Ongoing Debate Over Currency Value

In this post, I outline how I see the questions of demand for state money and domestic value of state money. My perspective is informed by neo-chartalism (modern monetary theory). Hopefully the post can serve as a basis for discussion and we can identify some of the sources of disagreement. I am mainly referring to disagreements between Modern Monetary Realists (MMRers) and Modern Monetary Theorists (MMTers), but others have expressed opinions such as John Carney at CNBC and John Kay at the Financial Times.

A few issues need clear treatment from the outset, because disagreements may be stemming from one or other of the issues without it being clear to both sides in a given instance.

Domestic Value. What I am considering is domestic value of the currency. I take no account of exchange rates between different state monies or potential private monies that are not denominated in the government’s unit of account.

Positive Demand. If at least somebody needs to get hold of the government’s money, there is some demand for the currency, but not necessarily widespread use of the government’s money.

Extent of Use/Demand. In principle, the government’s money could be used for all monetary transactions in a nation or only for some transactions, with alternative monies used at other times.

Role of Taxes

There seems to be disagreement over the significance of taxes. The MMRers appear to acknowledge that taxes play an important role (perhaps necessary?) but argue that they are insufficient to ensure the viability of the government’s money. My interpretation of MMT has been that enforceability of taxes (or fees or some other obligation to the state) is sufficient but not necessary (i.e. that other factors could conceivably be sufficient), even though historically this does not appear to have been the case.

In thinking about the possible necessity and/or sufficiency of tax enforceability in relation to government money, the question that springs to mind is, “necessary and/or sufficient for what?”

I suspect MMRers are thinking in terms of widespread use of the currency whereas MMTers have in mind the minimum requirement for the viability of the government’s money. For this reason, the MMRers stress that there are other factors relevant to the widespread acceptance of the government’s money, whereas MMTers point out that, at minimum, all that is necessary is the introduction and successful enforcement of a lump-sum tax.

The way I see the MMT position is this. Whether or not people think there are great things to be had by trading in the government’s money, that is immaterial to the question of whether the government can create sufficient demand for its currency to transfer resources as desired from the private to public domain. If there is a lump-sum tax, and it is successfully enforced, that will be sufficient. End of story.

That does not mean that the government’s money will be widely used beyond what is necessary to extinguish the tax obligation. Nor does it mean that if the government’s money is widely used, this will be solely due to the enforced tax obligation. MMTers agree that many other factors come into play including convention, convenience, other legal measures (e.g. contract law), and so on.

In the MMT view, it would not ultimately matter if people, having met their tax obligations, transacted in other monies the rest of the time. A reason governments try to restrict people as much as they can to use of the government’s money is that they have introduced consumption and income taxes, which can be avoided by transacting in other monies. However, if governmental attempts to restrict use failed and people largely adopted other monies for private transactions, the matter could be resolved by the government imposing only lump-sum taxes to the extent necessary to transfer the desired resources to the public domain. This, in itself, would be sufficient for viability of the government’s money.

Domestic Value of the Currency

In terms of the (domestic) value of the currency, the MMT position is that it is determined by the scarcity of the government’s money relative to the enforced tax obligation. The government, through its fiscal policy, should keep its money just plentiful enough to facilitate tax payments and any non-government net saving desire in the government’s money.

In a sense, enforced lump-sum taxes determine the minimum scope of the currency. That is, they define the minimum use the non-government could make of the government’s money while still abiding by the tax laws. Provided tax enforcement is successful, the government’s money will be used at least to that extent.

If the government’s money were not used beyond that, and most goods and services were for sale in some other money (or monies), the point of interest for other transactions would be the value of whatever money was in use. This would not impact on the (domestic) value of the government’s money. There would be fluctuations in exchange rates between these different monies, but that would have no bearing on the (domestic) value of the government’s money, which is what matters for dealings in that money.

In other words, lack of access to quality output or resources for sale in the government’s money beyond what was necessary to extinguish the tax obligation would result in the government’s money only circulating in a narrow sphere, but this would not impact on its value within that sphere. Provided that sphere was wide enough to enable the desired transfer of resources – which it would be, provided the lump-sum tax obligation was enforced – viability of the government’s money would be maintained.

Note on Productivity

Having said all that, as long as the government is maintaining the (domestic) value of its currency, there is little reason for the non-government not to opt for it rather than other monies.

This is irrespective of a nation’s level of productivity. The problem declining productivity causes for exchange rates will apply irrespective of the money in use within a nation. Using a money other than the government’s money will not resolve this problem. The difficulty in obtaining a foreign state money for the purposes of purchasing goods not for sale in domestic monies (whether the state money or private monies) will remain. The problem would be low productivity, not domestic value of the currency.

So it seems to me that successful tax enforcement and keeping the currency sufficiently scarce relative to the tax obligation and non-government net saving desire is both sufficient to ensure the viability of the government’s money and in all likelihood conducive to its widespread use, albeit in combination with a wide array of other factors.


64 thoughts on “Ongoing Debate Over Currency Value

  1. Ralph: To all those who think its tax and tax alone that gives money its value

    Who is arguing this?

    The value of money as a tax credit in meeting liabilities to the state guarantees its acceptance in moving resources from private to public use. The contention as I understand it is that this happens to the degree it is necessary to obtain the tax credits needed to preserve one’s freedom and property intact.

    No one I know pays taxes “voluntarily,” and I don’t know anyone who pays more in taxes than required because they are patriot or generous. Virtually no one likes sacrificing purchasing power to transfer resources to pubic use. They do everything they can to preserve purchasing power, by staying on the edge of the law. Some skirt the law, figuring that they either won’t be caught or will pay the fine if they are. Some are willing to take a bigger chance with losing some of their freedom, too, if caught, and we all probably know someone or of someone that did. This is not uncommon. So there has to be an incentive with negative reinforcement to motivate behavior where there is strong resistance. Especially when the positive reinforcement of visible and tangible benefits may be low.

    Without taxation and enforcement, transferring purchasing power away from the private sector would be ineffective because everyone would realize that a lot of others were in avoidance and the incentive would be to avoid instead of being one of the chumps.

    This means that the currency always has the value as a tax credit that government gives it. If taxation is very low, then that value is low in comparison with other factors, and if high the value of the tax credit increases in demand to meet obligations. So the tax obligation has to be sufficient to give the tax credit the value required so that government can move private resources to public use, but not so large as to overly restrict productivity in non-government.

    Most people don’t really appreciate this because currency is relatively abundant. But talk to people that live in a situation where money is not abundant. My wife’s family were farmers during the Great Depression. Money was extremely scarce because farmers only get paid at harvest time. Making the tax payment may involve going into debt. Add that to other necessary expenses and many farmers went bankrupt at that time since they were forced to borrow in greater quantity to maintain themselves than they could eventually service.

    I also know people who spent time as IRS agents. These are very smart people with CPAs. They know every trick in the book and take pride in catching out people that think that they are smarter than the Feds.

    The value of the money wrt purchasing power and changes in relative purchasing power domestically and internationally is determined by a variety of factors, one of which is the government’s price setting power as currency monopolists, e.g., setting the base-line price of money through the overnight rate.

    However, the value of money in terms of purchasing power is determined by what a unit of currency will purchase in the market. Economists are particularly interested in changes in cost of a unit of labor, the cost of a unit of energy, etc. in determining changes in purchasing power.

  2. Tom, et al,

    Can it be said that the interest payment on credit money (that created by the banks) acts in the same, or similar, way

    So because of the ‘peg’ between credit money and fiat money the combination of taxation and debt repayments – all of which can be settled with the state scrip – help drive the money system.

    So you have to pay taxes. You get into to debt to pay the taxes and then you have to pay off the debt while running up more taxes.

  3. Another matter to consider in the MMT paradigm is that taxes don’t fund government, since the state is the monopoly issuer of the currency. Rather, currency injections into non-government are required for non-government to obtain the needed tax credits in the first place. Of course, most people don’t understand this and think that their taxes are funding government expenditure, which is not the case.

    The state creates currency in two ways, 1) through its own direct expenditure and also 2) through the institutional arrangement of public-private partnerships called banks, which are really money-creation franchises sponsored by the state with its currency. Banks create credit money denominated in the currency as unit of account by extending loans — loans create deposits. However, final settlement of all transactions in the economy that don’t take place intrabank simply by adjusting accounts occur through exchange of currency, either as reserves in the interbank system on on the spot through the use of cash. Thus, the state injects currency into non-government indirectly through its “franchises.”

    There must be enough of the medium of exchange available in an economy to facilitate the transactions necessary to consume all production less capital investment including planned inventory. If too little, then unplanned inventory grows and there is economic contraction as firms cut back production. If too much for the economy to expand to meet the increased effective demand, then inflation occurs.

    So the government must balance money provision with economic production by adjusting the amount of vertical money injected by government and horizontal money created by banks with productive capacity. It’s never a matter of getting money from taxes to purchase private goods for public use. Rather it is a matter of ensuring a well-functioning economy from which government can extract the resources it requires for public use from the private sector.

    Government does this through changing its fiscal position by altering injection through expenditure and withdrawal through taxation, as well as regulating its franchises in the financial system through monetary policy and regulation. How government can accomplish this through knowledge of monetary operations, sectoral balances, functional finance and financial sector management is the subject of MMT.

    Thus we see that the business of transferring private resources to public uses is a complicated one, involving the entire economy. And the idea that government taxes to get money to transfer private resources to public use is wrongheaded.

    IN the MMT perspective the notion of taxes wrt state money is simply that taxes create a need to obtain currency to meet obligations that the currency issuer imposes. This establishes the currency as the unit of account in terms of which tax liability is figured, whether the transaction occurs in the currency as medium of exchange or not. For example barter transaction must be converted to the unit of account for tax reporting. This means that the entire economy is denominated and valued in terms of the unit of account.

    Thus, taxation does two things simultaneously. It creates purchasing power for the government’s unit of account that allows government to use its currency to transfer private resources denominated in the unit of account to public use, and it also is a chief factor in allowing government to manage the currency relative to the economy.

  4. Dan, A central bank which acts as lender of last resort is a good way of ameliorating financial crashes and recessions. Agreed. But you could have that in place even where tax formed a minute proportion of GDP.

    Also in a crash, the problem is not that the currency will lose value. If anything, it’s the opposite. That is that too much deflation takes place – in both senses of the word: i.e. too much unemployment and prices falling.

    Neil, Far as I can see you are asking whether money can be underpinned by the interest paid to private banks in the same way as tax underpins the state’s money. Having consulted the few remaining brain cells in my skuIl that haven’t died of old age, my answer is thus. Strikes me that any complex economy requires a form of money, and it will accept any old form of money that looks like it is being competently administered. Absent any form of money, I’d guess a large supermarket chain which issued tokens to be used to purchase its goods would find a big demand for the tokens from people who wanted to buy and sell stuff that nothing to do with the supermarket.

    Argentina and Hong Kong effectively used the US dollar as their currencies for long periods. The “tokens” acceptable for payment of tax do not have to be tokens issued by the government collecting the tax.

  5. Ralph,

    As long as there’s correlation between the domestic needs of the tax collector and the monetary policy of the token issuer it works fine. The problem is it’s only correlation, not coordination. When that correlation breaks down the domestic economy of of the tax collector gets stepped on, as happened to Argentina.

  6. You know, given the current state of affairs, I look back longingly at those days when all a Modern Monetary Theorist or Realist had to look forward to was a nice dust-up with the Austrians!

  7. And on that note, as more of a personal comment about myself, I was on my way to becoming an Austrian until I discovered MMT.

  8. Oliver @8:03am

    I’m not sure who is a “strict” Chartalist. Perhaps Knapp? I’m not sure that splitting hairs b/n “state theory of money” or “theory of state money” is anything more than semantics, but could be wrong.

    At any rate, as far as the “modern” Chartalists go–MMT’ers, that is–our research on the history of money is virtually the same as Graeber’s. Note that Randy edited a book on the history of money a few years back titled “Credit and State Theories of Money.” There’s thus no contradiction in suggesting credit money precedes state money for us–Randy’s written that himself several times.

  9. Scott, Joe,

    Splitting hairs – my favourite past time. Probably because I have none left of my own… And since the difference between the MMT & MMR folks apparently lies within the breadth of half a hair, I agree we should call the whole thing off.

  10. “And since the difference between the MMT & MMR folks apparently lies within the breadth of half a hair, I agree we should call the whole thing off.”

    Let it run its course. Different views are always useful and operating from a different angle may yield something of use.

    Much as I enjoy hearing the MMT economists point of view, they are rather settled on a particular angle, which means some questions have become self-evident truths and axiomatic – rather than being supported by solid argument and evidence. Hardly surprising if you’ve spent a decade or more ploughing a lonely furrow. MMT economists are human too.

    Let the debate continue!

  11. Oliver, I meant my comment here to refer only to the issue of origin. Not to the rest of the issues between MMR and MMT. I think those are really of great significance. Here’s the summary of my series:

    and here’s a postscript:

    The issues are highlighted are very important. The fight over the origin of money is about jockeying for position to gain an advantage in the ideological conflict.

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