The Medium of Account Dominates the Functions of Money

Scott Sumner says something interesting about money being the medium of account:

“I argue that money is the medium of account.”

I agree. We spent a lot of time ere at MR with the equation S = I + (S-I), and one of the conversations about this idea (Thanks again Steve R.) was about how there are tons of assets sitting on the balance sheets of the world, all valued using the medium of account, where the medium of exchange has very little impact on what happens with these assets. These assets all matter for S and I.

Many of our more important transactions in the financial world do not involve exchanging the medium of exchange. They involve the valuation of assets in the medium of account, and promises to provide (possibly) some medium of exchange later in compensation. For example, an interest rate swap doesn’t involve much or any exchange of the medium of exchange at the initiation of the trade. Yet, plain vanilla IRS define much of our financial world.

IRS are bookkeeping entries until something changes in the real world, so how can they be considered to be using the medium of exchange? IRS use the medium of account.

Then, taxing agencies don’t just tax transactions which use the medium of exchange. They also tax transactions which involve gifting of real estate, compensation received as options on corporate equity, or payment in kind. These transactions must be given values in the medium of account, which then require taxes paid in the medium of exchange.

Also, much of our current recession has been caused by transactions which did not involve the medium of exchange. The revaluation of ABS – clearly one of the precipitating forces of the tragedy in 2008 – were simply bookkeeping entries on non-traded bonds. The reason banks stopped lending the medium of exchange was due to changes in valuation on untraded bonds in the medium of account. Similar bonds may have traded, but some large majority of the ABS revaluation happened in a few dozen (maybe a few hundred) spreadsheets around the world, not in millions of recorded exchanges of these bonds for money. There were literally no trades for these ABS, no “exchange of medium” for specific bonds, so the valuation changes must have come from valuation changes which happened in the medium of account.

Note these spreadsheet-only valuation changes directly caused the lending problems in 2008.

My take is the accounting function of money dominates the exchange function. It’s hard to see when you don’t think about accounting much, but accountants rule our world, because they define it.

(Update: The internet bubble was an MoA driven phenomenon, and the mid 2000’s refi-boom was a MoA phenomenon.In the intenet bubble, many transactions were exchanges of equity with zero MoE involved. Any refi equity extraction involves guessing the market value of a parcel of real estate and then giving someone MoE in exchange for that new value. The MoE is available when the MoA valuation changes. )

 

 

 

 

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LVG
3 years 6 months ago

Look at this disaster. This MMT person Paul, who never understood the S=I discussions think corporations can’t make a profit without government spending.

http://mikenormaneconomics.blogspot.com/2012/10/paul-meli-sectoral-balances-within.html

Admin
3 years 6 months ago

Well, to be fair, if there’s NO govt spending, corporations will be too busy fighting off savages in dune buggies to book a profit.

Admin
3 years 6 months ago

Ha. I’ve been watching this great series on the History channel called “The Men Who Built America”. What really happens without govt is that the capitalists keep almost ALL of the profits and they basically submit their workers to the equivalent of death by labor due to horrid work conditions. That was the wild wild west back in the 1800s! If anything, the govt came in and made things harder for the corporations by forcing them to treat their employees like human beings. 🙂

Admin
3 years 6 months ago

I’m reading Eric Foner’s Reconstruction book. Its fascinating how after the Civil War, the pro-civil rights party (the Republicans) had guys who were basically socialists wanting to nationalize railroads and banks as well as robber barons like Rockefeller and Stanford. All they really agreed on was political and, for the most part, social equality for African-Americans.
That’s one of the reasons economics was such a mess during this period (the depression that started in the 1870s ran on pretty much continuously to the end of the century). Since there was no legitimate political opposition*, once the low wage gold bugs took the reins of the GOP, elections couldn’t do much to change direction.
*The Democratic party at that time was basically the political arm of the Ku Klux Klan, the first thing they did when they took over Congress in 1893 was repeal the Reconstruction laws protecting black voting rights.

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wh10
3 years 6 months ago

heh that’s of course broad and sweeping but a compelling, balanced viewpoint at 40K

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jt26
3 years 6 months ago

But based on Nick Rowe’s discussion, http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/10/medium-of-account-vs-medium-of-exchange.html
… MOE seems to be most important since “An excess demand for the medium of exchange causes a recession”. But, you’re right, the financial crisis could be due to “changes in expectations” because the value of an asset in MOA is 0, but these expectations are related to not getting back your MOE at some point in the future.

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Greg
3 years 6 months ago

I must confess to not really being sure why anyone ever wanted to distinguish between the two “properties”. What use comes from separating?

If you cant account for it, it didnt happen.

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Tom Hickey
3 years 6 months ago

“I must confess to not really being sure why anyone ever wanted to distinguish between the two “properties”. What use comes from separating?”

Chris Cook has pointed out that money is more properly conceived as credit than debt. Money is created when accounts are credited, and most money in modern economies comes from banks’ crediting deposit accounts with loans they extend. This is the use of money as a unit of account. There is no use of money as a medium of exchange at this point, since nothing has been exchanged but promises.

If the borrower withdraws funds for a transaction by cash or writes a check that must be cleared with rb, then money comes into play as a medium of exchange.

However, if transactions are settled by netting, all that happens is shifting numbers signifying units of account. There is no use of actual “money” (cash or rb) as a medium of exchange involved.

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Greg
3 years 6 months ago

“Money is created when accounts are credited, and most money in modern economies comes from banks’ crediting deposit accounts with loans they extend. This is the use of money as a unit of account. There is no use of money as a medium of exchange at this point, since nothing has been exchanged but promises.”

Every loan Ive ever obtained required some sort of collateral. You have to “have” something to get a loan. And you lose that something if payments dont get made No one who has nothing to their name will get a loan from a bank. Maybe a friend will lend you something but that is an entirely different dynamic than what we are usually discussing here. When I get a mortgage Im still about 180 months form actually taking ownership from the bank.

Id be interested in your answer here JKH.

The whole separation seems entirely unnecessary in todays world, which may put me in agreement with Scott Sumner (*chills*)

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Fed Up
3 years 6 months ago

“Every loan Ive ever obtained required some sort of collateral.”

What about credit card debt?

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Greg
3 years 6 months ago

Yes credit card debt is collateral free, but it is almost 20%. Might as well have collateral

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Fed Up
3 years 6 months ago

My mom got one before the 2008 crisis at fed funds plus 3%. She is paying it down because CD’s now have a very low interest rate. Lower interest rates have caused her to spend less (message to bernanke).

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Fed Up
3 years 6 months ago

World? Not sure. USA? Not sure but thinking 800 billion to 900 billion. I believe that is expected future (mostly wage) income, which may or may not come true.

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Fed Up
3 years 6 months ago

“The Collateral is future earnings.”

I don’t consider that collateral. Future earnings is about making the interest and principal payments. I consider collateral to be an asset that can be seized and sold to repay the debt if people default. With most? credit card debt, there is no asset to seize.

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beowulf
3 years 6 months ago
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Tom Hickey
3 years 6 months ago

Greg “Essentially what people are borrowing when they go into debt is their OWN future earnings. Which is why, as I see it, that the private money system is unstable. Every person involved in borrowing must be able to accurately forecast their future earnings.”

And when employment was stable, with people staying in the same job, perhaps for life, it was possible to assess future earnings with some degree of assurance. That model of employment security has now shifted pretty radically, even in paternalistic Japan, making such assessment more difficult, if not a stab in the dark wrt lots of workers.

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Greg
3 years 6 months ago

Yes. Essentially what people are borrowing when they go into debt is their OWN future earnings. Which is why, as I see it, that the private money system is unstable. Every person involved in borrowing must be able to accurately forecast their future earnings. And the banking system is motivated to encourage us to be over optimistic about our futures, which makes them more likely to blowup.

Its a trade off between living in the present and paying off the past. I just finished a refi and was able to take $2100/month worth of house/car/vacation prop payments and reducing them to 750$. Now if I make the minimums and pay the term I will pay much more in total now but I now have over 1300$/month of present consumption I can do. I want to live more in the present so its worth paying more overall to not be paying off past debts faster. Living for today, living in the present moment has a cost.

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jt26
3 years 6 months ago

What you normally need is a high paying job … something that sources MOE! 😉

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Tom Hickey
3 years 6 months ago

Yes, but collateral is a “pledge” not an exchange.

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Greg
3 years 6 months ago

Could it not be thought of as a conditional exchange.

Additionally its a condition which under most circumstances is compulsory.

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JKH
3 years 6 months ago

Tom,

You’re behaving too much like a bean counter.

There’s enormous philosophical scope available in answering this question.

🙂

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Tom Hickey
3 years 6 months ago

🙂

I was just putting forward Chris Cook’s observation, which I thought was well taken if we restrict the def. of “money” to govt money and bank money. Do you think he is correct?

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JKH
3 years 6 months ago

To be honest, Tom, I haven’t had or taken the time to think much about this question. On cursory view, I initially favored the medium of exchange emphasis. But I like Mike’s post here very much. And I think your comment here is also fine.

I wasn’t being entirely facetious on the philosophy reference. I think this is one of those issues where you have to be very precise about exactly what the question is in order to get full value from the discussion. I haven’t looked at either the Rowe or the Sumner posts closely enough to know whether this has been done in either case – or at the comments in either case, which might be equally revealing along these lines.

At the 40,000 foot level, it is interesting to note the density with which the “medium of account” occupies the economy’s balance sheet structure and various stresses on that balance sheet structure – as well as the rapidity with which the “medium of exchange” enables daily transactions – just look at the FX market for example.

Money clearly has both characteristics, or at least enables both characteristics – accounting and exchange.

So I think the precise question and the meaningfulness of that question does become philosophical.

I trust I have made myself perfectly obscure.

🙂

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Tom Hickey
3 years 6 months ago

The philosopher’s question is about criteria, most especially, criteria of meaning and truth. When the subject matter is tightly bounded by clearly defined rules upon which all agree, it is usually possible to decide any dispute based on the rules.

But if the rules are not clear, e.g., criteria concerning how to apply them is in question, then the answer may be up in the air if the parties cannot agree. Of course, when quality is involved, then the matter become subjective and “de gustibus non est disputandum” applies.

While it is true that some appeal to “transcendentals” that mediate between subjectivity and objectivity, the existence of transcendentals is also in dispute with no agreed upon criteria. As a result most interesting questions are undecidable based on universally agreed upon criteria.

To obscure the issues further. 🙂

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JKH
3 years 6 months ago

“As a result most interesting questions are undecidable based on universally agreed upon criteria.”

Now THAT’s what I’m talking about.

Thank goodness for a legitimate escape hatch on this one.

“de gustibus non est disputandum”

This is a good one to know also.

I intend to insert it in family conversation, ASAP.

P.S.

(seriously)

Did the Socratic method include searching for the right question?

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Tom Hickey
3 years 6 months ago

“Did the Socratic method include searching for the right question?”

That’s a very prescient question itself. Socratic dialectic is a logical approach quite different from Aristotle’s analytical one. Dialectic is about honing the question, since questions determine the type of answer they elicit. Due to cognitive bias we tend to frame questions that lead to an answer in terms of how questions are framed . Being stated within a frame of reference, questions contain implicit assumptions. The dialectical method is designed to elucidate this by evoking different perspectives. The analytical method doesn’t deal with it, since it operates within a frame, although inconsistency and anomaly reveal issues in the approach.

Guest
3 years 6 months ago

I’ve been following this debate and I think it makes more sense if you ignore any claims that Sumner/Rowe have about “what is money.” Just pretend that the word “money” doesn’t exist. If you do then the debate boils down to an interesting exchange on the interaction between the MOE, MOE, and various assumptions about stickiness.

The word money should be banned from the economic vocabulary because its use tends to causes more fights than forward progress. Words like MOE, MOA, and unit of account are far better specified.

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JKH
3 years 6 months ago

That debate revolves most around competing interpretations where the MOA and the MOE are not the same. Mike has expanded the scope to what may be described loosely as Minsky balance sheet proportions and effects, which I don’t see addressed in the Rowe/Sumner debate.

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Fed Up
3 years 6 months ago

“The word money should be banned from the economic vocabulary because its use tends to causes more fights than forward progress. ”

Exactly!!!!! I suggest going with currency, central bank reserves, and demand deposits.

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JKH
3 years 6 months ago

Here’s one, Mike, along the lines of a stock/flow consistency riff:

In favor of medium of account:

The value of the medium of account function correlates with balance sheet scope.

The value of the medium of exchange function correlates with income statement and flow of funds statement scope.

Balance sheet scope is generally larger than income statement or flow of funds statement scope (how much larger is an interesting question).

(Macro and micro)

In favor of medium of exchange:

The physical or electronic stuff of money is inherently present in the income statement and flow of funds statement.

This is not the case for the balance sheet – except for those asset categories that fall under the chosen definition of money.

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JKH
3 years 6 months ago

sorry – which is the provocative statement Mike?

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Tom Hickey
3 years 6 months ago

As I recall, Chris Cook was responding to the idea that “money is debt,” i.e., somebody’s IOU. He said it was more accurate to say that money is credit in that money is created by crediting accounts.

Compare Warren’s idea of currency as a tax credit, and bank money a franchise that the govt gives banks to generate tax credits within the franchise rules. He calls this “leveraging” the currency, that is, expanding the amount of tax credits over what the govt itself creates through fiscal policy and cb lending.

I think he would say that once money is created through credit, then it can function as a medium of exchange, a store of value, and a record of non-bank credit denominated in the unit of account. But these are subsidiary to money creation, which occurs by crediting accounts.

But this is only my understanding of Cook’s view expressed in my words.

Admin
3 years 6 months ago

“On the other hand, all of those statements by Greenspan about the “wealth effect” start to seem like fumbling attempts to come to grip with the medium of account effects of monetary policy.”

The guy who really dived into the wealth effect is Per Gunnar Berglund (“The grand-ratios model is a formalization of ideas formulated by Vickrey and foreshadowed by Godley and Cripps”) He’s described it in slightly different ways over time (links are from 1997, 2001 and 2006 respectively).
http://archives.econ.utah.edu/archives/pkt/1997m10-e/msg00037.html
http://www.newschool.edu/scepa/publications/workingpapers/archive/cepa0212.pdf
http://books.google.com/books?id=jztO57DobxQC&lpg=PA149&pg=PA149#v=

The meat of it is this [from first link]:
“The limit of the debt/GDP ratio is set by the spending propensities, i.e. by
the wealth-to-spending turnover rate. The lower the turnover rate, the
higher the debt/GDP ratio limit. It seems that the capital asset/GDP ratio
varies around 4:1 in the long run [i.e. GDP usually 20% of capital stock]. Now, suppose that the private wealth-to-spending turnover rate is 5:1, and that the whole stock of assets is privately owned. This means that there will be a spending shortage of 20% of the GDP, only 4/5 of the GDP will be purchased. Hence the gov’t must “fill in” with another 20% of GDP of demand, to balance the GDP and the spending.”

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Tom Hickey
3 years 6 months ago

Then there were seconds and thirds, and probably some fourths, based on what the bank was willing to loan against the same collateral based on a rising market. Then after the crash, at least some of that “collateral” was just bulldozed as less then worthless. All that’s left for the bank to sell in order to recoup is an empty lot.

Not to mention all the securitization that leveraged the leverage.

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Greg
3 years 6 months ago
“We may have strayed from the path a bit here, because this statement (and the related statements and questions) isn’t/aren’t as empirical and reality driven as we typically prefer around here at MR. On the other hand, all of those statements by Greenspan about the “wealth effect” start to seem like fumbling attempts to come to grip with the medium of account effects of monetary policy.” Yep. I tell the guys I work with that their 401K statement with 500,000$ on it is NOT the same as a 500,000$ bill. It might be better, it might be worse, a lot worse. “Think about a collateralized loan, a loan backed by real estate. One person owns this property outright which they created at a value of V, and someone else wants to purchase it at V. The net wealth of the entire system remains the same before and after the loan. Is the entire system more likely to engage in further trade now that the loan has been created? Yes, but the person who sold the house isn’t truly any wealthier.” I dont know. As we define wealth, here and now, in US$, on a balance sheet, that person may truly be wealthier. He may be able to demand significantly more of the available resources after the sale than before. It might not be that way for long but certainly for a period of time it is true, it seems to me. “Of course this is greatly simplified, and the bank wouldn’t lend full value of X. But I’d argue this world is far more likely to have more economic activity than the first world” I agree. People will exchange as long as they arent OBVIOUSLY losing the exchange. Once enough people start obviously losing the exchange, the exchanging stops. Especially… Read more »
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Greg
3 years 6 months ago

“Money clearly has both characteristics, or at least enables both characteristics – accounting and exchange.”

Yes, but if the exchange isnt accounted for isnt it then a “black market exchange”?

And if it is accounted for doesnt the accounting and exchange properties morph into one?

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Tom Hickey
3 years 6 months ago

Accounting is an ex post record of transactions, and not all transactions involve exchange of assets or goods. For example, when a loan is extended and a deposit account is credited, what is exchanged is a set of promises. The bank promises to provide means of settlement as the borrower desires, either by cash at the window or clear a check or electronic transfer. The borrower agrees to repayment plus interest on time.

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