Asymptosis

You probably won’t be surprised to know that exchange, trade, reciprocity, tit for tat, and associated notions of “fairness” and “just deserts” have deep roots in humans’ evolutionary origins. We see expressions of these traits in capuchin monkeys and chimps (researchers created a “cash economy” where chimps were trained to exchange inedible tokens for food, then their trading behaviors were studied), in human children as young as two, in domestic dogs, and even in corvids — ravens and crows.

But humans are unique in this as in many other things. We use a socially-constructed mechanism to effect and mediate that trade — a thing we call “money.” What is this thing? What does it mean to say that it’s “socially constructed”? What are the specifics of that social construct? How does it work?

Money has lots of different meanings when you hear it in the vernacular. A physical one- or five-dollar bill is “money,” for instance (“Hands up and gimme all your money!”). But so is a person’s net worth, or wealth (“How much money do you have?”), even though dead presidents on paper or even checking-account balances are often insignificant or ignored in tallies of net worth (think: stocks, bonds, real estate, etc.).

You might think you could turn to economists for an understanding of the term. Not so. They don’t have an agreed-upon definition of “money.” The closest they come is a tripartite “it’s used as” description that completely begs the question of what money is: It’s used as a medium of account, as a medium of exchange, and as a medium of storage. I and many others have pointed out the myriad problems with this tripartite non-definition. Start by asking yourself: what in the heck do they mean by “medium” in each of those three? You’ll often hear economists speak of (undefined) “monetary assets,” “monetary commodities,” and similar, attempting to communicate in absence of a definition.

When economists speak of the “money supply” (a stock measure, not a flow measure as suggested by “supply”), they are gesturing toward a body of financial securities that are somewhat currency-like. Primarily: they’re used in exchanges for real-world goods and services, and have fixed values relative to the unit of account — e.g. “the dollar” (think: “the inch”). They assemble various “monetary aggregates” of these currency-like things — MB (the “monetary base”), M0, M1, M2, M3, and MZM (“money of zero maturity”). Here’s a handy chart on Wikipedia.

This conflation of “money” with currency-like financial securities reveals a basic misunderstanding of money that pervades the economics profession. That misunderstanding is based on a fairly tale.

In the golden days of yore, it is told, all exchange was barter. Think: Adam Smith’s imagined bucolic butcher and baker village. This worked fine, except that your milk wasn’t necessarily ready and to hand when my corn came ripe. And moving all those physical commodities around was arduous. This inserted large quantities of sand and mud into the gears and wheels of trade.

But then some innovator came up with a great invention — physical currency! Coins. “Money.” This invention launched humanity forward into its manifest destiny of friction-free exchange and the glories of market capitalism.

Except, that’s not how it happened. No known economy was ever based on barter. And coins were a very late arrival.

The best efforts at understanding the nature and origins of money have come from anthropologists, archaeologists, and historians who actually study early human commerce and trade, and from various associated (“heterodox”) fringes of economic thinking. David Graeber recounts much of this history (though unevenly) in Debt: The First 5,000 Years. Randall Wray, a leading proponent of the insurgent and increasingly influential Modern Monetary Theory (MMT) school of economics, has offered up some great explications. (Though even he is reduced, at times, to talking about “money things.”) If you’re after a gentle introduction, Planet Money has a great segment on money’s rather vexed history and odder incarnations.

The main finding from all this: the earliest uses of money in recorded civilization were not coins, or anything like them. They were tallies of credits and debits (gives and takes), assets and liabilities (rights and responsibilities, ownership and obligations), quantified in numbers. Accounting. (In technical terms: sign-value notation.) Tally sticks go back twenty-five or thirty thousand years. More sophisticated systems emerged six to seven thousand years ago (Sumerian clay tablets and their strings-of-beads predecessors). The first coins weren’t minted until circa 700 BCE — thousands or tens of thousands of years after the invention of “money.”

These tally systems give us our first clue to the nature of this elusive “social construct” called money: it’s an accounting construct. The earliest human recording systems we know of — proto-writing — were all used for accounting.* So the need for social accounting may even explain the invention of writing.

This “accounting” invention is a human manifestation of, and mechanism for, reciprocity instincts whose origins long predate humanity. It’s an invented technique to do the counting that is at least somewhat, at least implicitly, necessary to reciprocal, tit-for-tat social relationships. It’s even been suggested that the arduous work of social accounting — keeping track of all those social relationships with all those people — may have been the primary impetus for the rapid evolutionary expansion of the human brain. “Money” allowed humans to outsource some of that arduous mental recording onto tally sheets.

None of this is to suggest that explicit accounting is necessary for social relationships. That would be silly. Small tribal cultures are mostly dominated by “gift economies” based on unquantified exchanges. And even in modern societies, much or most of the “value” we exchange — among family, friends, and even business associates — is not accounted for explicitly or numerically. But money, by any useful definition, is so accounted for. Money simply doesn’t exist without accounting.

Coins and other pieces of physical currency are, in an important sense, an extra step removed from money itself. They’re conveniently exchangeable physical tokens of accounting relationships, allowing people to shift the tallies of rights and responsibilities without editing tally sheets. But the tally sheets, even if they are only implicit, are where the money resides.

This is of course contrary to everyday usage. A dollar bill is “money,” right? But that is often true of technical terms of art. This confusion of physical tokens and other currency-like things (viz, economists’ monetary aggregates, and Wray’s “money things”) with money itself make it difficult or impossible to discuss money coherently.

What may surprise you: all of this historical and anthropological information and understanding is esoteric, rare knowledge among economists. It’s pretty much absent from Econ 101 teaching, and beyond. Economists’ discomfort with the discipline’s status as a true “social science,” employing the methodologies and epistemological constructs of social science — their “physics envy” — ironically leaves them bereft of a definition for what is arguably the most fundamental construct in their discipline. Likewise for other crucial and constantly-employed economic terms: assets, capital, savings, wealth, and others.

Now to be fair: a definition of money will never be simple and straightforward. Physicists’ definition of “energy” certainly isn’t. But physicists don’t completely talk past each other when they use the word and its associated concepts. Economists do when they talk about money. Constantly.

Physicists’ definition of energy is useful because it’s part of a mutually coherent complex of other carefully defined terms and understandings — things like “work,” “force,” “inertia,” and “momentum.” Money, as a (necessarily “social”) accounting construct, requires a similar complex of carefully defined, associated accounting terms — all of which themselves are about social-accounting relationships.

At this point you’re probably drumming your fingers impatiently: “So give: what is money?” Here, a bloodless and technical term-of-art definition:

The value of assets, as designated in a unit of account.

Which raises the obvious questions: What do you mean by “assets” and “unit of account”? Those are the kind of associated definitions that are necessary to any useful definition of money. Hint: assets are pure accounting, balance-sheet entities, numeric representations of the value of goods (or of claims on goods, or claims on claims on…). That’s where I’ll go in my next post.

Sneak preview: we’ll start by thinking carefully about another (evolved?) human social construct without which assets don’t, can’t, exist — ownership.

* Some scholars believe repeated symbolic patterns going back much further, in cave paintings for instance, embodied early “writing,” but that is widely contested, and nobody knows what the symbols — if they are symbols — represented.

Cross-posted at Evonomics.

In a recent post Tyler Cowen makes an admirable effort to lay out his overarching approach to thinking about macroeconomics, revealing the assumptions underlying his understanding of how economies work. (Even more salutary, this has prompted others to do likewise: Nick Rowe, Ryan Avent.)

Cowen’s first assertion:

In world history, 99% of all business cycles are real business cycles.

This may be true, but it is almost certainly immaterial to the operations of modern, financialized monetary economies. He acknowledges as much in his second assertion:

In the more recent segment of world history, a lot of cycles have been caused by negative nominal shocks. I consider the Christina and David Romer “shock identification” paper (pdf, and note the name order) to be one of the very best pieces of research in all of macroeconomics.

That paper, which revisits and revises Friedman and Schwartz’s Monetary History, is clearly foundational to Cowen’s understanding of how economies work, so it bears examination — in particular, its foundational assumptions. The Romers state one of those assumptions explicitly on page 134 (emphasis mine):

…an assumption that trend inflation by itself does not affect the dynamics of real output. We find this assumption reasonable: there appears to be no plausible channel other than policy through which trend inflation could cause large short-run output swings.

This will (or should) raise many eyebrows; it certainly did mine. Because: it completely ignores the effects of inflation on debt relationships.

It’s as if Irving Fisher and Hyman Minsky had never written.

Assuming “inflation” means roughly equivalent wage and price increases, at least over the medium/long term (yes, an iffy assumption given recent decades, but…), inflation increases nominal incomes without increasing nominal expenditures for existing debt service. (Yes, with some exceptions for inflation-indexed debt contracts.) Deflation, the reverse. Nominal debt-service expenditures are (very) sticky. Or described differently: inflation constitutes a massive ongoing transfer of real buying power from creditors to debtors — and again, deflation the reverse.

“No plausible channel”?

Excepting one passing and immaterial mention of government debt, the the words “debt” and “liability” do not appear in the Romer and Romer paper, and it has only two passing mentions of “assets.” It’s as if balance sheets did not exist — which in fact they do not in the national accounting constructs then existing, that the Romers, Friedman, Schwartz, and presumably Cowen today are using in their mental economic models and in the “narrative” approach to explaining economies that Friedman, Schwartz, and the Romers explicitly champion.

If you go further and allow that wages and prices can inflate at different rates (which you must, given recent decades), you have extremely large and changing differentials between price inflation, wage inflation, and (especially) asset-price inflation.

All of these inflation dynamics are assumed away, made invisible and immaterial, in Romer and Romer — hence largely, at least presumably so, in Cowen’s understanding of economies. It is explicitly assumed (hence concluded) that those dynamics have no “real” effect. As in Romer and Romer, the words “debt,” “liability,” and “asset” are absent from Cowen’s “macroeconomic framework.” (Though he does give a polite if content-free nod to Minsky in his ninth statement.)

This explains much, in my opinion, about Cowen’s — and many other mainstream economists’ — flawed understanding of how economies work.

Cross-posted at Angry Bear.

I’ve pointed out multiple times that despite Europe’s big, supposedly growth-strangling governments, Europe and the U.S. have grown at the same rate over the last 45 years. Here’s the latest data from the OECD, through 2014 (click for larger):

And here’s the spreadsheet. Have your way with it. More discussion and explanation in a previous post.

You can cherry-pick brief periods along the bottom diagonal to support any argument you like. But between 1970 and 2014, U.S. real GDP per capita grew 117%. The EU15 grew 115%. (Rounding explains the 1% difference shown above.) Statistically, we call that “the same.”

Which brought me back to a question that’s been nagging me for years: why hasn’t Europe caught up? Basic growth theory tells us it should (convergence, Solow, all that). And it did, very impressively, in the thirty years after World War II (interestingly, this during a period when the world lay in tatters, and the U.S. utterly dominated global manufacturing, trade, and commerce).

But then in the mid 70s Europe stopped catching up. U.S. GDP per capita today (2014) is $50,620. For Europe it’s $38,870 — only 77% of the U.S. figure, roughly what it’s been since the 70s. What’s with that?

Small-government advocates will suggest that the big European governments built after World War II are the culprit; they finally started to bite in the 70s. But then, again: why has Europe grown just as fast as the U.S. since the 70s? It’s a conundrum.

I’m thinking the small-government types might be right: it’s about government. But they’ve got the wrong explanation.

Think about how GDP is measured. Private-sector output is estimated by spending on final goods and services in the market. But that doesn’t work for government goods, because they aren’t sold in the market. So they’re estimated based on the cost of producing and delivering them.

Small-government advocates frequently make this point about the measurement of government production. But they then jump immediately to a foregone conclusion: that the value of government goods are services are being overestimated by this method. (You can see Tyler Cowen doing it here.)

That makes no sense to me. What would private output look like if it was measured at the cost of production? Way lower. Is government really so inefficient that its production costs are higher than its output? It’s hard to say, but that seems wildly improbable, strikes me as a pure leap of faith, completely contrary to reasonable Bayesian priors about input versus output in production.

Imagine, rather, that the cost-of-production estimation method is underestimating the value of government goods — just as it would (wildly) underestimate private goods if they were measured that way. Now do the math: EU built out governments encompassing about 40% of GDP. The U.S. is about 25%. Think: America’s insanely expensive health care and higher education, much or most of it measured at market prices for GDP purposes, not cost of production as in Europe. Add in our extraordinary spending on financial services — spending which is far lower in Europe, with its more-comprehensive government pension and retirement programs. Feel free to add to the list.

All those European government services are measured at cost of production, while equivalent U.S. services are measured at (much higher) market cost. Is it any wonder that U.S. GDP looks higher?

I’d be delighted to hear from readers about any measures or studies that have managed to quantify this difficult conundrum. What’s the value or “utility” of government services, designated in dollars (or whatever)?

Update: I can’t believe I failed to mention what’s probably the primary cause of the US/EU differential: Europeans work less. A lot less. Like four or six weeks a year less. They’ve chosen free time with their families, time to do things they love with people they love, over square footage and cubic inches.

Got family values?

I can’t believe I forgot to mention it, because I’ve written about it at least half a dozen times.

If Europeans worked as many hours as Americans, their GDP figures would still be roughly 14% below the U.S. But mis-measurement of government output, plus several other GDP-measurement discrepancies across countries, could easily explain that.

Cross-posted at Angry Bear.

 

I’ve got a new post up at a new site, Evonomics Magazine (“The next evolution of economics”). It’s an impressive offshoot with some great articles, assembled by folks involved with The Evolution Institute, which I’m a big booster for.

My readers here will find much familiar in the post, but I’m happy with how it pulls various threads together. I’ll be following comments over there, so have your way with it.

Cross-posted at Angry Bear.