Modern Monetary Systems: Understanding the Mechanics of Money and Value
Modern money is a strange thing. To most of us, money appears as something continuously given to landlords and businesses to secure a place to live, food to eat, and all the little parts to make that thing called “a living.” Since a living is made of money-giving, it must be regularly collected — or, to put it another way, money is gathered by people who need to “un-gather” it. For the working majority whose only access to money is to labor under an employer for wages, money is a full-time job and whole lives are revised, re-written, or canceled just to make ends meet, leaving us too little time to ask how a monetary system works — or even what money is.
The Evolution of Money & Currency:
A Brief History of Value, Exchange, Gold, Paper
Somewhere in the mist of prehistory, humans lived with no permanent settlements, agriculture, or industry and each person had identical job-titles as hunter-gatherers. Since everyone produced the same thing, exchange was unnecessary. As farming methods developed, food surpluses allowed people to settle and improve soil-productivity, leading to more complex forms of social, economic, and religious organization. Gradual division of labor took place as specialized labor, skill, and knowledge became professions, crafts, and statuses in social hierarchies and emergent relations of distribution.
Value, Exchange, & Currency
Religious organization developed into governing authority that required tributes to support administrators and soldiers, which required accounting to compare units of quantity, record past transactions, and devise measures of value. Trade-relations formed and questions like ‘how much salt is a shekel of barley worth?’ or ‘is a jar of oil equal to a sack of wool?’ established ratios of equal value between different goods. Widely-accepted commodities came to be used as a medium of exchange or currency. (from the Latin currens, meaning ‘flow or circulation’)
Metal Coinage & the Definition of Money
Cast or engraved to identify weight and purity, metal weights, bars, and rings began to be used as currency during the Bronze Age. While grain and livestock remained useful, metal stored value in relatively small sizes and had an infinite shelf-life, making it particularly handy to long-distance traders. True coins appeared somewhere around 650 B.C., often bearing images of animals, mythic heroes, rulers, or religious symbols.
Grain, cattle, cigarettes, bitcoin — anything can act as currency but money is also a unit of account and store of value. Since coins represent equal values, they act as a unit of account — a 10¢ coin is equal to two 5¢ coins because ‘cents’ are identical units. Both scarce and hard to fake, the intrinsic value of coins tend to be fairly stable and thus a store of value. Issued by the mints of states and empires, coinage — from electrum, bronze, or copper to silver and gold — was one a dominant form of money for the last few thousand years…
Reserves, Paper, & Fiat
Paper money evolved from promissory notes issued by banks for money-deposits that enabled merchants to do business without lugging chests of gold around. Banknotes originally functioned on the same principle as coinage — instead of minting coins for circulation, notes were issued to represent the intrinsic value of metals held in reserves. By the modern era, monetary institutions in most industrialized nations were organized as reserve systems with a central bank authorized by the state to issue the national currency.
Though reserve systems and banknotes had practical advantages over coinage, both of them — paper representing metals and metal money itself — are designed to function on the same basic principle. Modern money, however, is different. Most currencies ditched the gold standard after the US jumped ship in 1971 but these worthless bits of paper, aka ‘fiat money,’ are still pretty good at being money.
But how can this value-less money work?
The State Theory of Money
After observing banknotes’ relation to reserves, Georg Friedrich Knapp proposed that money’s value did not result from any intrinsic value in metals but from the state’s ability to impose taxes. While the idea that money’s value comes from intrinsic value in its material seems to be common sense, it simply never added up to the observable reality and the state theory of money is able to explain why. Metal has intrinsic value on its own, of course — but this value isn’t worth a lot if your taxes must be paid in a different currency and that means the state has the last word about value inside its borders. If the state only accepts taxes in Roman coinage, having tons of gold or Swiss Francs is irrelevant because the options are (A) buy the state’s money, (B) move away, or © spark a protracted people’s war to topple the regime so you can change its legal tender.
The power to issue money has pretty much always been an exclusive privilege of the state and coins were frequently produced to fund the armies needed to expand a state’s borders — ‘money is power,’ as they say. Imperialist states routinely banned coins minted in conquered territories and imposed taxes that could only be paid in imperial coin. To Rome, for example, imposing taxes in its territories meant more coin to pay more armies to conquer more people to loot treasuries to mint more coins and gain more territories to tax and so on ad infinitum.
Modern Monetary Systems & MMT
Under today’s capitalist systems, money plays a larger role in human societies than ever but this greater intimacy with money’s form is contradicted by broad uncertainty about its substance and how it works overall. On a daily basis, nearly everyone handles fiat money and, despite knowing it literally has no intrinsic value, it is accepted as if it were gold itself, which it clearly is not. The root of the confusion, however, is not that fiat is treated like gold but that it is expected to behave like gold — but modern money isn’t gold.
And modern monetary systems do not function the same way that metal trinkets and reserve-backed currencies do…
How Modern Money Works
The first thing to understand is monetary sovereignty — a nation is monetarily sovereign if it has exclusive and unlimited authority to issue its currency. Since fiat money issued by a monetarily sovereign state isn’t fixed to the value of anything else, its government cannot run out of money because it creates money from nothing by spending it into circulation. Full stop. This does not mean the government should spend infinite amounts of its money — but it technically can.
Just as modern money is created from nothing by spending it into circulation, money is destroyed through taxation. The ‘taxpayer dollar’ funds nothing — it is deleted from the money supply, nothing more. Taxes do not fund spending because it is impossible for a monetarily sovereign government to need its citizens’ fiat paper to alter numbers in a spreadsheet. Taxation’s most important function is to generate a base-level of demand for the currency by ensuring those who benefit from participating in the nation’s economic production or commerce must also use some of its currency. Since taxation removes currency from circulation, taxation is also a lever to fine-tune inflation.
Why Balancing the Budget Is a Silly Idea
Spending creates money and taxation destroys it, then spending creates it again. Modern money is like a circuit — money is spent into circulation and taxed back out. A balanced budget means that the amounts entering and exiting are equal. Deficit spending — more money being spent than being taxed — means the non-government, aka the people at large, must gain wealth. A surplus — more money being taxed than spent — means the people at large must lose wealth. If the goal is to create jobs, increase the production of economic value, or develop resources, then a budget surplus is clearly the worst strategy possible and even a balanced budget is unhelpful at best.
Spending deficits are equal to the people’s surplus.
Modern Money vs. Debasement & Devaluation
If a government issues commodity-money, such as gold coins or notes backed by gold, then an increase in quantity by mint or by print will result in debasement or devaluation unless more gold is added. In that case, the government has to either produce or borrow gold or impose new taxes to siphon some money back to its treasury before it can spend without devaluing or debasing it. But modern money — currency issued at a flexible exchange-rate by a monetarily sovereign government — is not the same thing as commodity money. Devaluation happens if a currency’s fixed exchange-rate (its relation to gold or whatever) is lowered by issuing too much of it — but modern money isn’t fixed to gold or anything else.
Spending Modern Money & Inflation
Inflation happens to prices, not money, and it is caused by markets, not by money. Whether the money is gold or paper, if the total that people are spending is more than the total goods and services available to buy, the result is inflation and it happens because demand is greater than what is available. Whatever the currency, spending more money than production can handle will inflate market-prices.
SPENDING IS ULTIMATELY RESTRAINED ONLY
BY THE IDLE LABOR & RESOURCES AVAILABLE
If a government continuously spent money into the system without doing anything else, it would result in inflation because the total economic value in the system is unchanged but with a higher total buying power. One of the cool things about money, however, is that it can convince people to do and make things and it is also able to buy materials and tools that people do and make things with. That means, if idle labor and resources are available, money can be spent without inflation so long as spending activates that idle labor and resources to add economic value to the society.
In other words, there is no reason to fear deficit spending if that spending employs people who were jobless or provides capital to workers to develop its value because, when money and value are added simultaneously, it does not provoke inflation. Public infrastructure projects, universal healthcare, a workers’ self-managed jobs guarantee, and tuition free public universities — programs like these could be tomorrow’s reality.
Knowledge — Not Money — Is Power
Ancient thinkers developed a cosmological model called the Ptolemaic Model — it envisioned earth as the center of a series of nested, interlocking spheres that rotated the sun, stars, and planets across the sky and [spoiler alert] it turned out to be incorrect. Despite being wrong, the model is still a solid way to calculate seasons, motion, speed, and position of planets, and when constellations appear — but new models emerged that did all that and more. Those models took humanity to the moon, not because it was impossible before, but because the old model could not account for its possibility.
The way we are taught to understand money is rooted in an outdated model that developed when virtually all money was metal and this model cannot account for the reality of money today. Money is not gold. The truth is — and always was — that money is a way to distribute access to the actual value of real goods and services and the material forces and resources used to produce them. The fact that the state accepts taxes in fiat paper and enforces its status as legal tender is enough to establish it as the society’s medium of exchange, despite its intrinsic valuelessness. In fact, this worthlessness is what makes modern money more useful than gold ever was — money can be as abundant as it needs to be but gold cannot reflect that.
Most of the time, it has been true that ‘money is power’ but no inanimate object has power until people give it power and forget they did. And knowing that takes its power away and returns it to its original treasury, where the real power always remains.
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