Tuesday, October 30, 2012

The Social Contrivance of Money... a bit contrived?

An Old Man and his Grandson, circa 1490. Domenico Ghirlandaio

The title of this post comes from this Paul Samuelson paper. Paul Krugman mentioned the paper last week, as did a few others, including Bob Murphy and Garett Jones. Nick Rowe has brought it up a few times (here for instance). So I trudged through it. Here are a few quick thoughts.

The setup goes something like this. Samuelson comes up with a science fiction world in which there's a young generation and an old generation. There are no durable goods. So if the current generation can't save, how can it prepare for a retirement in which it can hardly produce anything? Retirement will be "brutish".

On the other hand, what if they print "oblongs of paper" and "officially through the state, or unofficially through custom, make a grand consensus on the use of these greenbacks as a money of exchange." Then the current generation will be able to acquire some of these paper bits and exchange them in their old age to the young for consumption. The world is now a better place, thanks to the social contrivance of fiat money. [Note: by fiat, I mean intrinsically useless and valueless].

This is an interesting model. But just because the model says that the social contrivance of fiat money is an optimal solution doesn't mean that modern central bank money, which by all means appears to be like the fiat money in Samuelson's model, is likewise a social contrivance.

Samuelson never addresses the incredible degree of inter-generational coordination that would be required to arrive at a social contrivance that dictates that useless objects must be accepted. Why would future generations accept bits of paper if they don't know from the start that the next generation won't laugh at it? Think of the incredible amount of government resources that would be required to enforce the "grand consensus" or, absent force, the quantity of storytelling that would be necessary to instill the customs necessary for fiat to always be accepted.

Samuelson's "social contrivance" is in many ways similar to the idea of a Walrasian auctioneer. Both mechanisms do herculean amounts of work. But outside of an overlapping generations model, this work would be tremendously costly. Now I don't doubt that we could arrive at a social contrivance of fiat money if we really put the resources into it, but why bother? If we want items that are capable of storing wealth over time, we can skimp on the tremendous effort of running a fiat scheme by using things that already have some intrinsic value. A modern central bank that issues well-backed credit will do, as will commodities like gold. The intrinsic value of a commodity or credit item will adequately secure the confidence of the various generations that any exchange they participate in will be fair and quid pro quo. Intrinsic value thereby performs the same function as Samuelson's social contrivance… but at far less cost.

The other thing I noticed about Samuelson's model is that he misappropriates the word "money".  Money is commonly considered to be a highly liquid object, but in Samuelson's model his green bits of paper only get passed off once every generation. For the rest of time they are simply held. The bits of paper that restore his science fiction world to health could equally be called guano, social security, or whatever. In short, his model explains the possibility of fiat stores of value, but not fiat means-of-exchange.

So to sum up, using Samuelson's model of fiat money in order to explain modern central bank money doesn't follow. Social contrivances are expensive. Far easier to secure each generations' trust and participation by setting up a central bank that issues intrinsically valuable and well-backed notes and deposits. A central bank therefore spares society from spending the mass quantity of resources that a socially contrived fiat item would require.  Modern central bank liabilities may look like the socially-contrived green bits of paper in Samuelson's paper, but they aren't.


  1. If a physicist wrote a thesis discussing a hypothetical world where the law of gravity didn't exist, would the other members of the physics community discuss it, as if it had any relevance to the world we actually live in?

    Or would it be considered science fiction?

    So please tell me what point there is with this discussion?

    1. Economics isn't physics.

      Economic models are exactly like science fiction. Both create an artificial world with a few simplified assumptions, populate that world, then push the characters to a climax to see what happens. Orwell's 1984 is a model in which there is no capacity for individual actions, the overlapping generations model is a science fiction story in which there are no storable goods.

      One hopes that the alternative realities we create, either through SF or economics, might teach us a bit about our much more complex world.

  2. Maybe not entirely coincidental I published this, about Robert Lucas his definition of money (which is based upon the Samuelson idea), around the same time:


    Merijn Knibbe

  3. Money is simply a CONTRIVANCE and does NOT properly allocate resources. I could go further into this but I wi briefly say WHY do you think most of your clothing is made in China? It's not because China has ALL the resources, it is because companies pay the employees shit money and then ship your shit over to you! Please grow a brain and realize money is not the thing you think it is. It is simply a means of control and ensuring the rich stay rich. I understand keeping your job because you have to live. But at least acknowledge the fact that money is BULLSHIT. Please?

  4. It surprises me that you use gold as an example of something with intrinsic value. You can't directly eat it, drink it, burn it, use it for shelter, it is clearly worse than most other abundant metals to build tools.... So we end up with the jewelry utility, which is literally again a "beauty contest" (leaving apart that the existence of gold rings, bracelets, necklaces, etc could be explained for transport and security of that medium of exchange rather than for just "looking hadnsome")

    Correct me if I am wrong, but I think that for some reason you totally disregard the utility of exchange in itself. There are services provided by persons or entities that are valuable because they facilitate exchange (traders in general, a stock exchange, etc). And there are also things that are useful because they have the properties to provide that very same service of facilitating exchange (portable, divisible, durable, fungible, limited quantity, etc).

    Those things that provide that service are what Carl Menger meant with his concept of commodity: A commodity is a commodity because the only purpose of the owner is to sell the thing. So being useful for other purpose different than selling it is not within the essence of the concept of commodity (as he defines it in his work).

    I am fully aware that definition is anachronic nowadays, we use indeed the opposite meaning, but I think is worth the effort to strictly read Menger's work using that definition to fully understand his monetary theory, which I think is extremely powerful to explain the utility of media of exchange in general (which he calls commodities).