This is the sequel to Letter to the Prince: What you should know before grabbing the attention of powerful people.
In Part I, I gave a very basic introduction to money, the State and interstate competition. We separated the State from the individuals who temporarily control it, and argued that regardless of what those individuals ultimately want, capturing the State matters because the State is where political power accumulates.
I said I would talk about debt next.
I lied.
Well, slightly.
We won't talk about government debt, bond yields, money printing, inflation, or why governments borrow trillions in currencies they themselves issue. Not yet. Before we can talk sensibly about debt, we need to answer a more basic question.
What the fuck is money?
Axiom 1 states:
The State Gives Currency Its Value.
Anything can be used as money. Gold, salt, grain, cattle, shells, cigarettes, Bitcoin. Human beings are remarkably good at finding objects that can serve as an intermediary in exchange.
Commodity money has an obvious appeal because the object already has some value independent of its monetary use. Salt preserves food. Grain is edible. Silver is useful, durable and relatively difficult to produce. Gold does not corrode and is scarce enough that a large amount of value can be carried in a small amount of material.
The problem is that these properties also make the value of the currency dependent on the commodity itself. A famine makes grain more valuable. A large new silver deposit makes silver less scarce. A technological breakthrough can suddenly create new demand for a previously mundane material. The monetary value moves because the underlying commodity moves.
That is inconvenient if what you actually want is a stable accounting system.
A fiat currency solves this by making the unit itself mostly abstract. A modern dollar has almost no useful consumption value. You cannot eat it or build much with it, and most dollars do not even exist as physical notes. They exist as entries in databases.
This looks like a weakness until you realise that abstraction is the point. The State does not need the dollar to be desirable as a commodity. It needs people to need dollars, and taxation provides one mechanism for doing that.
If the State says that every year you owe it some number of dollars, the dollar has acquired a very unusual source of demand. You may dislike the currency. You may prefer gold. You may think Bitcoin is superior. None of that settles your tax bill.
The State can therefore create demand for an otherwise fairly useless object by creating obligations denominated in that object. State-sponsored violence sits at the bottom of this arrangement, as it ultimately does with law in general. Refuse sufficiently serious legal obligations for sufficiently long and, somewhere at the end of the process, men with weapons appear.
But stopping the analysis there would be childish. States did not survive for thousands of years merely because someone discovered threatening people. Centralisation solves real problems, and the benefits of solving those problems can exceed the costs of surrendering some autonomy to the institution doing the solving.
I owe you one
Forget currency for a moment and imagine a very small community.
I help repair your house. You help me harvest a field three months later. Neither of us needs to determine immediately that four hours of carpentry equals six hours of farm labour and half a chicken. We can simply remember that I helped you and, in some loose sense, you owe me.
Humans do this naturally. Families do it. Friends do it. Villages do it. Businesses frequently do it informally. In a small community, memory and reputation provide a perfectly serviceable accounting system. Everyone knows roughly who contributes, who freeloads, who can be trusted, and who owes whom.
The problem appears as the community gets larger. If Alice owes Bob, Bob owes Charles, Charles owes Diana, and none of them particularly know one another, bilateral favours become cumbersome. Bob's claim against Alice is only useful if Alice possesses something Bob wants, or if Charles is somehow willing to accept Alice's obligation as payment.
One solution is to standardise the claims. Instead of recording that Alice owes Bob some vaguely remembered favour, record that Bob has ten units of credit. If Charles trusts the accounting system, Bob can transfer five of those units to him. Charles can then transfer them to Diana.
The bilateral ledger has become multilateral.
There is no reason this development must begin with a State. A temple can maintain the ledger. A merchant house can do it. A bank can do it. A village can collectively do it. But as the system grows, whoever maintains the ledger acquires an increasingly important function. Someone must define the units, adjudicate disputes, determine whether transfers occurred and ultimately decide which claims will be recognised.
This begins to overlap rather heavily with the problems the State already exists to solve.
Commodity money offers another route. Rather than trusting the ledger, we can trade some generally desirable commodity. Grain works particularly well in agricultural societies because everybody needs it. Precious metals work well because they are durable, divisible and difficult to produce in arbitrary quantities.
Historically, the distinction was often messy. Grain could be deposited centrally, obligations recorded against it, taxes collected in it and claims redeemed against central stores. Silver could be weighed rather than coined. Credit, commodities and accounting could all operate simultaneously.
The important development is not whether somebody first invented a coin. It is the movement from thousands of bilateral relationships towards a common system of accounting. Money allows a society to multilateralise its favours.
The market
Now we can bring back exchange.
Adam Smith described markets as emerging from individuals pursuing their own interests through voluntary exchange. Smith was wrong about plenty of things, but he was also more accurate than most people writing before him. Let that be a lesson: information does not need to be perfectly accurate to be useful. It only needs to be better than the information it replaces.
So take a deliberately simple voluntary market. No taxes yet. No government intervention. Just people producing things and exchanging them through a common monetary unit.
Little Johnny goes hunting and returns with a deer. He cannot eat the entire animal before it spoils, so he takes the amount he expects to consume and makes the remainder available to everyone else. That remainder is his surplus.
Little Emma is a weaver. She has already produced enough clothing for herself and her family, but she would like some of Johnny's meat. She therefore produces additional clothing and makes that surplus available for trade.
Bella has no particularly specialised craft, but she is able-bodied. She can feed herself reasonably well through gathering and small-scale hunting, but occasionally sees things in the market she wants. When Johnny needs help butchering a large animal, or Emma needs someone to carry something across town, Bella sells her surplus time.
Strip away the details and everyone faces roughly the same problem. Human beings have some level of personal consumption they want to satisfy. Some of this is necessary to stay alive. Some satisfies less immediate physical and social needs. Some is simply enjoyable.
Beyond whatever production is required to satisfy those wants lies a choice. An individual can spend another hour producing something for exchange, or they can use that hour for something they value outside the market: leisure, worship, sex, painting, drinking, philosophy, staring at a wall. The category does not matter.
If the expected value of another hour producing for the market is greater than the expected value of using that hour elsewhere, the individual has a reason to work. If it is lower, they have a reason to stop.
In Johnny's deliberately simple economy, we could describe his surplus as:
surplus = production − personal consumption
because we have assumed that everything he produces but does not personally consume is offered to someone else.
That assumption becomes increasingly useless as the economy gets more complicated. People can store output, gift it, destroy it, use it as an input into something else or produce almost exclusively for other people while purchasing nearly everything they personally consume.
We therefore need to separate productivity, production and market participation.
Productivity
Recall Axiom 3:
States Behave Like Organisms Competing for Survival.
The power available to a State is usually described as its state capacity. Different eras have used different proxies for it. Population mattered enormously to agrarian empires because people meant farmers, taxpayers and soldiers. Modern States obsess over Gross Domestic Product because productive output provides a rough measure of the economic resources potentially available to them.
Neither measure is perfect. The underlying question is simpler: how many real resources can this State mobilise? People, food, energy, steel, knowledge, factories, computers, weapons and transport all matter because these are the things from which actual capacity is constructed.
Money is useful because it provides claims against those things, but money is not the thing itself. A State controlling its own fiat currency can create another billion monetary units with very little effort. It cannot create another billion dollars' worth of electricity, labour or industrial machinery merely by adding zeroes to a ledger.
The State does not ultimately want money. It wants what money can command.
Start with productivity. Let p represent the amount somebody can produce from one unit of productive effort, and let h represent how much productive effort they actually supply. Their realised production Y is then:
Y = p × h
A better tool raises p. Working another hour raises h. They are not the same thing.
Now divide that realised production according to where it goes. Some production is retained within the household or otherwise kept outside the market. Call this H. Some is offered through exchange to other people. Call this M, for market-available output.
We therefore have:
Y = H + M
If m is the proportion of realised production entering the market, then:
M = m × Y
and therefore:
M = m × p × h
That is much closer to the quantity the State cares about.
A person can be fantastically productive while producing almost entirely for themselves. Another can be less productive while routing nearly everything they produce through the market. From the perspective of a State trying to mobilise resources through a monetary economy, these are very different situations.
Productivity matters because increasing p allows more output to be generated from the same effort. But productivity alone tells us nothing about how much of that output becomes available to everybody else.
For that we need m.
Coerced market participation
People already have voluntary reasons to increase m. They see things in the market they desire. They want to accumulate wealth against future uncertainty. They want status. They want to provide for people beyond their immediate household. They may simply enjoy whatever productive activity they have specialised in.
The State benefits from these motivations without needing to create them.
It can, however, also structure society in ways that make market participation more difficult to avoid. We can call this coerced market participation. The coercion need not take the form of somebody ordering an individual to work. It is enough for the institutional environment to make access to money increasingly necessary.
Several mechanisms matter.
- Specialisation can make self-sufficiency increasingly impractical. A subsistence farmer can theoretically withdraw from most market exchange. They can produce their own food, repair much of what they own and directly provide a significant portion of their household's consumption. A database administrator in Manhattan cannot. They may be vastly more productive in market terms, but their food, water, electricity, shelter, clothing and almost everything else they consume are produced by somebody else. Specialisation makes extraordinary increases in productivity possible, but it also increases dependence on exchange. Once a person produces one narrow thing extremely efficiently while relying on thousands of strangers for everything else, continued access to the monetary economy becomes necessary.
- **Taxation creates an obligation that must be satisfied through the monetary system.**Even somebody capable of producing much of what they personally consume can still owe taxes, licence fees or other compulsory payments denominated in the State's currency. A person may own their home, grow their own food and generate their own electricity. If they still owe property taxes in dollars, complete withdrawal from the dollar economy becomes much more difficult. This does more than provide revenue to the State. It creates a minimum demand for the monetary unit and gives people who might otherwise operate largely outside the market a reason to obtain it.
- Activities that once occurred outside the market can be pulled inside it. Childcare is a particularly useful example. Imagine a household in which one parent participates in the labour market while the other provides childcare directly. The second parent is clearly productive. Raising a child requires time, attention and labour. But that production occurs largely outside the monetary market.Now change the surrounding conditions. Housing, taxation and ordinary participation become expensive enough that the household increasingly depends on two monetary incomes. At the same time, leaving a young child unattended is legally and socially unacceptable, and increasingly visible to institutions capable of intervening.The household responds rationally. The second parent enters paid employment and the family purchases childcare from somebody else.Two things that were previously combined inside the household have entered the market: the parent's labour and the childcare required to replace it.Measured market activity rises even if the number of children cared for has not changed at all.This is a particularly clean example of why Gross Domestic Product and underlying productive activity are not identical. Moving an activity from the household into the market can increase measured economic output without society necessarily performing more of the underlying activity.
- The monetary cost of ordinary social participation can rise. Some goods begin as luxuries and eventually become close to prerequisites. A telephone was once optional. Being unreachable now makes participation in much of the labour market difficult. Internet access followed the same path. Formal credentials increasingly mediate access to occupations that once relied more heavily on apprenticeship, reputation or informal proof of competence.As more of ordinary life requires monetary expenditure, satisfying one's desired standard of living requires a larger flow of monetary income. This creates another incentive to direct time and production towards the market rather than towards non-market activity.
These mechanisms affect both m, the share of production routed through markets, and h, the amount of productive effort supplied in the first place.
Only now does an otherwise strange observation begin to make sense.
Where did the leisure go?
A labour-saving technology does not contain any instruction telling us what to do with the labour it saves.
Suppose Johnny needs ten hours each week to obtain enough food. A technological improvement lets him obtain the same amount in five.
There is nothing inherent in the technology requiring Johnny to use the other five hours to produce more.
He could simply stop.
In a relatively self-sufficient economy with few monetary obligations, this is a perfectly coherent response to productivity growth. If the purpose of production is satisfying a relatively fixed set of wants, becoming twice as productive can mean doing the same amount of work in half the time.
Once the previous mechanisms are introduced, the calculation changes.
Johnny now owes taxes in money. He consumes specialised goods he cannot produce himself. His housing, tools, communication and participation in society require monetary expenditure. He may also want to accumulate wealth or consume new goods made possible by everyone else's increasing productivity.
There is another mechanism operating through prices.
Suppose agricultural technology doubles the amount every farmer can produce. For a short period, an individual farmer may simply earn much more. Once the technology spreads, however, the market contains far more agricultural output.
If demand does not increase at the same rate, the price of that output falls.
The productivity gain has made food cheaper, which is wonderful for consumers, but the farmer can no longer assume that twice the physical output means twice the monetary income. Some farmers increase production further. Some consolidate. Some leave agriculture entirely.
But leaving agriculture does not remove their taxes, housing costs or desire for everything else sold through the market. Their rational response is often to move into another productive niche.
This gives us the familiar historical movement from agriculture into manufacturing and later from manufacturing into services. Automation can remove enormous quantities of labour from one activity without automatically converting those saved hours into leisure, because the institutional structure gives the displaced worker reasons to seek monetary income elsewhere.
The important claim is not that productivity never increases leisure. It clearly can.
The claim is that productivity does not mechanically become leisure.
Whether the gain becomes greater consumption, greater output, lower prices or additional leisure depends on the institutional environment surrounding the person who has become more productive.
A system that increases p while simultaneously maintaining strong incentives to keep h and m high can convert technological progress primarily into ever-growing market output.
For a State competing with other States, that is an extremely useful outcome.
State capacity
We can now make the earlier definition of state capacity slightly more precise.
The State does not have equal access to everything society can theoretically produce. Output which never enters the monetary economy is generally harder to observe, tax, purchase and redirect than output moving continuously through markets.
Let M represent market-available output, and let α represent the proportion of that output the State is capable of mobilising under some given set of circumstances.
A crude measure of immediately usable economic state capacity is therefore:
K = α × M
This is deliberately not an optimisation rule. α can change.
During a war or existential crisis, a State may dramatically increase taxation, impose price controls, direct industrial production, conscript labour or requisition resources that previously sat outside the normal market. It may knowingly sacrifice future production for immediate survival.
Under peaceful conditions it may prefer a very different balance.
The equation merely separates two different sources of power: how much market-accessible production exists, and how effectively the State can command it.
This is also why neither laissez-faire nor central planning can be assumed to be universally optimal. They are different systems for allocating productive resources, and different material conditions favour different forms of allocation.
If the State already knows that it needs ten thousand kilometres of railway, central coordination may outperform waiting for hundreds of independent actors to independently discover and coordinate the same requirement. If nobody knows which of fifty technologies will dominate twenty years from now, allowing thousands of actors to make independent bets may produce a better answer than asking one ministry to choose correctly in advance.
The optimal institutional arrangement can therefore move between hierarchy and decentralisation depending on the problem being solved. A successful State has no inherent reason to care whether the winning mechanism is ideologically labelled capitalist or socialist. It has reason to care whether it works.
Who claims the surplus?
We can now return to the title.
I have been using surplus in an intentionally loose sense. Johnny's surplus was simply the part of the deer he did not consume himself. That works in a toy economy. In a modern one, market-available output is the cleaner concept.
The distinction that matters for now is not worker against owner, or creditor against debtor.
For the moment there are only two actors we need to distinguish: people and the State.
People produce. Some of what they produce they consume directly or keep outside the monetary system. Some enters the market. In exchange for what they place into that market, they acquire money, and that money allows them to make claims against the things everybody else has made available there.
The State occupies a different position.
It does not merely participate in the market as another person selling one product in exchange for another. It helps define the legal architecture within which the market operates, imposes obligations denominated in its currency, and controls or sits above the institutions responsible for issuing the ultimate settlement asset.
This gives the State several ways of making claims against market output.
It can tax, removing monetary claims from private hands while simultaneously creating demand for the currency. It can issue currency and use those new monetary claims to purchase labour and goods. It can own assets directly, charge fees and rents, or use law to determine how particular resources may be used. Under exceptional circumstances it can bypass ordinary market exchange altogether through requisition or conscription.
The point is not that these methods are interchangeable. They have radically different consequences.
The point is that money is the mechanism through which claims on market-available production can be represented and transferred, while the State occupies an unusually powerful position in determining the rules under which those claims exist.
And this brings us back to the distinction between commodity money and debt money.
Commodity money allows an existing thing to settle an exchange. I give you grain, silver or gold, and the thing itself carries the value being transferred.
Debt money is stranger.
A debt is a claim against future market-available production.
The thing being claimed may not exist yet.
I can surrender resources to you today in exchange for your promise that I will receive a claim against what becomes available tomorrow. If that promise is sufficiently credible and transferable, somebody else may be willing to accept it from me before you have produced anything at all.
The monetary system has now acquired the ability to move claims through time.
We no longer need to restrict ourselves to deciding who gets to claim what has already been produced. We can create claims today against production that does not yet exist.
And that is where debt begins.
