Thursday, December 20, 2012

What's money worth to you?

Brad DeLong has a fun post, on one level inside baseball, but with some more accessible macro content. On the surface he's disagreeing with Noah Smith over Smith's disagreement with DeLong's assessment that the state of macro is wrong. But DeLong's way of making his case is to pile up instances of Stephen Williamson writing things that, to me, look pretty silly.

Among the wreckage is a passage from Williamson about bubbles, in which he mentions that "Money, for example, is a pure bubble, as its fundamental [value] is zero." DeLong is justified in taking this down, but I think he makes an interesting error along the way.

Williamson starts by talking about how you would determine if something were a bubble: you figure out the fundamental value of an asset, based on its future payoffs, then look at the current market price of the asset; if there's space between the market price and the fundamental value, you've got a bubble. And at the end, he throws in his line about money's fundamental value being zero.

The essence of DeLong's reply is that money certainly does have value, because of what it is "a substitute for trust":

In the absence of money, you can transact only with people with whom (a) you have an (unlikely) double coincidence of wants, or (b) you have an ongoing non-economic relationship that enables you to trust each other to make your credit good. In the presence of money, you can transact with damn near everybody. This increase in the scope of potential market transaction partners is immensely valuable. This is the service flow that money provides. This gives it "fundamental value". Positive value of an asset that paid no dividends or coupons in any state of the world and that did not enlarge the scope of those you could transact with would be a bubble. Positive value of money is not a bubble.
This is where I think DeLong goes astray, in an interesting way that misses what's truly fundamental about money in a different sense.

Why am I willing to give something up to get a house? Most of it, for most people, is the use value: I want to own that house, because I want to live in those rooms, with that yard, on that street, ... A piece of it is not its use value to you, but your guess of its future exchange value: I want to own that house because I think someone else will pay me for it later. This is where we get the possibility of a bubble.

Let's say my use value of a given house is $200,000, but I think someone else will pay $300,000 for it in a year. Then I might be quite willing to pay $250,000 for it now. The key question is why they'll be willing to pay $300 grand. I may expect incomes to be rising, or some change to happen in the neighborhood that will increase people's interest in living there. If it's something like that, then there's no bubble. My expectations could be wrong, but I'm basing my willingness to pay for the house on an expectation of someone's future use value, even if it's not my future use value.

It's a different story if I expect someone to be willing to pay $300 grand, because I expect that they'll expect someone else to be willing to pay $400 grand, and that person in turn will think someone else will pay $500,000, ... It's a bubble because it's not grounded in anyone's interest in the house itself, only in an infintie regress of ability to hand it off to someone else.

What about money? Why am I willing to give something up to get it? Why will I hand over my house, or my time, in exchange for money? I'm willing to give up something real and accept money in return because I'm confident that someone else will give me something real, and take the money off my hands. That's it.

Inspect yourself. When you agree to take a job, or sell a product, what's your motivation for giving up something real and taking money in return? Is it becuase of the "service flow" that money provides? Is it because you recognize that barter is a worse situation? No. It's because you have a reasonably accurate assessment of what you can buy with, say $50,000, or $20,000, and you think that that basket of goods is: a) worth the time you're giving up to get it; and/or b) better than any real alternative you're aware of.

In other words, we give up real things in exchange for money, solely because we think that someone else will give up real things in exchange for money. And I suspect DeLong is disturbed by this, because once you put it that way, it seems like it's no different than a housing bubble: I'm willing to give something up to get money (a house), not because the money (the house) is useful to me in itself, but only because someone else will accept the money (the house) in exchange for something I do actually want. Which implies that money is a bubble, which in turn implies that we'd have to agree with Williamson.

So DeLong has to construct an argument in which money is useful in itself, so that it won't be a bubble. And here's the error. The institution of money is useful to society as a whole, for exactly the reasons DeLong discusses; for all our sayings about the evils of money, we really would be worse off in a society that didn't have a well-functioning money system. And so we each of us individually benefits from the existence of money. But that's not why I agree to be paid in money, rather than food, airline tickets, gas, and free housing. In fact, the causality is quite the opposite. We're able to have a functional money system because people accept money in exchange for real things, and people accept money in exchange for real things because they're confident that everyone else will accept money for real things. The institution of money is able to exist (and be useful) because of the underlying behavior, rather than the underlying behavior happening because the institution is useful.

Money is, in essence, a socially accepted, never-ending chain of promises. And if we get vertigo from staring into that infinite regress, we can draw on a little chartalism, because that draws on the one promise that has the force of the state behind it. The state's power to tax is the power to place an obligation on you. The state's promise is that it will release you from that obligation if you hand over a certain amount of the state-approved money. It seems plausible to me that this quite specific promise is enough to support the whole network of vague promises that we make to each other in accepting money on a daily basis; once the thing is up and running, its own momentum keeps it going.

So DeLong is absolutely right that the positive value of money is not a bubble. But he tries to make his point by arguing that money is just like everything else, whereas I think the real reason it's not a bubble is exactly because it's different from everything else.

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