Saturday, August 9, 2014

Quibbling with the language of trade

The way we ascribe labels to things results in the creation of categories, and this in turn affects the construction of our mental landscapes—best to get the words and categories right from the start lest our thinking goes astray. In this post I quibble with some of the common words and categories we use to describe trade.

Walking out the front door last night, I told my wife that I was going to buy a few items at the grocery store. But as I trekked down the street, I asked myself why I hadn't chosen to tell her an alternate version: that I was going to the grocery store to sell my cash. The problem with this wording, I figured, was that if I was to be the one selling stuff in the upcoming transaction, then by process of elimination the grocery store could no longer be the seller in the deal but the buyer—of my cash. And that would be a weird way to view things.

Linguistic convention requires that there be a seller and a buyer in any trade. One side spends, the other receives. That separate terms are given to participants in an exchange implies that the two parties are irreconcilably different. By spending, buyers are doing something that stands in binary opposition to whatever it is that sellers are doing.

I don't think this dichotomization is a good way to characterize the intuition behind a transaction. All parties to any deal are essentially engaged in the same activity: trade. Escaping linguistic convention for a moment, let's put things this way: when I go to the grocery store I am a seller of coloured bits of paper, and the store is in turn spending its food to buy those bits. The binary opposition between buyers and sellers melts away since both myself and the store are simultaneously buyer and seller, spender and receiver. The exclusivity that previously characterized our positions no longer exists, rather, we are each engaged in mutual trade.

For the sake of simplification we should just drop all references to buyers, sellers, and spending. Instead, so-called buyers and sellers are best described as being equal counterparties to a swap. In last night's trip to the grocery store, the store and me were counterparties to a swap of paper notes for groceries.

It could be argued that the use of the terms 'buyer' and 'seller' are useful in that they capture the fact that one party to the trade is offering 'money' and the other asking for it. But the word 'money' is just as arbitrary. What is to fall into this category, what is to be excluded?

For instance, fan's of Arrested Development may remember the scene where Tobias and Lindsay walk into C.W. Swappigan's and trade a cocktail tray for mozzarella sticks. With neither item classified as money, is Lindsay the buyer or the seller? What is being spent: mozzarella sticks or a cocktail tray? We hem and haw when we try to describe this scene because we can't apply the language of buying/selling, spending/earning to situations involving the exchange of goods that are relatively illiquid. But these sorts of exchanges shouldn't be excluded from discussion just because we can't use regular language to describe them. Nor are they categorically different from exchanges that involve slightly more liquid goods. The language of swapping comes to the rescue: Lindsay and C.W. Swappigans are equal counterparties to a swap that involves two illiquid goods.

Classifying people as buyers or sellers is just as tricky when we start talking about exchanges of one currency for another. When you walk into a currency exchange shop to trade Canadian money for US money, are you the buyer or is the shopkeeper the buyer? Which one of you is spending? Again, the more universal language of swaps makes things easier: both you and the exchange shop are engaged in a swap of two highly-liquid items. Even if one item is slightly more liquid than the other (perhaps greenbacks are a shade more liquid than loonies), what separates the two of you in this trade isn't a Chinese wall of buyer vs seller, but simply a difference in the degree of liquidity (or not) of the items you are swapping.

And while I'm griping, why not exorcise the words borrower and lender? Like buyer and seller, the terms borrower and lender imply a stern barrier between two participants to a temporary trade when these participants are in fact undertaking the very same activity—trade. If we unbundle a transaction between a customer and a bank, what is happening? A consumer, the "borrower", is providing their personal IOU to the bank which in turn is offering its own IOU, a deposit, to the customer. While it is usually said that the customer borrows deposits from the lender bank, we might just as likely say that the customer is lending his or her IOU to the bank, and the bank is borrowing the customer's IOU.

So if we can boil a banking transaction down to a swap that reverses after a period of time, participants in this swap needn't be ring-fenced with their own unique noun. Rather, each can be simultaneously described with the same term: as counterparties.

But what about interest? Isn't the payment of interest a distinguishing enough feature that necessitates the terms debtor and lender? Interest emerges (in part) when parties agree to swap equally risky IOUs for a period of time, but one IOU is more liquid than the other. The counterparty that accepts the illiquid IOU while providing the liquid IOU, usually the bank, will ask for a fee, or a stream of interest payments, from the counterparty customer to compensate (the bank) for forgone liquidity. The other party to the trade, the customer, will be willing to pay an interest penalty as restitution for the superior liquidity return that the bank's IOU provides them. This doesn't change the fact that both bank and customer are engaged in a swap.

Things get tricky when a temporary swap involves exchanges of IOUs that are equally-liquid (and equally risky). Since no one forgoes liquidity over the course of this swap, interest doesn't arise. A good example of this is the repo market, where short term swaps of deposits for highly-liquid treasury bills occur at rates no different from 0%. The lender/borrower lexicon breaks down here since without interest we don't know which party is to earn which moniker. Is the bond owner the lender or the borrower? The deposit-taker?

Again, the clearer way to describe this situation is to default to more universal swap terminology. Both participants are counterparties to a swap of items of equal or varying liquidity profiles.

In sum, our language tries to find strict differences between participants in an exchange when there are none. There are no buyers nor sellers, no spenders, no lenders nor borrowers. Instead, we are all engaged in the same activity—trade. The things we own have varying degrees of liquidity and in endeavoring to swap them for things that are more, equally, or less liquid than that which we already own, we make efforts to grope towards a preferred final state of either greater or diminished liquidity.


  1. Nope: our language quite correctly reflects reality, in this case. There is a mutually understood medium of exchange, and only in those rare exceptions when there isn't do we need to specify both goods exchanged. And we use the "swap" language, rather than the "buy and sell" language, in those rare exceptions.

    When I first came to Canada, I walked in a Bank, and without thinking I said "I want to buy some Canadian Dollars". The teller looked at me strangely. Then she said "Ah! You mean you want to sell some British Pounds!".

    Because the Canadian Dollars side of the swap was obvious to her, but the British Pounds side was not obvious, until she looked at what I held in my hand.

    But yes, "borrow and lend" language is confusing. When I borrow money from my neighbour I am selling my IOU. But when I borrow my neighbour's ladder I am also selling my IOU. Because it is always mutually understood that I am selling my IOU, in both these cases. So when I ask my neighbour for a loan, I have to tell him whether it is his money or his ladder I want to buy with my IOU.

    And his money is more liquid than his ladder, but I might offer (or he might demand) that I pay interest in both these cases.

    1. I was still speaking British, of course, and she was speaking Canadian. I forgot to switch to the new local language.

      It would be very different teaching demand and supply curves in a barter economy. With only two goods it would be easy: the apple demand curve is the banana supply curve, and the apple supply curve is the banana demand curve. Three goods would be a mess.

    2. Which is why the "price of money" is regularly erroneously described as interest rates, which is the price of credit, of holding something across time. The price of money is its swap value, but the language of buy and sell in terms of the medium of exchange (and of borrower and lender) obscures that.

    3. Nick, I agree that our language reflects reality, in that it by-and-large allows us to make our way through a market day. But I don't think we should adopt the vernacular when we want to approach these topics in a more formal way. The meta-language (the language we use to describe the language) would do best to avoid imprecise terminology like buyer and seller. And we get hints of this sloppiness when the vernacular itself fails (ie. in barter and currency-to-currency trades). It's the same sort of problem that we run into when we first run into the problem of trying to understand value... the vernacular gets in the way until we make the leap towards thinking in terms of marginal value.

      Lorenzo, I agree. There are many prices of money, insofar as we view the price of something as a list of foregone opportunities, interest being only one of the many things we forgo by holding a highly liquid instrument.

  2. I hate to point out another error, but fans of Arrested Development don't acknowledge that the fourth season ever happend.

    1. It's definitely a step down from the other seasons, but having watched it a second time I've warmed up to it a bit.

  3. JP, I tend to agree with the Nick in the 1st part of his reply above, but I see your point.

    But getting back to borrower and lender: I agree with both you and Nick, but what I don't like is the term "demand for loans." This has it backwards in my view. I do like the idea that the person bringing the item with the higher moneyness to the the exchange is the one doing the buying and the other is doing the selling (if it's clear which good has more moneyness).

    Which is why "demand for loans" makes no sense. The borrower is the seller... and they aren't really obtaining a loan, they are obtaining money: the lender is obtaining the loan. It's sits as an asset on their balance sheet.

    I think this is just a peculiarity of the English language revolving around lending. If we replace the word "loan" with "bond" or "personal bond" then it all make sense again. The "demand for loans" is really something the lender has, not the borrower! The borrower is supplying the loans (bonds). Nick Rowe has described this before as "two supply curves interacting" ... but that didn't make sense to me either. These two supply curves are the supply of loans (determined by the borrower) and the supply of money (determined by the lender). There's no need to go there in my view... The borrower determines the supply curve here (for loans/bonds) and the lender is determining the demand curve (for loans/bonds). Bonds (with less moneyness) are the items being sold for deposits or cash (both with more moneyness).

    Also, there is one typically peculiar thing about the "loan market" which is uncommon in other markets: That is the loan seller (the borrower) very often has the option to repurchase his loan principal dollars in any amount he sees fit from WHOEVER happens to end up owning the loan he sold. Of course this is not always the case, without any restriction (pre-payment penalties are an example).

    I'm not a sophisticated investor of financial markets guy, so I'm probably wrong in thinking about how unusual this is... but for an ordinary Joe like me (er, ordinary Tom?), this is an unusual property for a "good." If I sell my car... I don't expect that I can come back later and purchase incremental pieces of my car back again (for the same price I sold them) at my discretion from whoever happens to be the owner of the car whenever I feel like doing this. Of course I don't generally sell the car with an upfront agreement that I will be required to buy back some minimum part of it again each month either (which is essentially what the principal payment schedule the borrower agrees to is).

    BTW, here's Nick's "two supply curves" interacting comment I referred to above:

    "Roughly speaking, it is not the demand curve for *money* that interacts with the supply curve to determine the stock of money; it is the supply curve of the thing that the bank is buying that interacts with the bank's supply curve of money."

    But again, I'd rephrase that as:

    "Roughly speaking, it is not the demand curve for *money* that interacts with the supply curve to determine the stock of money; it is the supply curve [determined by borrowers] of the thing that the bank is buying [loans = personal bonds from borrowers] that interacts with the bank's demand curve for these loans/bonds."

    But that's just me. :D

    1. As you can see, the "two supply curves interacting" comment also confused commentator "Dustin.":

      "Quick clarification - you said: "it is the supply curve of the thing that the bank is buying that interacts with the bank's supply curve of money"

      Is that a typo, or are we really talking about 2 supply curves? I've never considered this type of thing."

      So I liked where Nick was going with that, but the English language has the language of lending and borrowing turned 180 degrees out of phase from where it should be, and Nick only turned it back 90 degrees and ended up with two supply curves... I just adding in the final 90 degrees to get it back to "normal." :D

    2. ... re: my first comment above, I should have said that I don't like the phrase "demand for loans" the way it is usually meant by people, by which they mean the borrower's desire to borrow. "Demand for loans" is fine when speaking of what the lender determines. (But again, just say "demand for bonds" and it clears it right up).

    3. You might wonder why Nick's comment stuck in my head for so long... it was because I ended up attempting to diagram one of his examples (from the very next related post of his):

    4. Tom, I agree that thinking in terms of a bond rather than a loan helps clear things up. My preference is IOU since it covers the full range of terms, from overnight to perpetual debt instruments.

      "Also, there is one typically peculiar thing about the "loan market" which is uncommon in other markets: That is the loan seller (the borrower) very often has the option to repurchase his loan principal dollars in any amount he sees fit from WHOEVER happens to end up owning the loan he sold."

      An exception is perpetual debt in which the loan seller never has the option to repurchase their IOU. And goods markets are full of reversibility clauses in the form of warranties and return policies. Reversibility isn't a peculiar feature of debt markets.

      I'll read through some of your links to Nick's blog and will try to give some thoughts if I get the time.

  4. I think it's good to challenge the terminology as you've done here, but I also think it's fine to still talk about buyers and lenders.

    It's worth noting though that normally when we buy something, it is not a straightforward swap but a complicated arrangement involving several parties. If I pay you with commercial bank money, I am not simply transferring title to a part of my deposit. Instead, we have a four way agreement between you, me, and each of our banks, whereby different accounts get credited and debited. As a result, I never have to hold a claim on your bank and you never have to hold a claim on my bank.

    Of course, in most cases it is fine to interpret this whole arrangement as if it were a transfer of an enduring thing.

    1. Nick, I'm a big fan of breaking down each step in a clearing transaction into a series of swaps.

      As an aside, I think commentators often underestimate the degree of currency-to -currency trades because they are not in finance, and they underestimate the degree of goods-to-goods trades because they are neither criminals nor in business. Rather, they base most of their thinking on their retail experiences... which is results in a biased viewpoint since the whole point of retail is to hide the entire functioning of things behind a veil of simplicity.

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