on money - III

Monetary theory when all is said and done, is little more than a vast elaboration of the truth that “it all comes out in the wash.” -- J.M. Keynes, Treatise on Money

The question, what is money, is coming to the forefront of public attention due to the global financial situation. It is a question that reoccurs throughout history, getting put forth in times of great change and social disruption. It is a question that has no fixed answer. For in the end, money is the ultimate social construct. Thus, the underlying definition and value of any currency is derived from the structure, wealth, and stability of the society. Thus, changes in the American monetary system over the last several decades reveal not only changes in money itself, but of our entire political economy.

As a foundation for a more detailed discussion on money, I'm going to loosely utilize the categories and definitions provided by Keynes in his Treatise on Money, which if you're interested, provides much food for thought and was the foundation for much subsequent monetary postulating. However, I don't claim to be providing a strict interpretation of Keynes thought, nor arguments on his reasoning, I'll leave that to our economic clergy. Rather, I hope to provide a foundation for the general public to look into an issue for which they've had no eduction. An issue that exerts tremendous power over every facet of their daily lives and society as a whole. An issue events reveal necessitates a new resolution for the benefit of both our immediate and long term collective futures.

Keynes begins his Treatise with a simple one sentence definition, “Money-of-Account, namely that in which Debts and Prices and General Purchasing Power are expressed, is the primary concept of a Theory of Money.” He then proceeds to take two volumes to discuss what exactly he means by that. When most of us think of money, we think first of our paper currency, that is the medium of exchange. However, this is a relatively small part of the money total. As Keynes makes clear, an understanding of total money is Money-of-Account, which would include all savings and debts, that is all accounts in the banking system, and in our present circumstances, the shadow banking system

Money-of Account is comprised comprised of a multitude of components determining the value of money. Understanding how price impacts money value is relatively straight forward. For example, if you are holding a $100 and the price of the goods you want to purchase rise to $120, you now really have 20% less money. The same works in reverse, if prices fell $20, you'd have 20% more money. Debt makes matters more complex and General Purchasing Power is an idea of much greater complexity. Keynes' definition is simply, “We mean by the Purchasing Power of Money the power of money to buy the goods and services on the purchase of which for purposes of consumption a given community of individuals expend their money income.” His more detailed explanation of this shows how General Purchasing Power is based on everything from commodities to labor, that is, the wealth of a given society in general. All of which becomes much more complex when you look at not simply a closed national system, but a global system, such as we have, where individual currencies are nationally based, but through trade constantly interact with other nationally based currencies.

So, basically the value of money is derived from the society itself, in a complex back and forth interchange that includes supply, debt, prices, and the wealth of the economy as a whole.

In our American system, money can be created two ways, either by the government or through the banking system. In a fiat currency system like ours, that is not based any any specific commodity or any other specific value, there is in theory no real constraint to how much money can be created. With the banking system, one constraint on money creation is holding reserves on each loan it creates. While for the government, money creation in the end comes down to a matter of faith, both of it's people and the rest of the world. The value of money is never simply based on quantity, but also quality.

OK, hopefully, this has provided a few general terms and my simplifications will not be met with too much contention. Now, I'd like to divide money into two classifications which will help shed some light on the problematic situation we currently find ourselves. Money can be used for two things, investment or consumption. The latter of course is easier to define, as it simply means the purchasing of goods and services to consume. While investment, in theory, uses money to create future wealth for consumption, but this has become a much more complex affair over the last few decades.

One point Keynes hammers home again and again is investment needs to be tied to the rate of savings. He writes,

According to my own definition “sound credit conditions” would, of course, be those in which the market-rate of interest was equal to the natural-rate, and both the value and the cost of new investment were equal to the volume of current savings.

Over the last several decades in America we've seen a complete untying of the correlation between investment and savings. The savings rate has dropped through the floor, while “investment”, and here I mean the entire financial system, has risen through the roof. Now there's plenty of reasons for how this came about, but I will argue this fundamental disconnect along with fundamental changes in the American economy have led to a incredibly unstable global currency system.

Next: The Financialization of the American Economy or How to Revalue Money