Money, civilisation and their discontents
QE increases state money but reduces the quality of money
The usual way to destroy the social value of money is through inflation, and that has indeed been the fate of most fiat currencies. Yet there are other ways to reduce the quality of money and thus its ability to support a civilisation. Money becomes less useful, for example, when the objects you can spend it on are controlled, e.g. by rationing. It becomes less useful if the state imposes exchange controls and travellers cannot convert more than a certain sum (as was the case when I first went abroad from Britain; my passport was stamped with my £50 allowance). It is less useful the fewer the number of people who accept it. The most useful is a money accepted by everybody in the world, the least useful a money not accepted in payment anywhere. The quality of money declined in the later Roman Empire from the weight of excessive taxation; taxes paid in money were converted into levies paid in kind to a local lord. China provides examples of the decline in the use of money and a monetary standard.
The lower the quality of money, the more its purchasing power declines, as it becomes less valued in relation to other goods. Prices may rise, or be higher than they otherwise would be, while purchasing power declines.
Conversely with an increase in quality. As Philipp Bagus puts it:
“When the quality of money increases, money’s demand and, consequently, purchasing power will be higher than without this quality improvement. Money is, thus, no different than any other good. If the quality of a good increases, there will be more demand, and its price will be higher than without this increase of quality.
See Philipp Bagus here for a discussion of the quality of money.
A high-quality money is one that provides the basis for a safe and sustainable extension of credit by the private sector. Money has historically been a joint venture between the state and the private sector. Both have vital parts to play. Money is created by banks – “loans create deposits” – where those who receive credit are expected to observe the terms of the contract. A high quality money is a fruit of civilisation in the sense that it is a natural accompaniment of a society in which property rights are secured, promises in general kept, citizens are subject to the rule of law, taxes tolerable and the state keeps its contribution to monetary growth steady and reasonable. This is especially crucial for money in its role as a store of value.
How QE lowers the quality of money
QE policies make money growth more dependent on the vagaries of politics. They increase the state’s contribution to money growth in an effort to offset a fall in loans and thus in private-sector created money, but the overall growth of broad money has still lagged. Why? Recovery from the Great Recession has been disappointing, so demand for loans has been weak. Why? I say one reason is that QE weakens demand by reducing the perceived quality of money. People and companies acquire assets that can be converted easily back into money, like securities or real assets, as they are more uncertain about future monetary policies and thus about money. They are cautious. They worry about their debts. In such conditions low or even zero interest rates do not stimulate demand for loans as there is less demand to hold the resulting rise in the supply of (low quality) money.
If bankers fear that their customers are not credit worthy, they will not extend credit and the private sector’s contribution to a healthy growth in money will wither and die. If bankers see that government policies, while aimed at kickstarting the economy, are instead merely raising property and other asset prices, or keeping inefficient companies in existence, then bankers will divert credit to property-backed assets and zombie companies. This is what has happened under QE. Equally, if banks can make enough to pay their staff and bonuses by lending to property and investing in safe government paper or at the central bank, that is what they will do.
People can see that the privilege of money creation is being abused. This results in a decline in the quality of money and a sullen resistance to attempts to cajole and kick the economy into life.
The crisis, many decades in the making, has deep roots in a decline in the quality of money caused by an unholy alliance between the state, the financial sector and the central bank. The idea of a monetary standard, like the law, above the day-today tug of politics has been lost. Money has become a counter or plaything in the power struggle. True, as Ingham argues, control over the supply of money always has been the locus of a political struggle. Indeed, in his analysis it derives value from the outcome of such a struggle.
But, historically, the interests of the public have been safeguarded by the operation of a monetary standard.
Money is a delicate fruit of civilisation
A good money is fragile. It must be treated with respect. It rests on high ethical standards in society generally. It can be easily damaged through abuse; those with special responsibility for it include the state, its agent the central bank, and the bankers, who also create money through their credit decisions. All of us undermine money if we do not keep our contractual promises.
That is what we need to re-discover; that money is not an “thing” that “circulates with velocity” but a social relation (see Geoffrey Ingham, “The Nature of Money”, page 83). Or, as I would put it, a good money is a fragile, delicate fruit of civilisation.
That is why the state cannot just replace private growth of credit by expanding its contribution. Such statist policies upset the delicate equilibrium needed for money to fulfill its multiple roles not just in the economy but in society, its roles in linking generations, in connecting people through space and time and in enabling long-term private planning, measurement and investment.