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Tuesday, October 23, 2012

Money isn't a Bubble or a Ponzi Schemes

Paul Krugman is my favorite economist. I've been arguing this same subject for a while, and it's nice to see professor Krugman encapsulate the same arguments I've been making for years without the same gravitas.

Paul Krugman: "Noah Smith, who is a better human being than I am, wades through an anti-Krugman rant to find an interesting nugget: the claim that money is a bubble. It isn’t, of course; but my explanation of why it isn’t is a bit different from his, and has wider implications."
We've got these idiots who want "real money" -- which means money with intrinsic value that someone can stick in a mattress and hide. But Paul notes the distinction, what a Bubble is:
"I’d start by asking, what do we mean when we talk about bubbles? Basically, I’d argue, we mean that people are basing their decisions on beliefs about the future that are based on recent experience but can’t be fulfilled. E.g., people buy houses because they expect home prices to keep rising at a pace that would eventually leave nobody able to buy a first home."
Professor Krugman knows how to explain things so even a drop out can understand:
"Bubbles don’t have to involve prices. You can have a local construction boom driven by rapid growth in an area’s population and employment, when the main thing driving that rapid growth is … the local construction boom, which will eventually collapse when enough houses are completed. The point, whether prices are involved or not, is that the expectations of individuals add up to an aggregate impossibility."
Yes a bubble is similar to a Ponzi scheme except that usually a lot of folks are in on the risk and self-deception. Paul notes:
"This sounds a lot like what happens in a Ponzi scheme, where people are relying on an ever-growing number of new subscribers, and are doomed to disaster when the pool of potential suckers runs dry. And as Robert Schiller taught us long ago, bubbles are in fact “natural Ponzi schemes”, in which Bernie Madoff’s place is taken by the invisible hand of confusion."
The invisible hand of confusion is supplemented by people who do understand what is happening and plan to get their fill and get out before the whole thing collapses. Paul shows that fiat money is not a bubble:
"Is fiat money a bubble in this sense? Not at all. It’s true that green pieces of paper have no intrinsic value (except that they can be used to pay taxes, which is actually important), so that my willingness to accept green paper from you is based only on my belief that I can in turn hand that green paper over to someone else. But there’s nothing to prevent that process of monetary circulation from going on forever."
Except of course human herd behavior and human self destruction (the hurd running off a cliff):
"So what is fiat money? It is, as Paul Samuelson put it in his original overlapping-generations model (pdf), a “social contrivance”. It’s a convention, which works as long as the future is like the past. Obviously, such conventions can break down — but then so can things like property rights. In fact, you could argue that almost every asset in a modern economy owes its value to social convention; green pieces of paper could become worthless, but then so could any paper claim, which is, after all, worth something only because laws say it is — and laws can be repealed."
I downloaded the Real Economists article.
"And once you realize that a social convention is not at all the same thing as a bubble, several related fallacies fall into place."
A lot of our prices, and the wages we pay people are based on social convention. Which is a fancy word for generally accepted habits. It may make no sense that teachers are paid less than stock market cons, but the stock market cons pay themselves and someone pays the teachers and society might claim they are worth more, but refuses to pay them more.

"Take the common claim on the right that Social Security is a Ponzi scheme because the system has few real assets. It’s true that Social Security is mainly a system in which each generation pays for the previous generation’s retirement, in the expectation that it will receive the same treatment from the next generation. But like monetary circulation, this process can go on forever; there’s nothing unsustainable about it (yes, demography, but that’s about the levels of taxes and benefits, not the fundamental nature of the scheme). So there’s nothing Ponziesque at all."
But it makes a good argument for those who would prefer most of us rout around in garbage dumps for our meals.
Paul: "A final thought: the notion that there must be a “fundamental” source for money’s value, although it’s a right-wing trope, bears a strong family resemblance to the Marxist labor theory of value. In each case what people are missing is that value is an emergent property, not an essence: money, and actually everything, has a market value based on the role it plays in our economy — full stop."
The ponzi scheme is the idea that any of the thefts committed by right wing ideologues will ever trickle down to the people ripped off.

1 comment:

  1. Money is evidence of a legal relationship, a relationship of debt. The existence of money is therefore evidence of an outstanding debt. This relationship, this 'money', is brought into existence when someone goes into debt makes a promise to repay it i.e. honour it. Money is therefore 'promissory' and thus derives its value from the fact that it is a 'claim' on somebody; it is 'backed', if you like, by debtors' obligation, under the force of law, to honour their debts/promises.

    So, whilst I agree with you about the value and sustainability of both money and Social Security, money itself needs to be understood as more than just a social construct. It's also worth noting that if money comes into and out of existence as we go into and out of debt, then it might serve us to look more closely at claims that we 'borrow' our way into debt.