Hot or not?

The Rowe/Glasner/Sproul debate continues over hot potato-ish-ness of money. Here is Nick Rowe:

The hot potatoes simply pass from one hand to another. Unless they sell it back to the banks, to buy IOUs. But why would they want to do that? If I have opals I want to get rid of I will probably sell them at the specialised opal dealer, who will probably give me the best deal. If I have money I want to get rid of....well, everyone I deal with is a dealer in money. The bank is just one in a thousand. Why would we assume that the bank will always give me a better deal than the other 999?

Mike Sproul jumps in, but David doesn't, so instead I left a comment trying to anticipate what David would say:

Why would people want to return hot potatoes to the bank? David explicitly sets his illustration of reflux in a world characterized by fixed convertibility. Say the central bank promises to convert deposits into x gold ounces and vice versa. If there are too many deposits being created, people spend them away will nilly (which is your point). David's point is that should this happen, the market price of gold rises above the price at which the central bank offers conversion. Professional arbitrageurs will seize on this discrepancy by buying deposits and returning them to the central bank for gold. This arbitrage will close the gap between the two prices, the net effect being that excess deposits will reflux back to the issuing bank.

Your error, at least according to what I've read on Glasner's blog, is universalizing your experience with money as-a-consumer to all money-users. You're right, consumers do often spend their money away on stuff should they have an excess. But not so traders, speculators, and other banks. Says David:

"Arbitrage transaction are facilitated precisely by the commitments of central banks to maintain a fixed conversion rate between their currencies and an ounce of gold. Without such a simultaneous commitment, the scope for profitable arbitrage transactions, carried out by professional traders, not the likes of you and me, is greatly enhanced compared to ordinary monetary exchange much less to barter."

In our modern system, I'd hazard a guess that it is the interbank clearing system that generates the reflux process, and not a discrepancy in the gold price.

Anyways, I'm sure David will respond. It'll be interesting to see how he goes about it.

Here is a taxonomy of Sproul/Glasner/Rowe that I find somewhat useful:

Just ask each one of our contestants... Hot potato or not?

...modern central bank money?
Rowe - hot
Glasner - hot
Sproul - not

... convertible central bank money, or modern privately-issued money?
Rowe - hot
Glasner -not
Sproul - not

The thorny issue that rarely gets discussed is the exact definition of hot potato. In order to stop doing the hot potato, an asset has to "reflux" back to its issuer. If it can't reflux, then it does the hot potato, circulating eternally in the larger economy. Reflux is an odd word from the 19th century, its only modern usage in the modern economic vernacular (its seems to have come from physics?) is found among monetary economists interested in centuries' old debates that refuse to die (and rightly so, they are quite fascinating). A more modern term for reflux-ible might be "puttable" or "convertible". All three terms essentially imply a channel that allows the security holder to return the security back to its issuer at a set price on demand.

Here I think Mike Sproul is the most useful. His definition of reflux includes not just immediate reflux, but "potential" reflux, or "conditional" reflux. Here is his paper on the types of reflux which, incidentally, I had the pleasure of commenting on prior to publication (speaking of which, where is the honorable mention, Mike?). Here is Mike Sproul:

The number of potential reflux channels is much larger than just the four listed above. Shillings can reflux to the government when the government sells off buildings or used furniture, or with any number of other transactions, up to and including the unwinding of the government’s financial position, as might occur if the government were dissolved or went bankrupt. Each of these channels of reflux represents a form of convertibility.

It's worth reading the next bits too.

In short, given this open definition of reflux,  modern central bank money is "refluxible" - it is not a hot potato - because it always retains the property of conditional, or potential, reflux. Now here David Glasner and Nick Rowe are strictly correct if the definition of hot potato is to mean that money once-issued need not immediately return to the central bank. But if people's expectations are an important determinant of an asset's nature, then fiat central bank money will be treated as-if it were immediately refluxible because it has the property of being conditionally so.

Brought out of the monetary arena and into a different arena of debate, the financial arena, the same debate begins by asking... is a non-dividend paying corporate stock characterized by reflux? In a strict sense, corporate stock can rarely be putted back to its issuer on demand at a set price. Some companies do conduct regular non-course issuer bids to buyback their stock, which is a form of immediate reflux, but don't do so as a rule. So corporate stock, having been issued, putters around in the greater economy hot-potato like.

By convention though, firms do offer conditional reflux on their stock... they promise that the remaining assets after accounting for debt will always be paid out to stock holders upon windup or bankruptcy. Given this feature, stock is treated by the marketplace "as-if" it was capable of being immediately refluxed back to the issuer. Bringing this point back into the monetary arena, the same goes for modern central banks money, or so Mike and I would have it.