Simplifications and reference to bases are a useful thing to look more clear at what we have today and what we will have tomorrow. There will be a lot of simplifications in this essay, and many themes, aspects, and variables have been missed. But that was the goal, to look again at the nature of things, so that then the details and factors come together, like jigsaw puzzles, into a big picture.
Economics is an exchange between two parties of something useful to both parties. The exchange can be instantaneous and with a delayed return, what in the explanation of the behavior of living organisms is called mutualism and reciprocal altruism. Recall that altruism in reality is the provision of a good with an agreement to return it in the future. How distant that future is, and how much one can trust in the consumer of the good, determines the amount of good provided and the amount of good to be returned.
In fact, it is what in human society is commonly called a favor, and in economics a loan. Money is just a certification of the right to demand the return of the goods provided, i.e., a form of credit verification.
The peculiarity is that the exchange implies an approximate equivalence of the goods exchanged. Since the exchange is not made instantly, but with a delayed return of goods to one of the parties, the money is the very confirmation of the right to return the goods provided of a certain value.
The value of the returned good is usually greater than the value of the received good, because it includes a time premium for deferred return. This premium is the actual basis for the added value and growth in the value of the good. A deferred return allows the one who first received the benefits to produce a greater volume of benefits and to receive a greater benefit, as long as he did not pay too much for this deferred return.
Thus, the claim to return must be secured by goods already produced, the value of which is equivalent to the value of the goods required for return, plus some additional value for deferring return.
But what if suddenly there are more claims than there are corresponding obligations? What if one obligation is suddenly subject to two claims? In other words, an obligation with a value of 1 kg of cucumbers will be claimed with a value of 2 kg of cucumbers? And where can such “additional” claims, which are secured neither by the goods produced nor by the corresponding obligations, come from?
Let’s try to figure it out on our fingers.
According to Ludwig von Mises, money is simply a good that has become monopolistic and consensually recognized as the most convenient to exchange for other goods, given the deferred return of the goods received. This Misesian logic is developed in the codification of money as a certification of the right to demand the return of goods of a certain value. The key word here is return, since one can only return what one has given to someone for a period of time.
Let’s imagine a simplified speculative scenario. You are a baker, and you pick up cucumbers from the greengrocer. In an hour or late at night, the greengrocer will need bread from your bakery, and he will take it in the amount that corresponds to the value of his cucumbers. That is, you, taking cucumbers from the greengrocer, guarantee that for this amount of cucumbers you can give him some appropriate amount of bread.
But since it is inconvenient for you to carry bread with you, you give the seller of the cucumbers $10, which effectively means that the greengrocer gets the right to demand from his side to you to return the value of his cucumbers, only with another commodity, in our case bread. And since you could not give him the bread right away, and will only give it back after some time, the seller of the cucumbers expects a somewhat larger volume of bread than that corresponding to the cucumbers, that is, they expect a premium on the value returned to him – because he has actually loaned you money.
In other words, the greengrocer has given you cucumbers on credit with the expectation of returning their value in bread with a small premium for the use of that credit, that is, for time. The premium, which is the time premium, is important because bread is more valuable to the greengrocer today than tomorrow, which means that the amount of cucumbers he could give for bread now is greater than the amount of cucumbers he would give for bread tomorrow. Accordingly, tomorrow the greengrocer expects a slightly higher amount of bread, which is initially equivalent to the amount of cucumbers he gave you. This surcharge for the deferred return, that is, a temporary premium, is either a markup from the greengrocer today (a smaller amount of cucumbers he will give you for the nominally equivalent amount of bread), or a discount for him from your side tomorrow (a larger amount of bread that you will give the greengrocer for the nominally equivalent amount of cucumbers received).
So, the $10 you give the greengrocer is your obligation to give him the value of the cucumbers with some surplus for deferred return. For the greengrocer, the $10 received is a physical certification of the right to demand the return of the value given to you and the premium for deferred return.
That is, the $10 is simply a physical verification of the loan – a claim to return the loaned value with a premium. As stated earlier, this premium is actually the value added.
So why couldn’t we just negotiate or solve everything without any physical verification, as other living things do, for example, in the exchange of goods? Obviously because human exchanges are voluminous and varied.
First, you cannot physically account for and remember within, say, 24 hours all the verbal commitments you have made and the claim rights you have received, including the premiums you must pay or receive.
Second, you don’t know exactly what needs you will need to close for the values you have received, and on the other hand, you don’t know exactly which creditor will come to you for the return of any value.
Third, you need to have some unified measure of value for all physical goods, so that you understand how much to give back for what. Thus, money is a good unified form of verification of the right to demand the return of a borrowed value.
Value actually depends on two things: on the physical amount of some good, that is, its availability, and on the subjective value of the good to a particular person at a particular moment. In other words, value depends on supply and demand.
Thus prices are formed – the codification of the value of a good depending on its availability – supply and subjective utility – the demand for the goods by a particular individual. Both supply and demand are influenced by a huge number of different factors, but this is not the point.
So, we understand that money is practically a requirement to repay the loan, where the premium for delayed repayment is regulated by the price. The peculiarity is that in a harmonious denomination, all these obligations on the one side and they are the same as claims on the other side are secured by some real goods. Payment for the deferred return of the received value of some good by another good represents the added value. The growth of added value leads to an increase in the number of goods produced and exchanged, and, accordingly, the number of obligations and claims, i.e., money, increases. But this increase must be in accordance with the goods produced, because every obligation and claim implies an exchange of one good for another, that is, the claim is secured by the good produced and the obligation to produce and transfer another good of equivalent value.
That is why Milton Friedman introduced his rule, the essence of which is known to expand the money supply in accordance with productivity with a slight advance. Up to a certain level the excess of claims over liabilities can be a positive multiplier of consumption, productivity and economic growth in general. This excess is the very premium for credit on the part of the greengrocer, who has given the baker cucumbers and time to give the greengrocer an equivalent amount of bread to the value of the cucumbers.
This premium is the basis of value-added and reasonable imbalance-the excess of demand over supply. Nevertheless, this imbalance is based on the goods actually produced on both sides, it is just that the return to one side is delayed for some time, for which that side pays some markup.
In fact, the consuming party gets time, and thus opportunities to produce additional goods. Accordingly, Friedman’s rule actually means that the state needs to increase the volume of claims in line with the increase in the volume of those very markups-and no more.
In order to establish a uniform measure of the value of goods in exchange, money, as a physical instrument of verification of obligations and claims, was assigned a nominal value. Gold was chosen as the face value.
For example, when you buy a kilo of cucumbers, you give 2 kilos of bread for them. But since you can’t give the bread at once, you can give the seller of the cucumbers 2 grams of gold, such as a ring, as a universally accepted value. In fact, this gold is an obligation, or rather a guarantee that you will receive something of equal value in return for what you have given. That is, when the greengrocer comes to you for bread, he will give you 2 grams of gold back and receive his bread for the cucumbers he gave you.
Since it is also inconvenient to carry gold, as a universally accepted measure of the value of any good, this “collateral on credit” was replaced by “paper” claims secured by gold. Thus, the seller of cucumbers provided you with a good – 1 kg of cucumbers – and received for it an obligation to return an equivalent good in the form of money, secured by an appropriate amount of gold for the value of the cucumbers. That is, in essence, the vegetable grower received the same pledge as if you had given him gold directly. In this case, the value of the good is determined by the gold and is represented in the form of a corresponding amount of money.
We have established that the quantity of obligations and claims to fulfill obligations must correspond to the quantity of goods exchanged and goods produced, because obligations are given for the return of a certain amount of goods produced or goods to be produced in the future. In the same way, claims are made for the return of a certain quantity of goods produced or to be produced in the future, corresponding to those which have been transferred. That is, something is lent and something can be borrowed, and money merely certifies a claim or obligation with a universal measure of value by which any good can be measured.
Let me remind you again that the value of a good in exchange includes a discount or surcharge, which is actually the added value received by the lender in the case of a surcharge and given by the borrower in the case of a discount.
Now let’s try to imagine what happens when the volume and value of claims exceeds the volume and value of liabilities? That is, what happens when the volume of money – the physically certified right to receive goods of a certain nominal value – exceeds the volume of liabilities, that is, the physically produced or in the future produced goods that cover the liability? In other words, what happens when one quantity of goods has been transferred in an exchange, but more is required in return (we are not talking about a deferral markup)?
Nominally, it is impossible to satisfy the claim and fulfill the obligation: there are suddenly more claims, but there are no more obligations, because the additional claims are not secured by the corresponding obligations – they simply did not exist!
In our example, a situation arises in which the seller of cucumbers comes to the baker to collect his “cucumber” debt with bread, but now demands to give him not 2 kg of bread, which was equivalent to 1 kg of cucumbers, but 3 kg! But the baker does not have an extra kilogram of bread for the cucumber seller, he has only the 2 kilograms he needs for the exchange and planned… There is a scarcity of goods and inflation, that is, an inorganic increase in the value of goods at the expense of their apparent lack before demands, when unreasonable commitments requirements suddenly became more and their value is correspondingly reduced.
Why could there be more such demands, i.e., money? Perhaps the greengrocer found another claim on the baker, a notional $10, perhaps he stole it, perhaps he was given $10, or perhaps… he bought that claim at a discount from another agent.
At this point the question of state monetary policy arises. The state offers some agents to buy claims on other agents for a certain premium on the value of the claim – what is called the key rate. By lowering this premium, the state stimulates demand in the first place, i.e. it makes it possible to make as many demands as possible, in other words, to consume.
At the same time, the volume of claims ceases to correspond to obligations, i.e., the person who produced and transferred goods worth $100 demands the return of goods worth $200. Unobligated claims are eventually satisfied by new obligations to fulfill them in the future. This creates a leverage that, as it grows, turns into what is popularly called a “credit bubble.
The important question is the extent to which the obligation to return benefits in the future exceeds the ability to fulfill obligations today. After all, the longer the delay in fulfillment of an obligation, the more benefits need to be given in addition to the original ones: the premium rises, which means that the value of the claim must increase, since more benefits will be received for this claim than originally planned.
However, with the scarcity of goods and the increase in the number of demands, the value of demands actually decreases, and inflation is born. There are many demands, and their nominal value (total utility) is growing, and there is not enough goods to satisfy them, so the real value of demands (marginal utility) is falling.
This is an obvious and inevitable process when credit exceeds productive capacity. First, because the demands for the return of goods – money – came out of nowhere: they were not secured by the goods produced and transmitted adequate to them. And second, because there are not enough goods and opportunities to produce them, which leads to the deferral of obligations on new claims. The nominal value of the claim rises, because more goods must be transferred for a longer deferral, while the real value of the claim falls: the longer the term, the greater the risks.
So, unsecured claims increase the desire to satisfy them with goods, but the obligations under these claims cannot be fulfilled on presentation, so they are prolonged, giving rise to a shortage of goods and a decline in the real value of claims, i.e., money.
What does the state actually do by increasing leverage and expanding credit at the expense of a low credit rate? It says: go and demand more goods! But it is impossible to get more goods without producing equivalent goods! The cucumber seller produced and sold 1 kg of cucumbers, but suddenly demands not 2, but 3 kg of bread for them!
So where do these exaggerated demands come from? From the state, namely from those who are hired by society to oversee and arbitrate the process. But now the priorities of those who are supposed to do this are not arbitration, but manipulation. It is the government, i.e., the bureaucracy, that creates additional demands out of nothing and hands them out cheaply.
Why does the government do this? For one purpose only – to ensure itself maximum voter loyalty for today and tomorrow by continually taking benefits from tomorrow. After all, if the greengrocer brings the baker claims for the return value of not one but 2kg of cucumbers, the baker, as already mentioned, will be forced either to give away more bread or to commit to giving away this surplus in the future, and even more, which will be a premium to the creditor for waiting.
Then the baker himself will then be forced to do the same to the dairyman, and the dairyman to the locksmith, and the locksmith to the butcher, etc.
Today and tomorrow everyone will be satisfied: either you will receive more goods than are due, or you will receive an obligation to give them back at some future date, but also in a larger amount. This obligation can also be exchanged for some commodity or other obligation of greater value to you.
In fact, the government thereby creates leverage: it issues an additional claim on an existing obligation. In our example, the transaction obligation is for 1 kg of cucumbers, i.e. $10, and the claim now is for 2 kg of cucumbers, i.e. $20.
The logic is quite flawed, and it is the logic that underlies the credit multiplier: the more demands there are, the more goods will have to be created to meet those demands. So demand is supposed to stimulate supply, and demand itself, in turn, is stimulated by an increase in the number of demands, i.e., money.
However, the day after tomorrow, or in a week, or in some future, the end of this chain comes, and the last demand can no longer be satisfied now or tomorrow, since the obligated cannot resell his obligation, has no way to fulfill it and can no longer prolong its term even further.
There is a process of destruction of normal exchange, and it was launched not now, but exactly at the moment when the seller of the cucumbers had one extra claim, not secured by the good he produced.
Now back to the moment when the state issued additional claims on non-existent liabilities. As we have understood, money is simply the physical certification of a claim for the return of a good of such value for which the claim is issued. The measure of value up to a certain point was gold, and paper money was merely a verification of the amount of gold that corresponded to a certain value. Then, if the state issues more claims than there is gold, this means that the owner of the claim will demand more goods from the obligated person than he originally owed. Hence, there are more paper claims than there are real obligations, and correspondingly more than there is gold to secure its value.
On the one hand, the government was politically motivated to artificially inflate consumption by issuing more and more unsecured claims, that is, by expanding the money supply. On the other hand, the government was unable to ensure the value of money in gold, because the amount of money exceeded the amount of gold.
All in all, this led to the abolition of Bretton Woods, i.e. the de facto bankruptcy of the United States in the 70s. Then it was decided to abandon gold as a nominal means of exchange and a measure of value. Now the state itself secures the value of claims to fulfillment and guarantees the fulfillment of claims, i.e. actually guarantees the purchasing power of money. This, however, is a topic for another essay, which I will explore in other essays.
The claims market, the financial market, is an important part of the economic system in the paradigm of a market economy, an economy of horizontal equal exchange with an advance and a payment for it. This market may be substantial in volume, and claims may have different prices at different times and for different reasons, but the obligations on those claims will in fact still be fulfilled as much as is assumed at face value.
It is another matter that the obligation that will be executed to satisfy that claim may also have different utility to different agents. Accordingly, the price of the claim itself, just as of any other good, is made up of the subjective utility of the claim obligation for a particular agent and the actual supply of those claims. Demands are plentiful – they are cheap, and if a demand obligation is very important to the agent, he will buy it and receive the obligation fulfilled. That is, he will create an added benefit for himself, consisting of the same time premium.
Finally, it must be said that claims, or rather rights to demand the return of benefits, are in a general sense of the same nature – money, debt instruments, and shares. They are either received directly for the goods provided or bought, which is a quasi-direct exchange that turns into a proxy: still I have exchanged one good for another through the exchange of claims, for example I have bought bonds or taken a loan from a bank, which is a purchase of claims.
But the consequences of the state credit expansion also apply to the financial market without exception: inflation in assets, the rise in the value of companies declaring that within 10 years they are unlikely to show positive cash-flow, the huge flow of “stupid money” received for nothing and in the absence of the need for savings, a rigorous assessment of risks and their real productive capacity, etc..
So we see the obvious fact: the expansion of demands for the return of goods over and above those produced or transferred is only possible thanks to the state. This leads to a very large number of various negative consequences and effects on the economy and society, which I will discuss in the following essays. Here I will mention two of them.
The first is a distorted view of wealth. Wealth is not the result of the accumulation of money per se. Wealth is the result of technological development, productive capacity, competitive advantage, sales growth, wage growth corresponding to the productivity growth of goods, etc., etc. The accumulation of money must be secured by the corresponding possibility of exchange, i.e., a good can be exchanged for a good.
And this is what ensures free market exchange, where there are no endogenous injections of liquidity – unsecured money – that exceed the productive capacity of agents. Then nothing is exchanged for good, and this is the way of ever-increasing and prospect-killing crises with increasingly grave social and economic consequences.
The second is the growth of the state as such, which entails an increasing burden on the most productive and competitive agents. They are forced to finance the sprawling government and bureaucracy, as well as their political ambitions of rent-seeking political entrepreneurs, which, as the last 20 years have shown, translate into one and the same thing – unbridled consumerism and state centralization of wealth redistribution.
It is business that ends up paying for all the negative consequences of such government policies. The contraction of business activity under the pressure of inevitable inflation, as a consequence of credit expansion and the exchange of “nothing” for benefits, leads to the need for layoffs and wage cuts, which, in turn, leads to lower incomes. Then the state strengthens social programs or subsidies, but this is done at the expense of increased taxes on business, while credit conditions are also endogenously tightened by the state, and this is another factor in the depression of business.
In conclusion, the most important externality of endogenous credit expansion is this. It is the actual purchase by political entrepreneurs of voter loyalty by increasing consumer power today, but one has to pay for it tomorrow. And the price for this is the compression of individual opportunity, of the competitive market, of entrepreneurial initiative, and finally of freedom. I didn’t even want to mention the geopolitical consequences, but they are obviously very grim.
Look back and then take a sober look at the world you live in today. Remember one thing: it all started with an extra unsecured dollar from the government. And now… “it’s all up to Joe”…
