As the nature of the economy changes, the nature of money changes

Let's put history on fast forward. The feudal system dissolved. The trading empires arose, and soon in the great centers of trade like Florence and Genoa banking develops.

Government debt - and bankruptcy - are invented. ( See A History of Florence 1200-1575 for how Florence consolidated its government debt in 1343 and how the "Monte" - mountain of debt - dominated politics for decades.)

Philip II's Spain imports fleets of gold from the new world, squanders it in Habsburg dynastic wars, and then serially defaults on its debt starting in 1557.

The Dutch and then the English strengthen their empires with the invention of central banking, including the Bank of England in 1694, and careful management of a national debt.

Finance strengthens the sinews of war. Or destroys them. Spain disappears as a great power. England's Royal Navy comes to rule the waves.

France impoverishes itself with John Law's Bank disaster. The South Sea bubble causes wild swings of optimism and despair in England in 1720. Bank notes begin to circulate. Stock exchanges begin in coffee houses.

Alexander Hamilton transforms the future of the United States when he does a deal with Thomas Jefferson in 1790. He agrees southern states will get the new national capital, instead of the current location and his own home of New York City. In return Jefferson agrees the federal government will assume state revolutionary war debts and create a national debt. America would not just be a nation of yeoman farmers, as in Jefferson's vision. It would be a financial and industrial and military power. New York City eventually becomes the largest, richest city on the planet, while Washington D.C. remains a small empty southern town right up to the New Deal in the 1930s.

Inflation, sovereign default, credit booms and busts, vast wealth and sudden indigence come and go. Money becomes abstract, related to confidence, sovereign power, property, prudence and ideas of liberty.

The world starts becoming one interlinked, globalized economy. Money turns into an international system, most importantly the gold standard in the 19th century. Major currencies are linked together by strictly maintained values in gold. Movements of gold for settling international payments would inflate or deflate domestic economies, and increasingly causing outrage among farmers and workers. William Cullen Bryant's speech to the Democratic Party Convention in 1896 is the most famous example:

"Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests and the toilers everywhere, we will answer their demand for a gold standard by saying to them: You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold."

But that in a sense is just what happened well into the 1920s and 1930s. The first world war forced countries off the gold standard. The war caused immense inflation, as many governments simply printed money to pay obligations rather than raise taxes. Much of the gold reserves in the world also flowed to the safer USA.

Liaquat Ahamed tells the story in his book Lords of Finance: The Bankers Who Broke the World of how Winton Churchill disastrously put Britain back on the gold standard in 1925. It led to worsening mass unemployment and helped cause the general strike of 1926. Before long the whole world financial and trading system collapsed.


(I will have more to say about this political change later, in reference to Karl Polanyi's bookThe Great Transformation: The Political and Economic Origins of Our Time. Polanyi argues the gold standard soon became politically impossible after democracy meant populations would no longer accept the dislocation of deflation. The current monetary system became socially impossible.)

The interesting thing about the abortive restoration of the gold standard was the conviction among most Treasury officials, central bankers and economists that a return to the gold standard was both practically essential and morally necessary to restore the confidence of savers. ( Of course, inflation did ravage savers for much of the next seventy years.)

The gold standard meant governments could not interfere with or debase the currency. But economic aims alone are no longer sustainable in the twentieth century. The public will not accept the insecurity and volatility and u employment the link to gold apparently brings.

So governments loosen the system, effectively turning it into a dollar standard. Countries settle their accounts in US dollars (or in theory IMF special drawing rights). There is a residual link to gold, but it no longer automatically determines a country's money supply.

The Bretton Woods system of fixed exchange rates, as it is known, remains largely stable for thirty years. This is partly because international financial markets are hobbled. Capital flows are restricted, and exchange controls even apply to ordinary tourists in many countries. There are strict limits on how many pounds sterling a person can exchange for US dollars, for example. Currencies are not fully convertible.

But the Bretton Woods system breaks down in 1971 when Nixon breaks the dollar's link to gold. Currencies float freely, which helps countries adjust to the oil shocks of the 1970s and 1980s. Inflation breaks out. Currencies swing dramatically, despite international efforts like the Plaza accord in 1985.

Soon politicians want to use the monetary system for political ends again. The European Union links the DM, Franc and other currencies into an exchange-rate mechanism. It then evolves into a full-scale currency, the euro, in 1999 and its own banknotes in 2002. China links its currency to the US dollar. It purchases vast amounts of US treasury debt to keep the yuan's value from rising and its exports competitive.

And so to this week, when the euro is tearing itself apart and China is in an unsustainable boom. American consumers are overindebted and underspending. Markets are fragile. People are nervous. The monetary system is at the very heart of the problems.

Our ideas of money and the mechanisms and values money represent can upend society. And so we must be careful to neither stick to an outdated, rigid conception of money, nor allow it to be so flexible that soaring debt, sovereign default and depression are the result.

And here's the real point: our current problems - sovereign debt, recession, economic slowdown - are not just a matter of arithmetic. It is not just a matter of taxes and revenues and spending and credit and demand. It is not just a matter of the size of government.

It is a problem with our conception of money, its functions and limits and boundaries, just as so many times in the past.

As the nature of the economy changes, the nature of money changes. And vice versa.

Money dissolves social ties

Buchan also talks in his book( Frozen Desire: Meaning of Money, below) about how money dissolved the feudal order (p56).

Feudal services have none of the precision of a sale or purchase for money; they might be as specific as a spring campaign or as vague ad loyalty of you or yours until death. Money, which extinguished the sensation of obligation - you may wish to return to the bookshop where you bought this book, but you do not have to - would appear to be fatal to this world of enduring interconnections; and that is indeed what happened. Money gnawed at the foundations of feudalism in Europe from the end of the twelfth century, Japan from the seventeenth , and the Arabian sheikhdoms from the twentieth.

Other social technologies soon evolved to change the nature of money. Buchan talks about the invention, or at least publication of double-entry bookkeeping by Luca Pacioli in 1494. ( It may have been used by Venetian and Genoese merchant houses long before.) It was a rational system of debits and credits, much more sophisticated than simply amassing gold in storehouses. That first system of accountancy eventually led to modern large-scale business accounts and objectives, outside ownership by shareholders, and eventually the foreign trade, national accounts and GDP measures of our own day. Says Buchan,

Above all , Luca laid the foundation of the modern conception of profit, not as some vague increase in possession, but as something hard, even crystalline, mathematical and open to empirical test at any to e whatever through an interlocking system of books.

Even land itself was no longer just land. Much of medieval Europe was owned by great monastic estates and feudal lords tied to the land. Before long the land was mortgaged and alienable property and subject to money rents, culminating in the enclosure of common land in 18th century England.

Money replaces social reciprocity and obligation. It changes the nature of ownership and property.

Money as a tool

We are so surrounded and accustomed to money defining many of the boundaries and choices of our lives, so used to it being the hard edge of reality, that we forget that money has a history and has changed over time.

Indeed, many of the biggest mistakes in the economy in the last three hundred years have been to do with problems or diseases of money, such as inflation or credit bubbles.

All the same, money is perhaps the most powerful social tool that humanity has ever invented. It is a remarkable social technology, as I discussed here.

It enables transactions. It is a store of value. It coordinates extraordinarily complex webs of production, conveying information in the form of changing prices.

It is an impersonal, dispassionate way to allocate and distribute resources to people, to motivate them to do things, a mechanism to give and take away that seems automatic.

And it is entwined in a hundred ways with our social system. In the modern world, it is usually connected to status -although of course in the past merchant classes were looked down upon by an aristocracy whose wealth was in land.

It loosens or dissolves many social ties and changes values. It represents security or freedom or independence.

James Buchan, a former FT correspondent, wrote an unorthodox but beautifully written and original history of money named Frozen Desire: Meaning of Money. He starts by saying

Money, which we hope to see and hold every day, is diabolically hard to comprehend with words.

For money is incarnate desire. Money takes wishes, however vague or trivial or atrocious,and broadcasts them to the world, like the Mayday of a ship in difficulties.

He quotes Aristotle's Politics on the invention of money. Aristotle believed money came into being to bring into being an international division of labor:

When the inhabitants of one country become more dependent on those of another, and they imported what they needed, and exported what they had too much of, money necessarily came into use.

But Aristotle also hated money as wealth or profit, and that was one of the roots of the centuries-long prohibition of usury. Wealth arising from exchange

Is justly censured;for it is unnatural, and a mode by which men gain from each other. The most hated sort, and with the greatest reason, is interest, and not from that or which money was devised. For money came into being for the sake of exchange, but interest makes the money itself greater.

Right from the beginnning, money has evolved in surprising ways that surprise or worry us. And right from the beginning, money has been tangled with many moral convictions that structure it.

Arguing against abundance and Keynes

Here is an alternative view on abundance, by Stephen Moore of the powerful low-tax campaign group Club For Growth. He argues that the Keynesian idea that abundance can be a problem is just not true.

The grand pursuit of economics is to overcome scarcity and increase the production of goods and services. Keynesians believe that the economic problem is abundance: too much production and goods on the shelf and too few consumers. Consumers lined up for blocks to buy things in empty stores in communist Russia, but that never sparked production. In macroeconomics today, there is a fatal disregard for the heroes of the economy: the entrepreneur, the risk-taker, the one who innovates and creates the things we want to buy. "All economic problems are about removing impediments to supply, not demand," Arthur Laffer reminds us.

There is no doubt that lack of goods can , and IS, a huge problem for much of humanity, and that Soviet Russia was a slow-moving economic catastrophe.

Demand is not the issue for me. I am not inclined to defend standard Keynesianism. In the simplistic sense, that is not so much about a problem of abundance as too many goods chasing too little buying power at a point in time. The actual level of income and wealth At at point in time can be very low.

This is obvious if you think about it. Keynes thought there was insufficient demand in the Great Depression. But society was less than quarter as wealthy and abundant as it is today.

Moore is arguing microeconomics works, and the aggregate macroeconomics of demand management has led us astray. But this is still a debate about managing the economy over the cycle, not the long haul. At some point the flows in the economy get dominated by the transformations in the economy, like ice changing to water which later changes to steam.

There are plenty of entrepreneurs who are innovating now not to give us new products to buy, but new products we get for free. This very web hosting service, blogger, is an example. I don't pay Google a cent for it, even if they can make money by using it to sell other services like advertising.

The very fact that so many needs are becoming very cheap relative to income - but some are not - changes the nature of the economy and people's lives.

The reason I keep coming back to Keynes' partially whimsical essay Economic Possibilities for our Grandchildren is because it takes a long range view. What happens when abundance is not the primary problem, but a stage we've already achieved? When many valuable things are given away for free, or drug patents expire, and copyrights time out?

There are clearly no consumers lined up to desperately buy things off empty shelves in the US. But a lot of people in the middle class still struggle with making ends meet in this, the wealthiest and most powerful country in recorded history.

A lot of the problem is that money is an enormously powerful tool, but it also evolves and has its own problems. "Money illusion" is a well-known term in economics, largely about being unable to understand the effects of inflation. But problems of misperception of money go much deeper.

Under the weather

Have a head cold, but reading Lords of Finance: The Bankers Who Broke the World intermittently. Very well written.

Change of pace photo

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Roof tiles on the roof of Casa Batllo in Barcelona, designed by Antonio Gaudi.

Glad I do not live in Harbin

We were just watching one of Anthony Bourdain's fascinating and entertaining food travel shows. In this case, he was in Harbin in Manchuria, China in mid-winter at 25 below. He finds a rich local retired restaurant owner with an entire store of memorabilia from the old American West - and this is someone who had grown up with work gangs in the cultural revolution. The Chinese owner sings Mao-era marching songs with a funk overlay dressed in a cowboy hat. There are expat Russians knocking back vodka shots, and Americans building an entire new ski resort. Where else could you find something as obscure and bizarre and riveting on tv? The world is more weird and various and wonderful than we know.

Not putting Harbin on my list of tourist places to go, though.

Looking forward in the discussion

I am going to want to talk about

• money, as a social technology, coordination device, allocation and wealth, and its effect on social ties and relationships
  
• preferences and how people make mistakes in what they want for the future
  
• happiness, including recent research and whether it can be used as an intermediate aim that can gain wider acceptance
  
• more about cities and what makes them flourish, including Jane Jacob's views.
  
• ownership and property in the age of intangible investment. Who owns capital?
  

I think the answer I am groping towards is that money (and redistribution of money) is a social technology that is marvelous for solving material accumulation and loosening social barriers. But it has limits as a coordination device when the main things we want are not material or easily exchangeable.

Hardening class divisions?

Joel Kotkin writes extensively about the future of cities. He is pessimistic about the lessons of the London riots.

The hardening of class divisions has been building for a generation, first in the West but increasingly in fast-developing countries such as China. The growing chasm between the classes has its roots in globalization, which has taken jobs from blue-collar and now even white-collar employees; technology, which has allowed the fleetest and richest companies and individuals to shift operations at rapid speed to any locale; and the secularization of society, which has undermined the traditional values about work and family that have underpinned grassroots capitalism from its very origins.

Incidentally, Kotkin is not usually one to stress class. The article originally appeared in Forbes.

Walter Russell Mead adds:

Kotkin’s vision of the future is bleak, and highlights the challenges we face going forward. As globalization and new technologies accelerate the pace of destabilizing social change, old solutions to these problems become increasingly obsolete. Nobody yet knows the way forward — least of all established intellectuals, who are mostly still in love with the paradigms of the past.  A return to the blue model ideas of the 1960s is not the answer; neither is a return to the Victorian capitalism of the 1880s.  The 21st century demands something new, and if history is any guide, life will be scary and hard while we blunder our way toward something new.

I couldn't agree more, which is why I am trying to think through some of this on this blog. We have enough material abundance. But something deeper is going wrong.

"The middle classes are boiling with anger"

Thomas Friedman says the global IT revolution is transforming prospects for the middle class, and not for the better.

Why now? It starts with the fact that globalization and the information technology revolution have gone to a whole new level. Thanks to cloud computing, robotics, 3G wireless connectivity, Skype, Facebook, Google, LinkedIn, Twitter, the iPad, and cheap Internet-enabled smartphones, the world has gone from connected to hyper-connected.

This is the single most important trend in the world today. And it is a critical reason why, to get into the middle class now, you have to study harder, work smarter and adapt quicker than ever before. All this technology and globalization are eliminating more and more “routine” work — the sort of work that once sustained a lot of middle-class lifestyles.

"Britain burns the colour of ‘A Clockwork Orange’ "

Good FT article about the London riots here.

"Some of Britain’s urban centres are so atomised that it is now easier to connect with things than with people."

People aren't very good at making choices

One problem with making individual choice the foundation of society is there is increasing recognition that people are not necessarily very good at it - certainly for more complex choices. It is easy to choose which is the cheaper gallon of milk at the supermarket. It is much more difficult to figure out your 401k plan or give up smoking.

One of the most prominent of these new approaches is behavioral economics, which says we have systemic biases and errors in our thinking.

A related - and older - argument, which seems very relevant these days, is the existence of bubbles in markets. We are suffering the aftermath of a vast housing bubble, when millions of people lost all sense of proportion on housing prices.

The history of bubbles goes back hundreds of years - for example, see the classic Extraordinary Popular Delusions and The Madness of Crowds. One of the best works in economics on the subject is Charles Kindleburger's Manias, Panics, and Crashes: A History of Financial Crises (Wiley Investment Classics).

Far from being rational choosers, we are often swept up in the mood of the moment.

It is important to say this does not justify authoritarian choices by experts on other people's behalf. The experts are generally little better at making choices. But it does mean we have to work with what we have got, what Kant called "the crooked timber of humanity", rather than imagine people are better at making choices than they actually are.

What does it mean to be a "liberal"?

Coincidentally, an article about what liberalism is today in the Guardian, which is relatively fair.

I very much agree with one thing it argues - that liberalism is so much part of the mental furniture of the western world it is almost the condition of modernity. In the US, "liberal" is now mostly synonymous with "leftwing".

But the most fierce free-marketers are also liberals, from an older strand of classical liberalism. Contrast monarchy, aristocracy, tyranny, communism and the other very different frameworks that most people have lived in for all of recorded history. Compared with them, it is easier to see most Democrats and Republicans as coming from the same broad political tradition.

The Guardian article argues that liberalism is in essence the ideology of the rise of capitalism, and especially the rise of the middle class.

It is very difficult for anyone raised in the English-speaking world to think outside liberalism of one form or another. It seems intuitively obvious to us.

Economics gets most of its disciplinary architecture from that older strand of liberalism - rational choice and optimization, revealed preferences and utility.

The common ground of liberalism is really individual choice - and little interest in the actual aims and preferences people have, the actual choices they make and whether they are able to get what they want. People are assumed to have the foresight and ability to make heir own choices and choose their own purposes.

Liberalism does not really have a good answer for what the common good is, beyond largely procedural "fairness."

What is "fair?"

There is also a famous critique of Rawls-type liberalism in Robert Nozick's Anarchy, State, and Utopia, which is in essence a libertarian text - but also a keystone of political theory in recent decades.

Nozick says you cannot assess justice or fairness by looking at a society in a "time-slice"- the situation at a single point on time, regardless of how that came to be historically.

He gives an example of Wilt Chamberlain, a famous basketball player at the time. Suppose everybody in society starts equal. But it turns out a lot of people are willing to pay a dollar to see Wilt Chamberlain play basketball. They choose to do so voluntarily and with some enthusiasm.

Before long, Chamberlain is much wealthier than anyone else - and all because of people's free choices. Nozick asks in what way is this unjust or unfair? In this case equality at a point in time is not necessarily "fair" or unfair. It depends among other things on what has already happened. Our actual history matters. Rawl's original position does not work.

In real life, of course, we do not start equal. But even in its own terms, "fairness" is often controversial.

Maybe we need to think more about what people actually want in practice, rather than thinking about procedural justice alone.

Rules aren't why we play the game

This, then, is the problem with liberal political theory. It tries to set rules for the game. But there is no point, or meaning, to playing the game in the first place.

"Fairness" is essential to a game of football. Without fair application of the rules, it is difficult to play the game.

But why play the game at all?

Crossing boundaries

I am surprising myself a little. I started off with very much an economics focus, thinking about deeper changes in the economy. But I find myself bringing in more and more political and ethical theory.

Procedural fairness alone can be deeply empty

I was talking here about liberalism, in the classical theoretical sense, taking a wrong turn.

For the broad mainstream of liberalism, the whole point is to eliminate consideration of purpose or ends. Ends are seen as incommensurate, a matter of individual choice alone. They are a "do your own thing" matter rather than an commonly agreed values or goals.

And of course it is a commendable vision. The roots of much of our enlightenment, and later the origin of liberal thinking lie in the Thirty Years War in the seventeenth century, as the wars of religion devastated northern Europe. A large fraction of the population of Germany was killed. No wonder there was a legacy of distrust for fighting over creed or religion or opinion. Better leave people to decide their own ultimate truths and purposes than destroy countless cities and lay waste the countryside.

And I have deep sympathy for Isaiah Berlin's warnings against utopian thinking, as in Liberty: Incorporating Four Essays on Liberty - perfect consistent worlds which end up killing millions.

But liberalism has ended up in a dead end, fixated on process and procedure, to the exclusion of all ends - perhaps save alone for the left a residual hankering after equality.

Take the famous "original position", in the seminal work of liberal political theory in the last fifty years, John Rawls A Theory of Justice: Original Edition. It strips away all individuality and purpose. You choose the form of society before you know what position you will occupy in it. You have no history, no personality, no identity.

That "fairness" - procedural fairness - matters more than substantive individual or substantive societies or substantive purpose. The only real purpose is maximin calculation - you are likely to be better off if there is some measure of equality. Inequality is only permitted to raise the level of the least well-off by allowing markets and incentives to work.

In choosing to allow for any purpose we often in effect choose no purpose.

There needs to be some halfway house between ultimate incommensurable ends and contemporary liberalism's legalistic procedural thinness. There is a long history of other aims, such as virtue, honor, happiness.

Change of pace photo

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Jamaica Bay Wildlife Refuge, about an hour from midtown on the A train. There are a lot of varied landscapes in a small area.

Time and bandwidth

A rainy day in New Yok City. We spent a sunlit yesterday at Jamaica Bay Wildlife Refuge, near JFK, part of what the city parks department calls its "emerald empire." It is a timeless oasis of salt marsh and reeds and sand and birds' nesting areas .. all with the skyscrapers of midtown distantly visible.

It always seems to take a day or two for my brain to absorb and decompress after a kaleidoscopic week. You can get overstimulated, too much to process, too much to know or understand or deal with.

This week was extra frenetic, with huge market volatility and historic disorder in London.

People only have limited bandwidth, I think. There is only so much you can drink from the firehouse of stimulation and information and sensation before needing some downtime - if only for a few hours. Sometimes you have the mental energy to get to grips with something complex and new. Sometimes you want to just stare into space or meander on the Internet. Or have a glass of wine and play music.

We are amazingly fortunate to have all the stimlus of the city, and our apartment loaded down with books, and ten thousand movies to stream on Netflix, and infinite knowledge on the internet, and MOMA and the Met a short ride away.

But there is a limit to what anyone can individually consume of these jewels. Time and energy are inherently limited resources, in a way money in the bank or possessions are not. Bill Gates still has just 24 hours in the day. But they move faster and faster.

There are limits to what we can see or know or experience. We can never see or do more than a fraction of a fraction of what is out there. If material goods - at least those not at the Tiffany necklace level - are not scarce, time is still scarce. And to consume many of the more advanced products of our culture, some of the main advantages of "leisure", you need time. And energy.

Some deal with it by knowing only about their niche or speciality or career perch. That seems a pity.