Ecological Economics: Ecological Economics: Principles and ApplicationsPrinciples and Applications

Chapter 14: Chapter 14: MoneyMoneyHerman E. Daly and Joshua FarleyHerman E. Daly and Joshua Farley

Economics Joke about Money(because money is a funny thing…)

It is a slow day in a damp little Irish town. The rain is beating down and the streets are deserted.

Times are tough, everybody is in debt, and everybody lives on credit.

On this particular day a rich German tourist is driving through the town, stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night.

The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher.

The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer.

The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel.

The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the pub.

The publican slips the money along to the local prostitute drinking at the bar, who has also been facing hard times and has had to offer him “services” on credit.

The hooker then rushes to the hotel and pays off her room bill to the hotel owner with the €100 note.

The hotel proprietor then places the €100 note back on the counter so the rich traveller will not suspect anything.

At that moment the traveller comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town.

No one produced anything. No one earned anything. However, the whole town is now out of debt and looking to the future with a lot more optimism.

And that, is how the bailout package works.

Is it “Money is the root of all evil.” or “The love of money is the root of all evil”

Chapter Overview

o Moneyo Use Value and Exchange Valueo Seigniorageo Transactions with and without moneyo Virtual Wealth and Fiduciary Issueo Creating Money - Money as a symbolo The Fractional Reserve Systemo Money as a Public Goodo Money and Thermodynamics

Money functions

“Anyone who is not confused by money probably hasn’t thought about it very much.”

Money is:

A medium of exchange

A unit of account

A store of value

To measure exchange rate a unit is needed

and that unit must hold its value long enough

to effect both sides of the transaction.

Money is Mysterious• Unlike matter & energy it can be created and destroyed• Print a little of it on your own and you go to jail.• Print a lot of it and sell it to the government and call yourself

a commercial bank.• Individuals can transfer small amounts of money into real

assets.• A community as a whole cannot exchange all of its money

for real assets because someone will be left holding the bag (of money).

• Money legitimately allows us to avoid the inconvenience and inefficiency of barter.

Use value vs. exchange value

Use value arises from the actual use of commodities. There is a physical limit to use value. Self limiting.

Exchange value is abstract, inheres in money and does not necessarily have any physical embodiment. No obvious limit to the accumulation of exchange value. Not self limiting.

Marginal utility &

the diamonds-water paradox

A function of scarcity. Total utility of

Water is enormous but we only pay

For water at its marginal utility.

Marx and the evolution of transactions

C - C* Straight up bartering

C - M - C* Money as a medium. The goal is to increase use value.

M - C - M* “Capitalist circulation” Money makes commodity; commodity sells presumably for more money.

M* - M = ∆M Profit

A major transition from increasing use value to increasing exchange value.

Real wealth – commodities – obey the laws of thermodynamics. Money, a mere symbolic unit of account, can be created out of nothing and destroyed into nothing. There is a physical limit to the accumulation of use values. There is no obvious limit to the accumulation of exchange value. Fifty hammers are not much better than two (one and a spare) as far as use values are concerned. But in terms of exchange value, fifty hammers are much better than two, better yet in the form of fifty hammers worth of fungible money that be spent on anything, anywhere, anytime.

• “A hoard of hammers takes up space and is subject to rust, rot, and entropy. Fifty hammers’ worth of money is not subject to rust, rot, and entropy and far from costing a storage fee will earn interest from whomever gains the privilege of “storing” it for you. Production or use value is self limiting (does the owner of the hammers on the left need any more of them ?). Since there is no limit to the accumulation of abstract exchange value, and since abstract exchange value is convertible into concrete use value, we seem to have concluded that there must not be any limit to concrete use values either. This has perhaps led to the notion that exponential growth, the law of money growing in the bank at compound interest, is also the law of growth of the real, or material economy.”

OR

Dumber than a box of hammers

Virtual Wealth

Frederick Soddy - “Wealth is the positive quantity to

be measured and money as the claim to wealth is a debt.”

Virtual Wealth - is the aggregate value of the real assets that the community voluntarily abstains from holding in order to hold money instead.

The value of a dollar is determined by the wealth of a community divided by however many dollars are in circulation.

Frederick Soddy

Ode to Frederick SoddyThe Alfred Wegener of Economics ?http://en.wikipedia.org/wiki/Frederick_Soddy

In 1914 he was appointed to a chair at the University of Aberdeen, where he worked on research related to World War I. In 1919 he moved to Oxford University as Dr Lee's Professor of Chemistry, where, in the period up till 1936, he reorganized the laboratories and the syllabus in chemistry. He received the 1921 Nobel Prize in chemistry for his research in radioactive decay and particularly for his formulation of the theory of isotopes.

His work and essays popularizing the new understanding of radioactivity was the main inspiration for H. G. Wells's The World Set Free (1914), which features atomic bombs dropped from biplanes in a war set many years in the future. Wells's novel is also known as The Last War and imagines a peaceful world emerging from the chaos. In Wealth, Virtual Wealth and Debt Soddy praises Wells’s The World Set Free. He also says that radioactive processes probably power the stars.

In four books written from 1921 to 1934, Soddy carried on a "quixotic campaign for a radical restructuring of global monetary relationships", offering a perspective on economics rooted in physics—the laws of thermodynamics, in particular—and was "roundly dismissed as a crank". While most of his proposals - "to abandon the gold standard, let international exchange rates float, use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort" - are now conventional practice, his critique of fractional-reserve banking still "remains outside the bounds of conventional wisdom".[3]

10 minute Video on:The Fractional Reserve Banking Systemhttp://www.youtube.com/watch?v=pEAjOk_UY9I

Virtual Wealth• Frederick Soddy made the distinction between

wealth and debt very clear. “Wealth is the positive quantity to be measured and money as

the claim to wealth is a debt.”

• Monetary debt, the measure of wealth, is negative wealth, say ‘minus two pigs’. It obeys the laws of mathematics, but not of physics. Wealth, on the other hand, ‘plus two pigs’ obeys the laws of thermodynamics as well as mathematics. Positive pigs die, have to be fed, and cannot reproduce faster than their gestation period allows. Negative pigs are hyper-fecund and can multiply mathematically without limit.

• “You cannot permanently pit an absurd human convention, such as the spontaneous increment of debt (compound interest), against the natural law of the spontaneous decrement of wealth (entropy)”

Virtual Wealth continued….

• Virtual Wealth – the aggregate value of the real assets that the community voluntarily abstains from holding in order to hold money instead.

The value of a dollar, then, is the virtual wealth of the communitydivided by however manydollars are in circulation

These ideas are whySome people get

Wound up about the“Gold Standard”

Creating money & The Fractional Reserve System

The monetary value of the token, the profit made to the issuer and creator of money is Seigniorage.

Question: Who gets the seigniorage?Seigniorage from currency goes to the government. Seigniorage from demand deposits goes to the private sector, initially to commercial banks.

Money does not honor the laws of thermodynamics as it can be created and destroyed.

The Fractional Reserve System

Assuming just 10% reserve requirement

$100 of new cash deposit can create $900

In demand deposit.

$100Cash

Bank A $90 Bank B $81 Bank C $72.90 Bank I……..

$900 “new money”

If ‘r’ is the required reserve ratio, thedemand deposit multiplier is given by:

1 + (1-r) + (1-r)2 + …+ (1-r)n = 1/r

In case we missed it: 10 minute Video on:The Fractional Reserve Banking System

http://www.youtube.com/watch?v=pEAjOk_UY9I

Money as a Public Good

Money functions in some ways as a public goodMoney is nonexcludable: in fact money only has value if everyone can use it Money is nonrival: a dollar spent does not decrease in value.

The virtual wealth of the community could be treated as a publicly owned resource. BUT money is not treated as a publicly owned resource. The money supply is privately loaned into existence at interest encouraging a strong growth bias with cyclical instability.

An alternative money supply system:

Government controlled supply system with money printing and taxing or by increasing or decreasing international payments balances.

Or local currencies and local Exchange Trading Systems

Soddy’s suggested Reforms:• Gradually raise the reserve requirement to 100%

– Private banks out of money creation business– Control of money supply back in government hands

• Automatic rule based on a Price Level Index– If price level is falling then government prints money– If price level is rising then tax more than spend– International complicates matters but can be dealt with

• Freely fluctuating currency exchange rates– An equilibrium exchange rate surpluses or shortages in

the balance of payments between countries

What really exists now?• The Gold Standard (100% reserve) is long gone

• Fixed exchange rates gave way to flexible exchange rates but freely floating exchange rates are considered too volatile

• The money supply is largely determined by commercial banks that are manipulated but not controlled by the Federal Reserve.

• The Federal Reserve:– Sets Reserve Requirements

– Sets interest rates (discount rate) for lending $ to commercial banks

– Buys Govt bonds (expand $ supply) Sells Govt bonds (contract $ supply)

Money and Thermodynamics

Money can be both created and destroyed thereby forgoing the laws of thermodynamics. The problem is that though money (the symbol) does not adhere to the laws of thermodynamics, wealth does.

Exponential growth of wealth64 doublings of grain on a chess board

18,446,744,073,709,551,616: a quantity greater than 1,000 years of wheat production

The world can’t even handle 64 doublings of a grain of wheat

How many doublings can the world handle of populations? Of plastic waste?

How many times can we divide by half the number of species of plants and animals?

Food for thought……• Money is a problem because it leads us to think that wealth behaves

like its symbol, money; that because it is possible for few people to live on interest, it is possible for all to do so; that’s because money can be used to buy land and land can yield a permanent revenue, therefore money can yield a permanent revenue. (comment on some fallacies in this logic)

• “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the captial development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” John Maynard Keynes

• Annual Global production of Goods and Services is roughly $50 trillion• The markets (paper buying paper) spend $2 Trillion per day. (20 x more)• Real enterprise has become a bubble on the whirlpool of speculation.

Conclusions

M - C - M* treats money as an end rather than a means

This drives innovation for making money rather than production.

Currency Speculation can be considered M-M*-M**

Limits to the growth of money:

1) As long as the production of real goods and services increases, more money is required to pursue them but this kind of growth cannot continue on a finite planet.

2) Growing financial assets grow driving the demand for money. Financial bubbles inevitably burst.

3) Speculation can serve to transfer resources from those who produce to those who merely speculate.These transfers are tied to the above two limits.

So money is not really exempt from the laws of thermodynamics…..