THE Global Justice Movement Website

THE Global Justice Movement Website
This is the "Global Justice Movement" (dot org) we refer to in the title of this blog.

Wednesday, May 30, 2018

The First Problem Principle of MMT

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.