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Embarrassed by confused terminology

Aug 23 2016 15:40
Edward Ingram

THIS essay is not for the general reader, but for economists and bankers.

Everyone makes mistakes. If you don't make mistakes, it is because you are not doing anything.

My friend Redge Nkosi* has pointed out my latest mistake: the incorrect use of some banking terminology in my last essay but one.

For a very long time now, I have settled upon a key principle for the banking and currency sectors. It is based upon Adam Smith's point, well made, that free markets and free market pricing is good for the economy in a number of specific ways.

Among those ways is that in the absence of free markets and free pricing, we get distorted prices. Prices include asset values, incomes/earnings, interest rates, currencies, and all goods and services.

As J M Keynes pointed out in the first paragraph of his A Tract on Monetary Reform, if all prices are free to adjust to the falling value of money people would be wholly unaffected by that. Incomes and prices would all adjust for that as well as to everything else.

If money did not fall in value all prices would only adjust to everything else, including supply and demand, fashion, innovations, etc. If they also adjust for the falling value of money, then ALL of those prices would be higher than they otherwise would have been.

THE TASK OF MACRO-ECONOMIC DESIGN AND MANAGEMENT

Our task at the macro-economic design group is to lobby governments to ensure that we do have free market prices on the value of money aspect. Any prices which cannot, or are not allowed to, adjust in such a model way are issues to be looked into. All prices (incomes included) should be that much higher than they otherwise would be after money has fallen in value. That is the test to pass.

Interest rates are one of those prices. It follows that we need a free market in capital and credit so that the interest rate is free.

Our proposed new model for the economy would have this free market in credit. I believe that the level of competition in the lending and capital market sectors would then significantly increase. In my model, no lender would be too big to fail, reserve requirements would fall significantly, and deposits would be guaranteed by the Money Supply Authority (MSA) - the sovereign money creator.

MY APOLOGY

My apology is for using the incorrect (not generally accepted) meaning for base money  in my last but one essay; and also for fiat money. Both of these terms have wider/different uses than I have allocated to them.

In my model for the economies of nations, I need a term for permanent money which is made up of notes and coins and electronically 'printed' money. I have been calling that 'base money' which includes notes and coins, but there are other kinds of base money which I have ignored.

In my model, all of the more or less permanent money, put into circulation, would be created and issued by the MSA. Currently this could be done by central banks. They can incorporate the MSA as a department. Again, the issue is that central banks have a number of roles. I want to refer to this one specific role, so I need the term 'MSA' for that.

In my model a term is also needed for what I have been calling 'fiat money', by which I mean money not necessarily created by banks for lending, but in fact necessarily created by the MSA and by no other agency for lending, so that its quantity can at last be tightly controlled.

In both cases, the money of both kinds would be placed into the economy by the MSA and not necessarily given directly to the banks or to the government.

How the new money gets distributed is very important. There is another principle to observe - not interfering with established spending patterns when distributing new money of either kind, or failing to create enough of each so as to keep spending patterns balanced.

Another principle is to ensure that there is enough money in circulation, and ideally a bit too much rather than too little. Too little adds costs and delays, which slow the economy.

A little too much money is not a big problem because, as stated earlier, we will have addressed the pricing problems relating to the falling value of money already. That is if we get on with the task and do it.

Thinking through how that can be done is a major part of the macro-economic design syllabus.

Reforms are needed to all lending and savings contracts to adjust the value within the contracts for the falling value of money. Doing that takes out most of the confusing instability problems confronting policy-makers today. Almost all of the conflicting monetary policy signals will be removed. Simplification is the name of the game.

Reforms are also needed to the way the currency markets are structured.

In the currency markets we need one market for one price and we need two prices. We need a price for international trade and a price for international capital. We also need ways to limit arbitrage without slowing the exchange of money. Something else to think through.

COST SAVINGS

It can be shown that any deviation from any of these principles has a cost to the economy and also a social cost - people will lose homes, businesses, international trade, savings, and so forth. All will be hit through no fault of their own.

Politically this mayhem creates platforms for extreme governments that have little clue about what reforms may be needed.

* Redge Nkosi founded Firstsource Money in South Africa, now an affiliate of Positive Money in the UK. I am honoured to have been invited to work with him and sincerely hope that my terminological errors have not unduly embarrassed him.

 - Edward Ingram is a leading thinker on the world stage of  macro-economic design and has written a series of essays for Fin24. Views expressed are his own.

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