about the
principle that money is a creature of law.
Yes, but —
Money is a
creature of law in the sense that all money is a contract, and all contracts
are money. What the MMT people mean,
however, is that money is a “peculiar” (Keynes’s word) creation of the State
and money is illegitimate if the State has not declared it “legal tender.” The State decides what money is and can
change the standard or definition of money at will.
In other words,
under MMT the standard is not a standard at all because it makes no sense to
define a thing in terms of itself. It’s
a circular argument. You can’t let the
market set the price of your standard, because
prices are measured in terms of the standard!
That is because a
standard is “something
set up and established by authority as a rule for the measure of quantity,
weight, extent, value, or quality.”
(Merriam Webster.) You don’t go
adjusting standards, or what you have isn’t a standard.
 |
| Aureus of Augustus, standard coin for 2,000 years. |
For example,
suppose you say the price of a pound of gold is your standard of value (saying
the value of gold or the price of gold is your standard is a difference that
makes no difference because prices are measured in terms of gold). You then define the currency, call it a “goldie”
(or aureus, if you want to get classical), as 1/72 of a pound of gold.
What is the price
of a pound of gold? Seventy-two goldies,
of course.
Suppose, however,
nobody wants gold any more and demand falls.
The market value of a pound of gold drops to half what it was. All of a sudden that new chariot that cost 72
goldies last week now costs 144 goldies, or two pounds of gold.
What is the price
of a pound of gold? The same as before,
seventy-two goldies. It will only buy
half what it did before, but the goldie is exactly the same as it was the week
before in terms of the standard. The standard has been maintained. A goldie is worth exactly what it was the
week before in terms of the standard — which is the whole point of having a
standard in the first place.
Suppose everybody
wants gold, however, and the market value of a pound of gold rises to double
what it was. Suddenly that new chariot
costs 36 goldies instead of 72, i.e.,
half a pound of gold instead of one pound.
But what is the
price of a pound of gold? Again, the
same as it was before: seventy-two goldies.
Obviously, the
immediate problem is the same as it would be under any standard
whatsoever. The moment you change the market
value of the standard, the standard remains fixed, but all other prices change
to reflect the change in the market value of the standard.
But can’t you
adjust the standard to maintain a stable price level?
 |
| Modern Aureus or "Ducat." Same standard after 2,000 years. |
No. Why?
Because the goldie currency was created and entered into the economy on the
understanding that you could always exchange one goldie for 1/72 of a pound of
gold. Regardless what anything else
costs in terms of gold, a pound of gold remains a pound of gold. That’s because if you are measuring prices in
terms of gold, you cannot honestly change the number of goldies in a pound from 72, to 36, to 144, or anything
else.
Even if you did
change the value of a goldie so that it reflected the market price of gold in terms of something else, all
you’ve done is shift to another standard, e.g.,
chariots. In the end, however, the
goldie is going to be worth whatever the standard is worth, whatever you end up making it. You can adjust the standard so that a chariot
always costs 72 goldies, but the scenario stays the same . . . except you are now on the "chariot standard," not the gold standard. One week you pay a pound of gold, the next
week two pounds, and the next half a pound.
The standard is now the price of a chariot, not the price of gold, that
is all.
That is why the
precious metals were used as standards for so long: demand for them stayed
relatively constant, and they gave you a good idea what everything else was worth
in terms of the standard. That is also
why something like the kilowatt hour would be a better standard: demand remains
fairly constant, and thus the market value remains stable.
The kilowatt
hour? Not the price of a kilowatt hour?
 |
| R. Buckminster Fuller, suggested the Kwhr standard. |
No. First, of course, if you have a standard of
any kind, the price of the standard is
the standard! What is the price of a
pound of gold in terms of gold? One
pound, of course. Similarly, what is the price of a kilowatt hour in terms of kilowatt hours? One kilowatt hour.
You see, the
standard of value is what you’re using to measure value, that is, determine
price. Price is "the
quantity of one thing that is exchanged or demanded in barter or sale for
another" (Merriam Webster). So, if you say that the
price of the kilowatt hour is the standard, but it will be adjusted to reflect
the market price of the kilowatt hour . . . you just changed the standard to
whatever else you’re measuring value in terms of! Your standard is no longer your standard.
For
example, suppose you say you will adjust the standard of your currency so that
the price level of everything else remains stable. A goldie — or whatever — formerly worth 50
kilowatt hours is now worth 100 kilowatt hours because the price of the
kilowatt hour decreased and the currency inflated in terms of everything else on the market. You are now paying 20 kilowatt hours for what
you formerly paid 10 kilowatt hours, but the same one-fifth of a goldie.
Your
currency — the goldie — is no longer measured in terms of the kilowatt hour. Once you start changing the standard to
reflect the price level, the goldie is measured in terms of the general price
level, not the kilowatt hour; the price level is your (flexible) standard. You don’t, in fact, have a standard at all,
and you might as well admit it instead of saying the price of the kilowatt hour
is your standard . . . because it isn’t.
Obviously,
you want to avoid a situation (like MMT) in which you don’t have a standard for the
currency . . . and a standard that is adjusted for any reason is no longer a
standard; it has ceased to be standard. Adjustments may start out for what seems like
a good reason, but necessity always takes over . . . and the people in charge
of the standard often have very flexible notions of what constitutes necessity.
The
reason for having a standard in the first place is so that people know what something
is worth in terms of the standard.
The moment you start adjusting it — as is a cornerstone of MMT — all
bets are off.
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