Archive for June, 2021

Economic Origin Stories and the State of the World

June 28th, 2021 Comments off

Origin stories and creation myths pack a pretty hefty weight of import in human understandings of the world. Examples are too numerous to mention. What I’ve noticed in the field of economics is that such origin stories are often taken (mistakenly) to fully explain the current state of affairs. I’m going to discuss two examples here.

1. Why Money Has Value. The “double coincidence of wants” money-origin story, retailed by Adam Smith among many others, has been quite thoroughly debunked over the past century. But the better stories that have emerged continue to be seen by many economists — problematically in my opinion — as significant explanations of how things work right now.

One of those better stories is the tax-based origin of “fiat”-money value. A sovereign is collecting taxes in kind. They issue coins (necessarily if only implicitly pegged to an associated unit of account, which generally has same name as the coins — “The Shekel”), and declare that taxes must be paid using those coins. People need to accumulate those coins to pay taxes, so a consensus arises: everybody ascribes value to those coins, and they start using them in private exchange.

At that point there is a consensus currency which only achieved consensus value through the fiat imposition of taxes in that currency. That’s a plausible tale.

But once that consensus is achieved, taxes are no longer the only explanation for people’s ascription of value to the currency/coins. They’re valuable to people because of the consensus; it’s self-perpetuating. People in the private sector can exchange those coins with others for real goods/services, and to satisfy obligations from past provision of goods/services. And beyond “can”: sellers start demanding Shekels instead of bushels of corn, so buyers must use the consensus currency.

Now to be sure: That consensus is likewise maintained by another fiat mechanism: government enforcement of private contracts numerated in that currency. There’s a huge pyramid of legislative (or sovereign/autocratic), judicial, and enforcement machinery supporting the private-value consensus. But that’s separate from (and much larger than) the tax obligations, collections, and enforcement that originally bootstrapped and kick-started the consensus.

In the current state of the world, people can, really must, transfer USD-denominated assets to get what they want from, and fulfill their obligations to, other private actors — and also, yes, to pay their taxes. But the magnitude of US private-sector spending and obligations dwarfs tax obligations by a factor of roughly three to one. Given that magnitude, it seems misplaced to suggest that in the current state of the world, tax obligations are the only thing that impart value to the US consensus/fiat currency.

The tax story is a plausible and quite comprehensible (if somewhat stylized) understanding of how consensus currencies emerged and were ascribed value. But those currencies are seen as valuable today because…everyone agrees they have value, and demands them in exchanges and transfers, both private and public.

2. Financial Assets ≠ Liabilities. This supposed “accounting identity” belief is dismayingly widespread, even though a mere glance at the numbers shows it’s completely untrue, vastly incorrect. Just start with corporate equity shares, universally categorized as financial assets: The market asset value of those shares (ultimately in aggregate held on household balance sheets) is tens of trillions of dollars greater than the the related liabilities/shareholders’ equity on corporate balance sheets. The same pertains to bonds, even Treasuries, though the percentage disparity is far smaller.

Where did this notion come from? Another origin story: at the moment of issuance, the issuers’ liability equals the holder’s asset. When a corporation issues $1,000 of new bonds or equity shares and sells them to households, the corporation has a new $1K liability, and households have a new $1K asset; the two are equal. (Yes, there’s also a $1K cash-asset transfer, households -> firms; assets and liabilities increase, but ∆NW for both parties, either individually or combined, is zero.)

But as soon as those bonds/shares start trading in the market, their market asset values change. Every brokerage in the world sees trades at different prices, and marks every holder’s account statement/balance sheet to market. The household assets no longer equal the firms’ liabilities. The origin story no longer explains the current state of the world — not even close.