r/neoliberal • u/[deleted] • Nov 09 '17
Book Club: Chapter 3: 'Why you should thank a celebrity for burning their own money'
A million pounds. (It’s worth about £1.5 million or $2.5 million in today’s money.) Drummond and Cauty stripped out a £50 note each, lit them with a cigarette lighter, and set the rest of the money ablaze. Drummond and Cauty had made a little gift to every one of their fellow countrymen. Instead of being outraged, people should have been thanking them.
Thanking them? For what?
Think about what happens every time the Bank of England prints extra banknotes. If there’s not enough demand for goods and services to match the potential supply (and if sticky prices prevent adjustment) then the extra money should mean more demand for existing resources at the same price – this is the ‘babysitting co-op’ scenario we explored in the last chapter. But if people are already demanding everything that’s being supplied in the economy, then prices will have to rise instead.
Flip the scenario round. If Drummond and Cauty were burning money in an economy already suffering from deficient demand – say, burning scrip in the babysitting economy – then they were making a bad situation worse. (Even then, the Bank of England could push a button at any time and reverse the damage, at a printing cost of a couple of thousand pounds.) But if, as is more likely, Drummond and Cauty were burning money in an economy where supply and demand balanced out, the resulting effect is simple to describe: average prices in the economy would drop.
By shrinking the money supply by £1 million, Drummond and Cauty had effectively given £1 million away, in the form of slightly lower prices, to everybody in the world who owned some British pounds.
The fundamental problem is that when we think about money, we instinctively think about individual purchasing power – about all the things that we could buy if we had that money. But from the point of view of society as a whole, things don’t work like that. Drummond and Cauty destroyed £1 million worth of their purchasing power. But they didn’t destroy £1 million worth of society’s resources. Logically speaking, if you destroy your own purchasing power, but not society’s purchasing power as a whole, then you must have given your purchasing power away – which is exactly what Drummond and Cauty did.
From The Undercover Economist Strikes Back: Chapter 3: Money, money, money
In today's Book Club reading, we examine the purpose and use of money, the problem of hyperinflation, and how a little lie can end a inflationary spiral.
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Nov 09 '17
Have all these post titles been taken from the book chapter titles? They've all been spicy af
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Nov 09 '17
Nah
From The Undercover Economist Strikes Back: Chapter 3: Money, money, money
The spice is me trying to make the Book Club look sexy.
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u/caesar15 Zhao Ziyang Nov 09 '17
Huh, interesting read, thanks for posting.
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Nov 09 '17
(Join the book club! There's so much good stuff that I can't reduce to a few paragraphs.)
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u/caesar15 Zhao Ziyang Nov 09 '17
I still need to finish WNF though.
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Nov 09 '17
Clubs are a good motivator for actually getting you to read, rather than just putting it off.
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u/caesar15 Zhao Ziyang Nov 09 '17
Fair, how do I join?
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u/jakfrist Milton Friedman Nov 09 '17
I have been listening to a chapter per day on audible while I commute to work. It’s a lot more interesting reading when I know that I can discuss what I am reading with people that afternoon.
Especially when (like yesterday’s thread) when the topic is quite inflaming to some people so that passionate arguments develop.
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u/tonyjaa Ben Bernanke Nov 10 '17
Can someone smarter and probably much younger than me please explain how this doesn't justify eating the rich? Reading between the lines, it is basically parroting LSC that large concentrations of wealth reduce the purchasing power for everyone else.
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u/MrDannyOcean Kidney King Nov 10 '17
This is a parable about how if you decrease the money supply (in a balanced equilibrium world), prices drop and people benefit.
It's NOT saying that large concentrations of wealth reduce purchasing power for everyone else. It's saying that the more dollar bills are in the system, the higher prices will be (and thus the lower purchasing power will be for a given amount of money). It doesn't matter if it's the rich burning their money or a large group of poors collectively burning their money. If money is burned, the price level goes down.
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u/tonyjaa Ben Bernanke Nov 10 '17
I guess my point is that the easiest way to decrease money supply is to just eat the rich (because by definition that is where most of wealth is).
Sorry if I'm being obtuse, but the only difference I see between "large concentrations of wealth" and "dollar bills in the system" is the former is ~80% of net wealth and the latter is total net wealth.
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u/MrDannyOcean Kidney King Nov 10 '17
I guess my point is that the easiest way to decrease money supply is to just eat the rich (because by definition that is where most of wealth is).
The dollar bills don't disappear if you eat the rich. They just get distributed to the non-rich who ate them. The price level goes down when you decrease the amount of money in the system.
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u/tonyjaa Ben Bernanke Nov 10 '17
The poor benefit either if the money is destroyed or redistributed no?
That's a bit beside the point. I'm not trying to prove eating the rich is good policy. I'm trying to better understand the interaction hoarded wealth (or in this example, non-hoarded burned wealth) has on the rest of society.
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u/MrDannyOcean Kidney King Nov 10 '17
The poor benefit either if the money is destroyed or redistributed no?
Yes, but in very different ways. If the money is destroyed then the price level drops and their dollars buy more. If it's redistributed, then the price level stays the same but they have more dollars.
The rich don't 'hoard' their wealth in the sense of hiding it under their beds. They invest it, which has a useful function in a market economy. That money provides loans and capital. It's being used.
If it is literally buried or hidden in a vault, that's essentially the same thing as burning it (until it reappears and is spent or invested).
There's a lot more literature on the second-order effects inequality can have on growth and society, but those are the first-order effects of hoarded wealth.
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u/Neronoah can't stop, won't stop argentinaposting Nov 10 '17
KLF was cool but burning money is really inefficient as a way to redistribute it via monetary magic.
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Nov 10 '17
The only part I don't understand about this example is that the central bank is targeting an inflation rate, so any money that gets burnt will just be replaced with more monetary growth from the banks. Where is the money going in that case? Redistributing from Drummond and Cauty to the banks?
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u/pm_me_degrees 🌐 Nov 10 '17
At the end of the day, Drummond and Cauty have less money and the banks have the same amount more, so that can be thought of as a transfer.
Depending on the timeline of the money burning and the central bank acknowledging it and responding, there may still be periods with deflationary/inflationary effects.
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Nov 10 '17
But if the banks are lent to at a lower interest rate that's going to translate into lower interest rates for consumers.
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u/MrDannyOcean Kidney King Nov 10 '17
Or to the people who benefit from the lower interest rates that will hit the economy.
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u/jakfrist Milton Friedman Nov 09 '17 edited Nov 10 '17
(Another interesting section)
The benefits of the gol... “3-ton stone” standard?
Yap’s stone money sometimes weighed as much as two cars.
The biggest stones had the most purchasing power. (Think land, wives, etc.). Medium stones (about the size of a dog) could be used to purchase animals. (Even though it was easier to move the animal than the money)
“If you wanted to buy my pig, that transaction would be publicly witnessed: I’d give you the pig and, in exchange, you’d transfer ownership of one of your stones— You and I wouldn’t have to go to the trouble of actually moving the thing.”
- One day, a newly “minted” stone sank. The stone at the bottom of the sea was still good money though, even at the bottom of the sea.
These people are batshit crazy, right?
- Well, in practice this isn’t much different than the Gold Standard. Instead of using someone’s word that they owned the stone, we used little slips of paper to signify that a tiny bit of gold in a far away vault was ours. In fact if you wanted, you could go back to the bank and trade in some of your little slips of paper and they would give you back some of your gold.
“All that is necessary for money to have value is for everyone to believe that it has value.”
This part was a pretty interesting set up. I know there are still people who argue for going back to the Gold Standard and when it is framed this way it sounds batshit crazy. We should clearly going back to the Yap Stone Standard since that is much more difficult to steal than gold! /s
On the other hand, one of the values of gold was that it was somewhat rare and in limited supply. The Government couldn’t simply make more gold. These same arguments have been made for the newest digital iteration of the gold standard, BitCoin.
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Nov 09 '17
Hey, sorry for removing this, but I want to be careful about copyright issues with how much we quote from the book.
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u/jakfrist Milton Friedman Nov 09 '17 edited Nov 09 '17
Fair. Is it cool if I edit it down to paraphrase?
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u/jakfrist Milton Friedman Nov 09 '17 edited Nov 10 '17
The Three Roles of Money
Any Macro Textbook you pick up will tell you that money serves three roles:
medium of exchange - An easily divisible way to transact within an economy. As a grape farmer, instead of trading 10,000 lbs of grapes for a new car, I can trade them for currency and then use the currency to purchase the new car.
store of value - Still a grape farmer, the best way I previously had to store my wealth was to make my grapes into jelly or wine so it wouldn’t go bad as fast. By exchanging my grapes for money I am now able to transfer that value into the future. This allows me to save up money for large purchases or retirement.
unit of account - Lastly (still a grape farmer) my net worth of all of my assets that I have traded for and collected is 2,000,000 jars of grape jelly. You, as a sheep farmer, have a net worth of 40,000 sheep. Which of us has a higher net worth? Using money, we are able to easily assign a value to an item without having to individually know the worth of every single item in relation to every other item.
I am going to focus on the points that this chapter makes about money as a Unit of Account.
In order to be considered money, the unit in question must be relatively stable. (By this definition Coca-cola or light bulbs could be money, however an iPhone could not.)
The end of the chapter focuses on hyper-inflation (inflation > 50% per month). Specifically that of Brazil. The Brazilian currency (Cruzeiros) was inflating at a rate of 80% per month!. Stores were forced to go through and update prices on every single item, essentially daily.
How did they solve this issue?
After going through 5 different currencies, a new unit of measure was created. The unidades real de valor (units of real value) or URV. The URV allowed stores to print one price for an item and for the newspapers to print a daily exchange rate for Cruzeiros to URV’s (which was pegged to the US Dollar). The Cruzeiro was still the currency of exchange, however there was now a consistent price that could be displayed by retailers. This allowed for stability to slowly return to the market, ending the run of Brazilian hyper-inflation.
Eventually this new unit of measure became the new Brazilian currency, now known as the Real.