Skip to main content

Adam Smith: taxes contribute to fiat's liquidity premium, they don't drive its value


David Glasner had an article called Wicksteed on the Value of Paper Money.

David discusses the idea that it is the imposition of taxes by government, payable in fiat money tokens, that gives fiat money its value. This is chartalism, the very same idea that MMTers trumpet as their unique addition to economic discussion. This is one theory for why fiat money has value. Another is Mike Sproul's backing theory in which, just as a mutual fund's assets give its units value, a central bank's assets support the value of its liabilities. When it comes to explaining modern money, I'm partial to the latter. I'm not averse to the MMT explanation, but only as science fiction. I don't think any real monetary system has actually worked in this way.

David mentions that Adam Smith advocated the taxes-drive fiat money theory. Incidentally, Randall Wray says the same in his book Understanding Modern Money. I disagree. To make a long story short, in Smith's world, fiat money was any issue of paper money which was temporarily unredeemable and therefore circulated at a discount. In forcing people to pay taxes with this money, the sovereign created a built-in liquidity premium. But the tax obligation did not give the paper money it's original value - the probability of future redemption did. Here's the a better explanation that I left on David's blog:
I’ve read Smith pretty carefully on this. The offhanded comment comes after he talks about money that is no longer instantly convertible but redeemable at some future point in time. He uses as his example Scottish notes for which the option clause has been invoked and US colonial paper which is only redeemable after a few years.
Given deferred redemption, “such a paper money would, no doubt fall more or less below the value of gold and silver, according as the difficulty or uncertainty of obtaining payment was supposed to be greater or less, or the greater or less distance of time at which payment was exigible.”
The point being that Smith thought such money was valued according to its discounted probability of being redeemed at par.
Smith then brings up the point about taxes. 
“The paper of each colony being received in the payment of the provincial taxes, for the full value for which it had been issued, it necessarily derived from this use some additional value, over and above what it would have had, from the real or supposed distance of the term of its final discharge and redemption.”
Thus acceptability in payment of taxes added a liquidity premium to colonial paper. But it didn’t give that paper its original value. I read Smith as providing a chartal theory of the liquidity premium, and not an explanation for a positive value of fiat money.
Labels:

Comments

Post a Comment

Popular posts from this blog

Shadow banks want in from the cold

Remember when shadow banks regularly outcompeted stodgy banks because they could evade onerous regulatory requirements? Not any more. In negative rate land, regulatory requirements are a blessing for banks. Shadow banks want in, not out. In the old days, central banks imposed a tax on banks by requiring them to maintain reserves that paid zero percent interest. This tax was particularly burdensome during the inflationary 1970s when short term rates rose into the teens. The result was that banks had troubles passing on higher rates to savers, helping to drive the growth of the nascent U.S. money market mutual fund industry. Unlike banks, MMMFs didn't face reserve requirements and could therefore offer higher deposit rates to their customers. To help level the playing field between regulated banks and so-called shadow banks, a number of central banks (including the Bank of Canada) removed the tax by no longer setting a reserve requirement. While the Federal Reserve didn't go as f...
Post a Comment
Read more

The bond-stock conundrum

Here's a conundrum. Many commentators have been trying to puzzle out why stocks have been continually hitting new highs at the same time that bond yields have been hitting new lows. See here , here , here , and here . On the surface, equity markets and bond markets seem to be saying two different things about the future. Stronger equities indicate a bright future while rising bond prices (and falling yields) portend a bleak one. Since these two predictions can't both be right, either the bond market or the stock market is terribly wrong. It's the I'm with stupid theory of the bond and equity bull markets. I hope to show in this post that investor stupidity isn't the only way to explain today's concurrent bull market pattern. Improvements in financial market liquidity and declining expectations surrounding the pace of consumer price inflation can both account for why stocks and equities are moving higher together. More on these two factors later. 1. I'm with...
Post a Comment
Read more

Does QE actually reduce inflation?

There's a counterintuitive meme floating around in the blogosphere that quantitative easing doesn't do what we commonly suppose. Somehow QE reduces inflation or causes deflation, rather than increasing inflation. Among others, here are Nick Rowe , Bob Murphy , David Glasner , Stephen Williamson , David Andolfatto , Frances Coppola , and Bill Woolsey discussing the subject. Over the holidays I've been trying to wrap my head around this idea. Here are my rough thoughts, many of which may have been cribbed from the above sources, though I've lost track from which ones. Let's be clear at the outset. Inflation is a rise in the general price level, deflation is a fall in prices. QE is when a central bank purchases assets at market prices with newly issued reserves. In equilibrium, the expected returns on all goods and assets must be equal. If they aren't equal then people will rebalance towards superior yielding assets until the prices of these assets have risen high...
Post a Comment
Read more