Short & Simple 11 – Money as an IOU

Money can be thought of as an IOU (“I owe you”). The issuer of an IOU can buy goods or services from anybody who is willing to accept the IOU as payment.

In return, the issuer of the IOU promises to accept it back again in the future as payment for goods or services the issuer provides.

Anybody can attempt to issue an IOU. The difficulty, as the economist Hyman Minsky emphasized, is in getting it accepted.

For example, perhaps your neighbor offers to tend to your garden while you are away on holiday. You write “IOU” on a slip of paper and promise that you will accept the slip of paper back again in payment for a service to be performed on your return. Your neighbor knows and trusts you and so accepts this arrangement. On returning home, you wash your neighbor’s car and mend a fence, accepting back the IOU as payment.

Or, perhaps while you are away, your neighbor talks with a mutual friend who is a good math tutor. The friend agrees to tutor your neighbor’s child and accept your IOU as payment. This can work because the mutual friend knows and trusts you, the issuer, and also trusts that your neighbor would not try to pass off a fake (or counterfeit) IOU. When you return from holidays, the mutual friend asks you to babysit, and you agree to accept back your IOU as payment.

Of course, when dealing with friends or neighbors, we would not usually be so formal. There would be no need to issue physical slips of paper with “IOU” written on them. There would probably just be an understanding that friends or neighbors help each other out with no need for a slip of paper to change hands.

But the example illustrates the idea of money as an IOU. So long as there are people willing to accept the IOU, it can be issued. But the IOU will only circulate within its own circle of acceptance. Outside this circle, the IOU won’t be able to function.

A national currency is the IOU of its issuer. In monetarily sovereign nations, the issuer is government. When government uses the currency to purchase goods and services, it promises to accept back its IOU in payment of obligations to it. These obligations mostly take the form of taxes. Other examples are fees and fines.

A deposit is a bank’s IOU. When a bank issues a loan by simultaneously creating a deposit for the borrower, it is promising to accept back its IOU in the form of loan repayments made from the borrower’s account.

For a nation, we can think of a hierarchy of money, with the most widely accepted IOUs at the top. The government’s currency ranks highest. A little lower are bank deposits, which are a bank’s promise to provide government currency to account holders. Since government usually guarantees deposits up to some limit, bank deposits are “as good as currency” for most purposes and widely accepted. A little below them are deposits held at other financial institutions. Much further down the list might be a chain store’s gift vouchers. These can be transferred from one person to another and are accepted by the chain store as payment for its goods. Still further down are personal IOUs.

In the next two parts of the series, we will look a little more closely at government and bank IOUs, and the relationship between them.

 
Related Post

A little more detail on this topic and an academic citation can be found at the following link:

Money Interpreted as an IOU

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13 thoughts on “Short & Simple 11 – Money as an IOU

  1. Taxes drive currencies. The government acquires the authority to raise taxes by force or by democratic means, in a sovereign currency area; probably a nation state in UN terms. I am unsure who your target audience is Peter; but, can I suggest a short cut.

    “[…] we are concerned with why government “fiat” currency is accepted. The short answer was that “taxes drive money”: since you have a tax liability that must be cleared by delivering the government’s own currency back to the government, you want to obtain government currency. So in that sense, it is the tax liability that drives the desire to obtain government currency.” http://neweconomicperspectives.org/2011/07/response-to-blog-8-more-on-taxes-drive.html

    I will go away now, all the best 😉

  2. acorn: Not sure why you feel you have to go away? It’s up to you of course, but your comments and links are welcome.

    The “short & simple” posts are intended to be at an elementary level. The hope is that no prior knowledge of macroeconomics is strictly necessary to understand them.

    But links in the comments to material of a similar or more advanced level are appropriate as additional reading.

    And comments that go beyond the level of the posts are also fine.

  3. Aphorisms are good — if they are well phrased.

    “Taxes drive currency” may be OK for economists but it is not well-phrased for the public.

    Should be something like taxes create demand for a currency.

  4. Most people up and down my street view taxes as ‘inevitable’ (like death). They acquiesce to paying their taxes because they know what will happen if they don’t; and think ‘well, at best, my taxes might pay for hospitals and roads, a defence force etc’. Still they grumble about Govt. clipping their hard earned cash; and if payment of taxes were voluntary, I don’t know how much would flow towards Govt. accounts. That would be an interesting social experiment. On the street, there is a sense and resentment that the pollies and the rich, cream it off the top (as they do). Taxes ‘driving the currency or creating demand for the currency’ would still be a little esoteric to most of them.

    How to create and present a simple message everyone could understand???? I think it should somehow, directly address and bust the main illusion people have: – ‘your taxes do not fund Govt. Govt. funds Govt. – creating its own money. Govt. spending for the public benefit adds $fuel to the economy, and private taxes control the $flares. It’s all about human beings, their ingenuity, and ability to share’. Followed by the bit about the only constraints are real resources and human potential.

    Maybe I haven’t got this quite right, but I think people could be told quite honestly and simply, and they would understand. Of course the MMT voice is very small and the noise of the experts very large. It takes a lot of effort to unlearn something, and rewire the human brain. But because it is true, it will find its way; especially if the message is focused. Most things can be achieved if you focus!

  5. Have been thinking about this ‘focus’ thing a bit more.

    In judo, the opponent is thrown using their own mass and energy. Maybe Michael Hudson has it right in focusing on rent. Grab the capitalist bull by the horns, and toss him with rent? People on the street think the same thing, about capitalists taking the ‘lions’ share of their efforts? Like rent is this huge head on the bull; and the rest of his body is tiny – imbalance already exists?

  6. One of the best explainers I have found is https://www.youtube.com/watch?v=TDL4c8fMODk MMT needs a marketing campaign as big as any political party would deploy for a general election. How do you defeat four decades of now entrenched Neoliberalism, with its Thatcher / Reagan brand of Monetarism, I have no idea.

    There is a wealth of data that shows how the top 1% has taken a larger and larger share of gross national income (GNI) over those four decades. For instance http://1.bp.blogspot.com/-ugKixEmmLKE/TsJm1C_UAYI/AAAAAAAABQw/-S-El7xxqVs/s1600/british+1+percent.jpg

  7. Yes, excellent video. Thanks, acorn.

    I also want to mention Ellis Winningham’s blog (linked to in the sidebar) and Steve Grumbine of Real Progressives (also linked to in the sidebar). Ellis writes in a very clear and down-to-earth way. The two have a regular show in which they thrash out MMT basics, which can be viewed on facebook and also a little later on YouTube. Steve has also done great interviews with prominent MMTers, including the biggest names.

    I am assuming that everyone here is well aware of the primer by L. Randall Wray at New Economic Perspectives, Warren Mosler’s mandatory readings at The Center of the Universe and billy blog’s debriefing 101 category of posts. Links to these three blogs are also in the sidebar.

  8. Good thoughts, jr.

    Maybe this is mistaken, but I tend to think if somebody actually wants to understand the basics of MMT, they will be able to do so. For instance, who would struggle with the explainer video acorn links to above?

    But a person first has to realize that there is something to understand. There needs to be an awareness that the mainstream narrative is off the mark. As you point out, this is harder than it sounds, because the mainstream authorities have a mighty big trumpet and we don’t.

    If somebody does come to realize that there is something to understand, they still have to want to understand it.

    There seems to be a lot of resistance to the point that, logically, taxes cannot fund the spending of a currency-issuing government. In particular, I think that:

    1. Some want to believe that their tax payments do fund the government;

    2. Others don’t want the government to have the fiscal capacity implied.

    In a previous post, I suggested 1 might be approached by acknowledging that taxpayers do pay something for the activities of government. It’s just they don’t fund the government. In a similar way, customers pay something for the products they purchase in the private marketplace, but they do not fund that production. That requires the business in question to arrange initial finance in order for the production to take place at all (originally possible through private credit creation), just as government spending requires the government to create new government money in the form of reserve balances.

    However, the one or two MMTers who expressed an opinion on this did not like the suggestion, perhaps because any attempt at nuance (if it is that) can be confusing for newcomers. I could be wrong here too, but I do wonder if this is a mistake. For starters, taxpayers (and customers) perform labor in order to obtain the currency. So they pay a lot, in time and sweat. Then with currency they have obtained, they pay their taxes (in return they receive the benefits flowing from government spending) and the prices of products that they purchase in the private marketplace (again in exchange for benefits). They pay. They just don’t fund. At least, that’s how I see it.

    It is also the case that, once at full employment, if we want more government spending, taxes need to be higher to create space for that. This is offset, of course, by the fact that we pay less for privately supplied goods and services. Conversely, if we want more private spending (and, again, we are at full employment), we need to use more of the currency for payments made in the private marketplace, but get to pay lower taxes.

    I’m not sure much can be done in the case of 2.

    On the up side, for a person open to it, I think the most basic aspects of MMT are pretty easy to understand.

  9. The term “fund” is ambiguous.

    Ambiguity can (and will) be used to create confusion. FUD (fear uncertainty and doubt) is a well-honed tactic for creating confusion and the public dislikes confusion. Most people want simple answers — clear, concise and precise.

    Is it a good move to say that taxes don’t fund government when they manifestly do based on accounting (flow of funds report, sources and uses of funds).

    Better to use terms like “pay for” and “afford” than “fund.”

    Think soundbites (aphorisms, memes) that can be delivered in all forms and categories of media.

    “The medium is the message.” Marshall McLuhan.

  10. Interesting point, Tom. The word Stephanie Kelton used in her paper on whether taxes and bonds can finance government spending (she concludes they cannot) was finance, not fund. Not sure why I slipped into using fund. I just checked my earlier post (mentioned above) and it referred to finance, not funding..Does this make it any better, in your view?

  11. I would not use “finance” with the public either.

    Stick with common terms and expressions they understand intuitively, like “taxes do not pay for spending” and “a government that issues its own currency (and doesn’t create obligations in currencies it doesn’t issue itself) faces no spending constraint other than the availability of real resources for sale.”

    Simple and direct is best. No technical or professional jargon.

  12. Yes – someone willing to learn will learn (from a source they trust).

    I don’t know how to broach the reality tv crowd though. MMT as a soapie?

    For me, the ‘parti’ (organising principle – like an axis in architecture) is ‘$money should minister to human need’. And not destroy the planet. So that would be the theme of the soapie.

  13. In trying to think of ways to package MMT, I am reminded of Bernard Woolley’s “Red tape is fun” suggestion in Yes, Minister. 🙂

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