What happens when a bank fails

2023-03-192023-03-11 pnrj critique of neoclassical economics, current events, inequality, macroeconomics, market failure, public policy bank failure, bank run, banking, bankruptcy, central bank, credit, deposits, FDIC, finance, fractional-reserve, monetary policy, money, money multiplier, Positive Money, reserve ratio, Silicon Valley Bank, Washington Mutual

Mar 19 JDN 2460023

As of March 9, Silicon Valley Bank (SVB) has failed and officially been put into receivership under the FDIC. A bank that held $209 billion in assets has suddenly become insolvent.

This is the second-largest bank failure in US history, after Washington Mutual (WaMu) in 2008. In fact it will probably have more serious consequences than WaMu, for two reasons:

1. WaMu collapsed as part of the Great Recession, so there was already a lot of other things going on and a lot of policy responses already in place.

2. WaMu was mostly a conventional commercial bank that held deposits and loans for consumers, so its assets were largely protected by the FDIC, and thus its bankruptcy didn’t cause contagion the spread out to the rest of the system. (Other banks—shadow banks—did during the crash, but not so much WaMu.) SVB mostly served tech startups, so a whopping 89% of its deposits were not protected by FDIC insurance.

You’ve likely heard of many of the companies that had accounts at SVB: Roku, Roblox, Vimeo, even Vox. Stocks of the US financial industry lost $100 billion in value in two days.

The good news is that this will not be catastrophic. It probably won’t even trigger a recession (though the high interest rates we’ve been having lately potentially could drive us over that edge). Because this is commercial banking, it’s done out in the open, with transparency and reasonably good regulation. The FDIC knows what they are doing, and even though they aren’t covering all those deposits directly, they intend to find a buyer for the bank who will, and odds are good that they’ll be able to cover at least 80% of the lost funds.

In fact, while this one is exceptionally large, bank failures are not really all that uncommon. There have been nearly 100 failures of banks with assets over $1 billion in the US alone just since the 1970s. The FDIC exists to handle bank failures, and generally does the job well.

Then again, it’s worth asking whether we should really have a banking system in which failures are so routine.

The reason banks fail is kind of a dark open secret: They don’t actually have enough money to cover their deposits.

Banks loan away most of their cash, and rely upon the fact that most of their depositors will not want to withdraw their money at the same time. They are required to keep a certain ratio in reserves, but it’s usually fairly small, like 10%. This is called fractional-reserve banking.

As long as less than 10% of deposits get withdrawn at any given time, this works. But if a bunch of depositors suddenly decide to take out their money, the bank may not have enough to cover it all, and suddenly become insolvent.

In fact, the fear that a bank might become insolvent can actually cause it to become insolvent, in a self-fulfilling prophecy. Once depositors get word that the bank is about to fail, they rush to be the first to get their money out before it disappears. This is a bank run, and it’s basically what happened to SVB.

The FDIC was originally created to prevent or mitigate bank runs. Not only did they provide insurance that reduced the damage in the event of a bank failure; by assuring depositors that their money would be recovered even if the bank failed, they also reduced the chances of a bank run becoming a self-fulfilling prophecy.

Indeed, SVB is the exception that proves the rule, as they failed largely because their assets were mainly not FDIC insured.

Fractional-reserve banking effectively allows banks to create money, in the form of credit that they offer to borrowers. That credit gets deposited in other banks, which then go on to loan it out to still others; the result is that there is more money in the system than was ever actually printed by the central bank.

In most economies this commercial bank money is a far larger quantity than the central bank money actually printed by the central bank—often nearly 10 to 1. This ratio is called the money multiplier.

Indeed, it’s not a coincidence that the reserve ratio is 10% and the multiplier is 10; the theoretical maximum multiplier is always the inverse of the reserve ratio, so if you require reserves of 10%, the highest multiplier you can get is 10. Had we required 20% reserves, the multiplier would drop to 5.

Most countries have fractional-reserve banking, and have for centuries; but it’s actually a pretty weird system if you think about it.

Back when we were on the gold standard, fractional-reserve banking was a way of cheating, getting our money supply to be larger than the supply of gold would actually allow.

But now that we are on a pure fiat money system, it’s worth asking what fractional-reserve banking actually accomplishes. If we need more money, the central bank could just print more. Why do we delegate that task to commercial banks?

David Friedman of the Cato Institute had some especially harsh words on this, but honestly I find them hard to disagree with:

Before leaving the subject of fractional reserve systems, I should mention one particularly bizarre variant — a fractional reserve system based on fiat money. I call it bizarre because the essential function of a fractional reserve system is to reduce the resource cost of producing money, by allowing an ounce of reserves to replace, say, five ounces of currency. The resource cost of producing fiat money is zero; more precisely, it costs no more to print a five-dollar bill than a one-dollar bill, so the cost of having a larger number of dollars in circulation is zero. The cost of having more bills in circulation is not zero but small. A fractional reserve system based on fiat money thus economizes on the cost of producing something that costs nothing to produce; it adds the disadvantages of a fractional reserve system to the disadvantages of a fiat system without adding any corresponding advantages. It makes sense only as a discreet way of transferring some of the income that the government receives from producing money to the banking system, and is worth mentioning at all only because it is the system presently in use in this country.

Our banking system evolved gradually over time, and seems to have held onto many features that made more sense in an earlier era. Back when we had arbitrarily tied our central bank money supply to gold, creating a new money supply that was larger may have been a reasonable solution. But today, it just seems to be handing the reins over to private corporations, giving them more profits while forcing the rest of society to bear more risk.

The obvious alternative is full-reserve banking, where banks are simply required to hold 100% of their deposits in reserve and the multiplier drops to 1. This idea has been supported by a number of quite prominent economists, including Milton Friedman.

It’s not just a right-wing idea: The left-wing organization Positive Money is dedicated to advocating for a full-reserve banking system in the UK and EU. (The ECB VP’s criticism of the proposal is utterly baffling to me: it “would not create enough funding for investment and growth.” Um, you do know you can print more money, right? Hm, come to think of it, maybe the ECB doesn’t know that, because they think inflation is literally Hitler. There are legitimate criticisms to be had of Positive Money’s proposal, but “There won’t be enough money under this fiat money system” is a really weird take.)

There’s a relatively simple way to gradually transition from our current system to a full-reserve sytem: Simply increase the reserve ratio over time, and print more central bank money to keep the total money supply constant. If we find that it seems to be causing more problems than it solves, we could stop or reverse the trend.

Krugman has pointed out that this wouldn’t really fix the problems in the banking system, which actually seem to be much worse in the shadow banking sector than in conventional commercial banking. This is clearly right, but it isn’t really an argument against trying to improve conventional banking. I guess if stricter regulations on conventional banking push more money into the shadow banking system, that’s bad; but really that just means we should be imposing stricter regulations on the shadow banking system first (or simultaneously).

We don’t need to accept bank runs as a routine part of the financial system. There are other ways of doing things.

Who still uses cash?

2022-02-272022-02-20 pnrj current events, macroeconomics, public policy Angola, Botswana, cash, Chad, Ecuador, Federal Reserve, HSBC, Kenya, legal tender, monetary policy, money, Uganda

Feb 27 JDN 2459638

If you had to guess, what is the most common denomination of US dollar bills? You might check your wallet: $1? $20?

No, it’s actually $100. There are 13.1 billion $1 bills, 11.7 billion $20 bills, and 16.4 billion $100 bills. And since $100 bills are worth more, the vast majority of US dollar value in circulation is in those $100 bills—indeed, $1.64 trillion of the total $2.05 trillion cash supply.

This is… odd, to say the least. When’s the last time you spent a $100 bill? Then again, when’s the last time you spent… cash? In a typical week, 30% of Americans use no cash at all.

In the United States, cash is used for 26% of transactions, compared to 28% for debit card and 23% for credit cards. The US is actually a relatively cash-heavy country by First World standards. In the Netherlands and Scandinavia, cash is almost unheard of. When I last visited Amsterdam a couple of months ago, businesses were more likely to take US credit cards than they were to take cash euros.

A list of countries most reliant on cash shows mostly very poor countries, like Chad, Angola, and Burkina Faso. But even in Sub-Saharan Africa, mobile money is dominant in Botswana, Kenya and Uganda.

And yet the cash money supply is still quite large: $2.05 trillion is only a third of the US monetary base, but it’s still a huge amount of money. If most people aren’t using it, who is? And why is so much of it in the form of $100 bills?

It turns out that the answer to the second question can provide an answer to the first. $100 bills are not widely used for consumer purchases—indeed, most businesses won’t even accept them. (Honestly that has always bothered me: What exactly does “legal tender” mean, if you’re allowed to categorically refuse $100 bills? It’d be one thing to say “we can’t accept payment when we can’t make change”, and obviously nobody seriously expects you to accept $10,000 bills; but what if you have a $97 purchase?) When people spend cash, it’s mainly ones, fives, and twenties.

Who uses $100 bills? People who want to store money in a way that is anonymous, easily transportable—including across borders—and stable against market fluctuations. Drug dealers leap to mind (and indeed the money-laundering that HSBC did for drug cartels was largely in the form of thick stacks of $100 bills). Of course it isn’t just drug dealers, or even just illegal transactions, but it is mostly people who want to cross borders. 80% of US $100 bills are in circulation outside the United States. Since 80% of US cash is in the form of $100 bills, this means that nearly two-thirds of all US dollars are outside the US.

Knowing this, I have to wonder: Why does the Federal Reserve continue printing so many $100 bills? Okay, once they’re out there, it may be hard to get them back. But they do wear out eventually. (In fact, US dollars wear out faster than most currencies, because they are made of linen instead of plastic. Surprisingly, this actually makes them less eco-friendly despite being more biodegradable. Of course, the most eco-friendly method of payment is mobile payments, since their marginal environmental impact is basically zero.) So they could simply stop printing them, and eventually the global supply would dwindle.

They clearly haven’t done this—indeed, there were more $100 bills printed last year than any previous year, increasing the global supply by 2 billion bills, or $200 billion. Why not? Are they trying to keep money flowing for drug dealers? Even if the goal is to substitute for failing currencies in other countries (a somewhat odd, if altruistic, objective), wouldn’t that be more effective with $1 and $5 bills? $100 is a lot of money for people in Chad or Angola! Chad’s per-capita GDP is a staggeringly low $600 per year; that means that a $100 bill to a typical person in Chad would be like me holding onto a $10,000 bill (those exist, technically). Surely they’d prefer $1 bills—which would still feel to them like $100 bills feel to me. Even in middle-income countries, $100 is quite a bit; Ecuador actually uses the US dollar as its main currency, but their per-capita GDP is only $5,600, so $100 to them feels like $1000 to us.

If you want to usefully increase the money supply to stimulate consumer spending, print $20 bills—or just increase some numbers in bank reserve accounts. Printing $100 bills is honestly baffling to me. It seems at best inept, and at worst possibly corrupt—maybe they do want to support drug cartels?

The economics of interstellar travel

2021-12-192021-12-15 pnrj critique of neoclassical economics, futurism interstellar, money, Paul Krugman, quantum mechanics, relativity, space, space travel, trade

Dec 19 JDN 2459568

Since these are rather dark times—the Omicron strain means that COVID is still very much with us, after nearly two years—I thought we could all use something a bit more light-hearted and optimistic.

In 1978 Paul Krugman wrote a paper entitled “The Theory of Interstellar Trade”, which has what is surely one of the greatest abstracts of all time:

This paper extends interplanetary trade theory to an interstellar setting. It is chiefly concerned with the following question: how should interest charges on goods in transit be computed when the goods travel at close to the speed of light? This is a problem because the time taken in transit will appear less to an observer travelling with the goods than to a stationary observer. A solution is derived from economic theory, and two useless but true theorems are proved.

The rest of the paper is equally delightful, and well worth a read. Of particular note are these two sentences, which should give you a feel: “The rest of the paper is, will be, or has been, depending on the reader’s inertial frame, divided into three sections.” and “This extension is left as an exercise for interested readers because the author does not understand general relativity, and therefore cannot do it himself.”

As someone with training in both economics and relativistic physics, I can tell you that Krugman’s analysis is entirely valid, given its assumptions. (Really, this is unsurprising: He’s a Nobel Laureate. One could imagine he got his physics wrong, but he didn’t—and of course he didn’t get his economics wrong.) But, like much high-falutin economic theory, it relies upon assumptions that are unlikely to be true.

Set aside the assumptions of perfect competition and unlimited arbitrage that yield Krugman’s key result of equalized interest rates. These are indeed implausible, but they’re also so standard in economics as to be pedestrian.

No, what really concerns me is this: Why bother with interstellar trade at all?

Don’t get me wrong: I’m all in favor of interstellar travel and interstellar colonization. I want humanity to expand and explore the galaxy (or rather, I want that to be done by whatever humanity becomes, likely some kind of cybernetically and biogenetically enhanced transhumans in endless varieties we can scarcely imagine). But once we’ve gone through all the effort to spread ourselves to distant stars, it’s not clear to me that we’d ever have much reason to trade across interstellar distances.

If we ever manage to invent efficient, reliable, affordable faster-than-light (FTL) travel ala Star Trek, sure. In that case, there’s no fundamental difference between interstellar trade and any other kind of trade. But that’s not what Krugman’s paper is about, as its key theorems are actually about interest rates and prices in different inertial reference frames, which is only relevant if you’re limited to relativistic—that is, slower-than-light—velocities.

Moreover, as far as we can tell, that’s impossible. Yes, there are still some vague slivers of hope left with the Alcubierre Drive, wormholes, etc.; but by far the most likely scenario is that FTL travel is simply impossible and always will be.

FTL communication is much more plausible, as it merely requires the exploitation of nonlocal quantum entanglement outside quantum equilibrium; if the Bohm Interpretation is correct (as I strongly believe it is), then this is a technological problem rather than a theoretical one. At best this might one day lead to some form of nonlocal teleportation—but definitely not FTL starships. Since our souls are made of software, sending information can, in principle, send a person; but we almost surely won’t be sending mass faster than light.

So let’s assume, as Krugman did, that we will be limited to travel close to, but less than, the speed of light. (I recently picked up a term for this from Ursula K. Le Guin: “NAFAL”, “nearly-as-fast-as-light”.)

This means that any transfer of material from one star system to another will take, at minimum, years. It could even be decades or centuries, depending on how close to the speed of light we are able to get.

Assuming we have abundant antimatter or some similarly extremely energy-dense propulsion, it would reasonable to expect that we could build interstellar spacecraft that would be capable of accelerating at approximately Earth gravity (i.e. 1 g) for several years at a time. This would be quite comfortable for the crew of the ship—it would just feel like standing on Earth. And it turns out that this is sufficient to attain velocities quite close to the speed of light over the distances to nearby stars.

I will spare you the complicated derivation, but there are well-known equations which allow us to convert from proper acceleration (the acceleration felt on a spacecraft, i.e. 1 g in this case) to maximum velocity and total travel time, and they imply that a vessel which was constantly accelerating at 1 g (speeding up for the first half, then slowing down for the second half) could reach most nearby stars within about 50 to 100 years Earth time, or as little as 10 to 20 years ship time.

With higher levels of acceleration, you can shorten the trip; but that would require designing ships (or engineering crews?) in such a way as to sustain these high levels of acceleration for years at a time. Humans can sustain 3 g’s for hours, but not for years.

Even with only 1-g acceleration, the fuel costs for such a trip are staggering: Even with antimatter fuel you need dozens or hundreds of times as much mass in fuel as you have in payload—and with anything less than antimatter it’s basically just not possible. Yet there is nothing in the laws of physics saying you can’t do it, and I believe that someday we will.

Yet I sincerely doubt we would want to make such trips often. It’s one thing to send occasional waves of colonists, perhaps one each generation. It’s quite another to establish real two-way trade in goods.

Imagine placing an order for something—anything—and not receiving it for another 50 years. Even if, as I hope and believe, our descendants have attained far longer lifespans than we have, asymptotically approaching immortality, it seems unlikely that they’d be willing to wait decades for their shipments to arrive. In the same amount of time you could establish an entire industry in your own star system, built from the ground up, fully scaled to service entire planets.

In order to justify such a transit, you need to be carrying something truly impossible to produce locally. And there just won’t be very many such things.

People, yes. Definitely in the first wave of colonization, but likely in later waves as well, people will want to move themselves and their families across star systems, and will be willing to wait (especially since the time they experience on the ship won’t be nearly as daunting).

And there will be knowledge and experiences that are unique to particular star systems—but we’ll be sending that by radio signal and it will only take as many years as there are light-years between us; or we may even manage to figure out FTL ansibles and send it even faster than that.

It’s difficult for me to imagine what sort of goods could ever be so precious, so irreplaceable, that it would actually make sense to trade them across an interstellar distance. All habitable planets are likely to be made of essentially the same elements, in approximately the same proportions; whatever you may want, it’s almost certainly going to be easier to get it locally than it would be to buy it from another star system.

This is also why I think alien invasion is unlikely: There’s nothing they would particularly want from us that they couldn’t get more easily. Their most likely reason for invading would be specifically to conquer and rule us.

Certainly if you want gold or neodymium or deuterium, it’ll be thousands of times easier to get it at home. But even if you want something hard to make, like antimatter, or something organic and unique, like oregano, building up the industry to manufacture a product or the agriculture to grow a living organism is almost certainly going to be faster and easier than buying it from another solar system.

This is why I believe that for the first generation of interstellar colonists, imports will be textbooks, blueprints, and schematics to help build, and films, games, and songs to stay entertained and tied to home; exports will consist of of scientific data about the new planet as well as artistic depictions of life on an alien world. For later generations, it won’t be so lopsided: The colonies will have new ideas in science and engineering as well as new art forms to share. Billions of people on Earth and thousands or millions on each colony world will await each new transmission of knowledge and art with bated breath.

Long-distance trade historically was mainly conducted via precious metals such as gold; but if interstellar travel is feasible, gold is going to be dirt cheap. Any civilization capable of even sending a small intrepid crew of colonists to Epsilon Eridani is going to consider mining asteroids an utterly trivial task.

Will such transactions involve money? Will we sell these ideas, or simply give them away? Unlike my previous post where I focused on the local economy, here I find myself agreeing with Star Trek: Money isn’t going to make sense for interstellar travel. Unless we have very fast communication, the time lag between paying money out and then seeing it circulate back will be so long that the money returned to you will be basically worthless. And that’s assuming you figure out a way to make transactions clear that doesn’t require real-time authentication—because you won’t have it.

Consider Epsilon Eridani, a plausible choice for one of the first star systems we will colonize. That’s 10.5 light-years away, so a round-trip signal will take 21 years. If inflation is a steady 2%, that means that $100 today will need to come back as $151 to have the same value by the time you hear back from your transaction. If you had the option to invest in a 5% bond instead, you’d have $279 by then. And this is a nearby star.

It would be much easier to simply trade data for data, maybe just gigabyte for gigabyte or maybe by some more sophisticated notion of relative prices. You don’t need to worry about what your dollar will be worth 20 years from now; you know how much effort went into designing that blueprint for an antimatter processor and you know how much you’ll appreciate seeing that VR documentary on the rings of Aegir. You may even have in mind how much it cost you to pay people to design prototypes and how much you can sell the documentary for; but those monetary transactions will be conducted within your own star system, independently of whatever monetary system prevails on other stars.

Indeed, it’s likely that we wouldn’t even bother trying to negotiate how much to send—because that itself would have such overhead and face the same time-lags—and would instead simply make a habit of sending everything we possibly can. Such interchanges could be managed by governments at each end, supported by public endowments. “This year’s content from Epsilon Eridani, brought to you by the Smithsonian Institution.”

We probably won’t ever have—or need, or want—huge freighter ships carrying containers of goods from star to star. But with any luck, we will one day have art and ideas from across the galaxy shared by all of the endless variety of beings humanity has become.

Could the Star Trek economy really work?

2021-06-132021-06-06 pnrj futurism, inequality, macroeconomics, public policy basic income, debt, Elon Musk, energy, inequality, macroeconomics, money, population, scarcity, space travel, Star Trek, taxation, wealth

Jun 13 JDN 2459379

“The economics of the future are somewhat different”, Jean-Luc Picard explains to Lily Sloane in Star Trek: First Contact.

Captain Picard’s explanation is not very thorough, and all we have about the economic system of the Federation comes from similar short glimpes across the various Star Trek films and TV series. The best glimpses of what the Earth’s economy is like largely come from the Picard series in particular.

But I think we can safely conclude that all of the following are true:

1. Energy is extraordinarily abundant, with a single individual having access to an energy scale that would rival the energy production of entire nations at present. By E=mc², simply being able to teleport a human being or materialize a hamburger from raw energy, as seems to be routine in Starfleet, would require something on the order of 10^17 joules, or about 28 billion kilowatt-hours. The total energy supply of the world economy today is about 6*10^20 joules, or 100 trillion kilowatt-hours.

2. There is broad-based prosperity, but not absolute equality. At the very least different people live differently, though it is unclear whether anyone actually has a better standard of living than anyone else. The Picard family still seems to own their family vineyard that has been passed down for generations, and since the population of Earth is given as about 9 billion (a plausible but perhaps slightly low figure for our long-run stable population equilibrium), its acreage is large enough that clearly not everyone on Earth can own that much land.

3. Most resources that we currently think of as scarce are not scarce any longer. Replicator technology allows for the instantaneous production of food, clothing, raw materials, even sophisticated electronics. There is no longer a “manufacturing sector” as such; there are just replicators and people who use or program them. Most likely, even new replicators are made by replicating parts in other replicators and then assembling them. There are a few resources which remain scarce, such as dilithium (somehow involved in generating these massive quantities of energy) and latinum (a bizarre substance that is prized by many other cultures yet for unexplained reasons cannot be viably produced in replicators). Essentially everything else that is scarce is inherently so, such as front-row seats at concerts, original paintings, officer commissions in Starfleet, or land in San Francisco.

4. Interplanetary and even interstellar trade is routine. Starships with warp capability are available to both civilian and government institutions, and imports and exports can be made to planets dozens or even hundreds of light-years away as quickly as we can currently traverse the oceans with a container ship.

5. Money as we know it does not exist. People are not paid wages or salaries for their work. There is still some ownership of personal property, and particular families (including the Picards) seem to own land; but there does not appear to be any private ownership of capital. For that matter there doesn’t even appear to be be much in the way of capital; we never see any factories. There is obviously housing, there is infrastructure such as roads, public transit, and presumably power plants (very, very powerful power plants, see 1!), but that may be all. Nearly all manufacturing seems to be done by replicators, and what can’t be done by replicators (e.g. building new starships) seems to be all orchestrated by state-owned enterprises such as Starfleet.

Could such an economy actually work? Let’s stipulate that we really do manage to achieve such an extraordinary energy scale, millions of times more than what we can currently produce. Even very cheap, widespread nuclear energy would not be enough to make this plausible; we would need at least abundant antimatter, and quite likely something even more exotic than this, like zero point energy. Along this comes some horrifying risks—imagine an accident at a zero-point power plant that tears a hole in the fabric of space next to a major city, or a fanatical terrorist with a handheld 20-megaton antimatter bomb. But let’s assume we’ve found ways to manage those risks as well.

Furthermore, let’s stipulate that it’s possible to build replicators and warp drives and teleporters and all the similarly advanced technology that the Federation has, much of which is so radically advanced we can’t even be sure that such a thing is possible.

What I really want to ask is whether it’s possible to sustain a functional economy at this scale without money. George Roddenberry clearly seemed to think so. I am less convinced.

First of all, I want to acknowledge that there have been human societies which did not use money, or even any clear notion of a barter system. In fact, most human cultures for most of our history as a species allocated resources based on collective tribal ownership and personal favors. Some of the best parts of Debt: The First 5000 Years are about these different ways of allocating resources, which actually came much more naturally to us than money.

But there seem to have been rather harsh constraints on what sort of standard of living could be maintained in such societies. There was essentially zero technological advancement for thousands of years in most hunter-gatherer cultures, and even the wealthiest people in most of those societies overall had worse health, shorter lifespans, and far, far less access to goods and services than people we would consider in poverty today.

Then again, perhaps money is only needed to catalyze technological advancement; perhaps once you’ve already got all the technology you need, you can take money away and return to a better way of life without greed or inequality. That seems to be what Star Trek is claiming: That once we can make a sandwich or a jacket or a phone or even a car at the push of a button, we won’t need to worry about paying people because everyone can just have whatever they need.

Yet whatever they need is quite different from whatever they want, and therein lies the problem. Yes, I believe that with even moderate technological advancement—the sort of thing I expect to see in the next 50 years, not the next 300—we will have sufficient productivity that we could provide for the basic needs of every human being on Earth. A roof over your head, food on your table, clothes to wear, a doctor and a dentist to see twice a year, emergency services, running water, electricity, even Internet access and public transit—these are things we could feasibly provide to literally everyone with only about two or three times our current level of GDP, which means only about 2% annual economic growth for the next 50 years. Indeed, we could already provide them for every person in First World countries, and it is quite frankly appalling that we fail to do so.

However, most of us in the First World already live a good deal better than that. We don’t have the most basic housing possible, we have nice houses we want to live in. We don’t take buses everywhere, we own our own cars. We don’t eat the cheapest food that would provide adequate nutrition, we eat a wide variety of foods; we order pizza and Chinese takeout, and even eat at fancy restaurants on occasion. It’s less clear that we could provide this standard of living to everyone on Earth—but if economic growth continues long enough, maybe we can.

Worse, most of us would like to live even better than we do. My car is several years old right now, and it runs on gasoline; I’d very much like to upgrade to a brand-new electric car. My apartment is nice enough, but it’s quite small; I’d like to move to a larger place that would give me more space not only for daily living, but also for storage and for entertaining guests. I work comfortable hours for decent pay at a white-collar job that can be done entirely remotely on mostly my own schedule, but I’d prefer to take some time off and live independently while I focus more on my own writing. I sometimes enjoy cooking, but often it can be a chore, and sometimes I wish I could just go eat out at a nice restaurant for dinner every night. I don’t make all these changes because I can’t afford to—that is, because I don’t have the money.

Perhaps most of us would feel no need to have a billion dollars. I don’t really know what $100 billion actually gets you, as far as financial security, independence, or even consumption, that $50 million wouldn’t already. You can have total financial freedom and security with a middle-class American lifestyle with net wealth of about $2 million. If you want to also live in a mansion, drink Dom Perignon with every meal and drive a Lamborghini (which, quite frankly, I have no particular desire to do), you’ll need several million more—but even then you clearly don’t need $1 billion, let alone $100 billion. So there is indeed something pathological about wanting a billion dollars for yourself, and perhaps in the Federation they have mental health treatments for “wealth addiction” that prevent people from experiencing such pathological levels of greed.

Yet in fact, with the world as it stands, I would want a billion dollars. Not to own it. Not to let it sit and grow in some brokerage account. Not to simply be rich and be on the Forbes list. I couldn’t care less about those things. But with a billion dollars, I could donate enormous amounts to charities, saving thousands or even millions of lives. I could found my own institutions—research institutes, charitable foundations—and make my mark on the world. With $100 billion, I could make a serious stab at colonizing Mars—as Elon Musk seems to be doing, but most other billionaires have no particular interest in.

And it begins to strain credulity to imagine a world of such spectacular abundance that everyone could have enough to do that.

This is why I always struggle to answer when people ask me things like “If money were not object, how would you live your life?”; if money were no object, I’d end world hunger, cure cancer, and colonize the Solar System. Money is always an object. What I think you meant to ask was something much less ambitious, like “What would you do if you had a million dollars?” But I might actually have a million dollars someday—most likely by saving and investing the proceeds of a six-figure job as an economist over many years. (Save $2,000 per month for 20 years, growing it at 7% per year, and you’ll be over $1 million. You can do your own calculations here.) I doubt I’ll ever have $10 million, and I’m pretty sure I’ll never have $1 billion.

To be fair, it seems that many of the grand ambitions I would want to achieve with billions of dollars already are achieved by 23rd century; world hunger has definitely been ended, cancer seems to have been largely cured, and we have absolutely colonized the Solar System (and well beyond). But that doesn’t mean that new grand ambitions wouldn’t arise, and indeed I think they would. What if I wanted to command my own fleet of starships? What if I wanted a whole habitable planet to conduct experiments on, perhaps creating my own artificial ecosystem? The human imagination is capable of quite grand ambitions, and it’s unlikely that we could ever satisfy all of them for everyone.

Some things are just inherently scarce. I already mentioned some earlier: Original paintings, front-row seats, officer commissions, and above all, land. There’s only so much land that people want to live on, especially because people generally want to live near other people (Internet access could conceivably reduce the pressure for this, but, uh, so far it really hasn’t, so why would we think it will in 300 years?). Even if it’s true that people can have essentially arbitrary amounts of food, clothing, or electronics, the fact remains that there’s only so much real estate in San Francisco.

It would certainly help to build taller buildings, and presumably they would, though most of the depictions don’t really seem to show that; where are the 10-kilometer-tall skyscrapers made of some exotic alloy or held up by structural integrity fields? (Are the forces of NIMBY still too powerful?) But can everyone really have a 1000-square-meter apartment in the center of downtown? Maybe if you build tall enough? But you do still need to decide who gets the penthouse.

It’s possible that all inherently-scarce resources could be allocated by some mechanism other than money. Some even should be: Starfleet officer commissions are presumably allocated by merit. (Indeed, Starfleet seems implausibly good at selecting supremely competent officers.) Others could be: Concert tickets could be offered by lottery, and maybe people wouldn’t care so much about being in the real front row when you can always simulate the front row at home in your holodeck. Original paintings could all be placed in museums available for public access—and the tickets, too, could be allocated by lottery or simply first-come, first-served. (Picard mentions the Smithsonian, so public-access museums clearly still exist.)

Then there’s the question of how you get everyone to work, if you’re not paying them. Some jobs people will do for fun, or satisfaction, or duty, or prestige; it’s plausible that people would join Starfleet for free (I’m pretty sure I would). But can we really expect all jobs to work that way? Has automation reached such an advanced level that there are no menial jobs? Sanitation? Plumbing? Gardening? Paramedics? Police? People still seem to pick grapes by hand in the Picard vineyards; do they all do it for the satisfaction of a job well done? What happens if one day everyone decides they don’t feel like picking grapes today?

I certainly agree that most menial jobs are underpaid—most people do them because they can’t get better jobs. But surely we don’t want to preserve that? Surely we don’t want some sort of caste system that allocates people to work as plumbers or garbage collectors based on their birth? I guess we could use merit-based aptitude testing; it’s clear that the vast majority of people really aren’t cut out for Starfleet (indeed, perhaps I’m not!), and maybe some people really would be happiest working as janitors. But it’s really not at all clear what such a labor allocation system would be like. I guess if automation has reached such an advanced level that all the really necessary work is done by machines and human beings can just choose to work as they please, maybe that could work; it definitely seems like a very difficult system to manage.

So I guess it’s not completely out of the question that we could find some appropriate mechanism to allocate all goods and services without ever using money. But then my question becomes: Why? What do you have against money?

I understand hating inequality—indeed I share that feeling. I, too, am outraged by the existence of hectobillionaires in a world where people still die of malaria and malnutrition. But having a money system, or even a broadly free-market capitalist economy, doesn’t inherently have to mean allowing this absurd and appalling level of inequality. We could simply impose high, progressive taxes, redistribute wealth, and provide a generous basic income. If per-capita GDP is something like 100 times its current level (as it appears to be in Star Trek), then the basic income could be $1 million per year and still be entirely affordable.

That is, rather than trying to figure out how to design fair and efficient lotteries for tickets to concerts and museums, we could still charge for tickets, and just make sure that everyone has a million dollars a year in basic income. Instead of trying to find a way to convince people to clean bathrooms for free, we could just pay them to do it.

The taxes could even be so high at the upper brackets that they effectively impose a maximum income; say we have a 99% marginal rate above $20 million per year. Then the income inequality would collapse to quite a low level: No one below $1 million, essentially no one above $20 million. We could tax wealth as well, ensuring that even if people save or get lucky on the stock market (if we even still have a stock market—maybe that is unnecessary after all), they still can’t become hectobillionaires. But by still letting people use money and allowing some inequality, we’d still get all the efficiency gains of having a market economy (minus whatever deadweight loss such a tax system imposed—which I in fact suspect would not be nearly as large as most economists fear).

In all, I guess I am prepared to say that, given the assumption of such great feats of technological advancement, it is probably possible to sustain such a prosperous economy without the use of money. But why bother, when it’s so much easier to just have progressive taxes and a basic income?

Why is cryptocurrency popular?

2021-05-302021-05-23 pnrj financial advice, financial fraud, futurism, heuristics and biases, market failure, public policy Bitcoin, China, crypto, cryptocurrency, Dogecoin, Elon Musk, Etherium, FOMO, gambling, investment, money, Ponzi scheme, risk, stock market

May 30 JDN 2459365

At the time of writing, the price of most cryptocurrencies has crashed, likely due to a ban on conventional banks using cryptocurrency in China (though perhaps also due to Elon Musk personally refusing to accept Bitcoin at his businesses). But for all I know by the time this post goes live the price will surge again. Or maybe they’ll crash even further. Who knows? The prices of popular cryptocurrencies have been extremely volatile.

This post isn’t really about the fluctuations of cryptocurrency prices. It’s about something a bit deeper: Why are people willing to put money into cryptocurrencies at all?

The comparison is often made to fiat currency: “Bitcoin isn’t backed by anything, but neither is the US dollar.”

But the US dollar is backed by something: It’s backed by the US government. Yes, it’s not tradeable for gold at a fixed price, but so what? You can use it to pay taxes. The government requires it to be legal tender for all debts. There are certain guaranteed exchange rights built into the US dollar, which underpin the value that the dollar takes on in other exchanges. Moreover, the US Federal Reserve carefully manages the supply of US dollars so as to keep their value roughly constant.

Bitcoin does not have this (nor does Dogecoin, or Etherium, or any of the other hundreds of lesser-known cryptocurrencies). There is no central bank. There is no government making them legal tender for any debts at all, let alone all of them. Nobody collects taxes in Bitcoin.

And so, because its value is untethered, Bitcoin’s price rises and falls, often in huge jumps, more or less randomly. If you look all the way back to when it was introduced, Bitcoin does seem to have an overall upward price trend, but this honestly seems like a statistical inevitability: If you start out being worthless, the only way your price can change is upward. While some people have become quite rich by buying into Bitcoin early on, there’s no particular reason to think that it will rise in value from here on out.

Nor does Bitcoin have any intrinsic value. You can’t eat it, or build things out of it, or use it for scientific research. It won’t even entertain you (unless you have a very weird sense of entertainment). Bitcoin doesn’t even have “intrinsic value” the way gold does (which is honestly an abuse of the term, since gold isn’t actually especially useful): It isn’t innately scarce. It was made scarce by its design: Through the blockchain, a clever application of encryption technology, it was made difficult to generate new Bitcoins (called “mining”) in an exponentially increasing way. But the decision of what encryption algorithm to use was utterly arbitrary. Bitcoin mining could just as well have been made a thousand times easier or a thousand times harder. They seem to have hit a sweet spot where they made it just hard enough that it make Bitcoin seem scarce while still making it feel feasible to get.

We could actually make a cryptocurrency that does something useful, by tying its mining to a genuinely valuable pursuit, like analyzing scientific data or proving mathematical theorems. Perhaps I should suggest a partnership with Folding@Home to make FoldCoin, the crypto coin you mine by folding proteins. There are some technical details there that would be a bit tricky, but I think it would probably be feasible. And then at least all this computing power would accomplish something, and the money people make would be to compensate them for their contribution.

But Bitcoin is not useful. No institution exists to stabilize its value. It constantly rises and falls in price. Why do people buy it?

In a word, FOMO. The fear of missing out. People buy Bitcoin because they see that a handful of other people have become rich by buying and selling Bitcoin. Bitcoin symbolizes financial freedom: The chance to become financially secure without having to participate any longer in our (utterly broken) labor market.

In this, volatility is not a bug but a feature: A stable currency won’t change much in value, so you’d only buy into it because you plan on spending it. But an unstable currency, now, there you might manage to get lucky speculating on its value and get rich quick for nothing. Or, more likely, you’ll end up poorer. You really have no way of knowing.

That makes cryptocurrency fundamentally like gambling. A few people make a lot of money playing poker, too; but most people who play poker lose money. Indeed, those people who get rich are only able to get rich because other people lose money. The game is zero-sum—and likewise so is cryptocurrency.

Note that this is not how the stock market works, or at least not how it’s supposed to work (sometimes maybe). When you buy a stock, you are buying a share of the profits of a corporation—a real, actual corporation that produces and sells goods or services. You’re (ostensibly) supplying capital to fund the operations of that corporation, so that they might make and sell more goods in order to earn more profit, which they will then share with you.

Likewise when you buy a bond: You are lending money to an institution (usually a corporation or a government) that intends to use that money to do something—some real actual thing in the world, like building a factory or a bridge. They are willing to pay interest on that debt in order to get the money now rather than having to wait.

Initial Coin Offerings were supposed to be away to turn cryptocurrency into a genuine investment, but at least in their current virtually unregulated form, they are basically indistinguishable from a Ponzi scheme. Unless the value of the coin is somehow tied to actual ownership of the corporation or shares of its profits (the way stocks are), there’s nothing to ensure that the people who buy into the coin will actually receive anything in return for the capital they invest. There’s really very little stopping a startup from running an ICO, receiving a bunch of cash, and then absconding to the Cayman Islands. If they made it really obvious like that, maybe a lawsuit would succeed; but as long as they can create even the appearance of a good-faith investment—or even actually make their business profitable!—there’s nothing forcing them to pay a cent to the owners of their cryptocurrency.

The really frustrating thing for me about all this is that, sometimes, it works. There actually are now thousands of people who made decisions that by any objective standard were irrational and irresponsible, and then came out of it millionaires. It’s much like the lottery: Playing the lottery is clearly and objectively a bad idea, but every once in awhile it will work and make you massively better off.

It’s like I said in a post about a year ago: Glorifying superstars glorifies risk. When a handful of people can massively succeed by making a decision, that makes a lot of other people think that it was a good decision. But quite often, it wasn’t a good decision at all; they just got spectacularly lucky.

I can’t exactly say you shouldn’t buy any cryptocurrency. It probably has better odds than playing poker or blackjack, and it certainly has better odds than playing the lottery. But what I can say is this: It’s about odds. It’s gambling. It may be relatively smart gambling (poker and blackjack are certainly a better idea than roulette or slot machines), with relatively good odds—but it’s still gambling. It’s a zero-sum high-risk exchange of money that makes a few people rich and lots of other people poorer.

With that in mind, don’t put any money into cryptocurrency that you couldn’t afford to lose at a blackjack table. If you’re looking for something to seriously invest your savings in, the answer remains the same: Stocks. All the stocks.

I doubt this particular crash will be the end for cryptocurrency, but I do think it may be the beginning of the end. I think people are finally beginning to realize that cryptocurrencies are really not the spectacular innovation that they were hyped to be, but more like a high-tech iteration of the ancient art of the Ponzi scheme. Maybe blockchain technology will ultimately prove useful for something—hey, maybe we should actually try making FoldCoin. But the future of money remains much as it has been for quite some time: Fiat currency managed by central banks.

What would a game with realistic markets look like?

2018-08-122018-08-12 pnrj experimental economics, macroeconomics, public policy arbitrage, gaming, Law of One Price, monetary policy, money, Pirate Code, Skyrim, video games

Aug 12 JDN 2458343

From Pokemon to Dungeons & Dragons, Final Fantasy to Mass Effect, almost all role-playing games have some sort of market: Typically, you buy and sell equipment, and often can buy services such as sleeping at inns. Yet the way those markets work is extremely rigid and unrealistic.

(I’m of course excluding games like EVE Online that actually create real markets between players; those markets are so realistic I actually think they would provide a good opportunity for genuine controlled experiments in macroeconomics.)

The weirdest thing about in-game markets is the fact that items almost always come with a fixed price. Sometimes there is some opportunity for haggling, or some randomization between different merchants; but the notion always persists that the item has a “true price” that is being adjusted upward or downward. This is more or less the opposite of how prices actually work in real markets.

There is no “true price” of a car or a pizza. Prices are whatever buyers and sellers make them. There is a true value—the amount of real benefit that can be obtained from a good—but even this is something that varies between individuals and also changes based on the other goods being consumed. The value of a pizza is considerably higher for someone who hasn’t eaten in days than to someone who just finished eating another pizza.

There is also what is called “The Law of One Price”, but like all laws of economics, it’s like the Pirate Code , more what you’d call a “guideline”, and it only applies to a particular good in a particular market at a particular time. The Law of One Price doesn’t even say that a pizza should have the same price tomorrow as it does today, or that the same pizza can’t be sold to two different customers at two different prices; it only says that the same pizza shouldn’t have two different prices in the same place at the same time for the same customer. (It seems almost tautological, right? And yet it still fails empirically, and does so again and again. I have seen offers for the same book in the same condition posted on the same website that differed by as much as 50%.)

In well-developed capitalist markets in large First World countries, we can lull ourselves into the illusion that there is only one price for a good, because markets are highly liquid and either highly competitive or controlled by a strong and stable oligopoly that enforces a particular price across places and times. The McDonald’s Dollar Menu is a policy choice by a massive multinational corporation; it’s not what would occur naturally if those items were sold on a competitive market.

Even then, this illusion can be broken when we are faced with a large economic shock, such as the OPEC price shock in 1973 or a natural disaster like Hurricane Katrina. It also tends to be broken for illiquid goods such as real estate.

If we consider the environment in which most role-playing games take place, it’s usually a sort of quasi-medieval or quasi-Renaissance feudal society, where a given government controls only a small region and traveling between towns is difficult and dangerous. Not only should the prices of goods differ substantially between towns, the currency used should frequently differ as well. Yes, most places would accept gold and silver; but a kingdom with a stable government will generally have a currency of significant seignorage, with coins worth considerably more than the gold used to mint them—yet the value of that seignorage will drop off as you move further away from that kingdom and its sphere of influence.

Moreover, prices should be inconsistent even between traders in the same town, and extremely volatile. When a town is mostly self-sufficient and trade is only a small part of its economy, even a small shock such as a bad thunderstorm or a brief drought can yield massive shifts in prices. Shortages and gluts will be frequent, as both supply and demand are small and ever-changing.

This wouldn’t be that difficult to implement. The simplest way would just be to institute random shocks to prices that vary by place and time. A more sophisticated method would be to actually simulate supply and demand for different goods, and then have prices respond to realistic shocks (e.g. a drought makes wheat more expensive, and the price of swords suddenly skyrockets after news of an impending dragon attack). Experiments have shown that competitive market outcomes can be achieved by simulating even a dozen or so traders using very simple heuristics like “don’t pay more than you can afford” and “don’t charge less than it cost you”.

Why don’t game designers implement this? I think there are two reasons.

The first is simply that it would be more complicated. This is a legitimate concern in many cases; I particularly think Pokemon can justify using a simple economy, given its target audience. I particularly agree that having more than a handful of currencies would be too much for players to keep track of; though perhaps having two or three (one for each major faction?) is still more interesting than only having one.

Also, tabletop games are inherently more limited in the amount of computation they can use, compared to video games. But for a game as complicated as say Skyrim, this really isn’t much of a defense. Skyrim actually simulated the daily routines of over a hundred different non-player characters; it could have been simulating markets in the background as well—in fact, it could have simply had those same non-player characters buy and sell goods with each other in a double-auction market that would automatically generate the prices that players face.

The more important reason, I think, is that game designers have a paralyzing fear of arbitrage.

I find it particularly aggravating how frequently games will set it up so that the price at which you buy and the price at which you sell are constrained so that the buying price is always higher, often as much as twice as high. This is not at all how markets work in the real world; frankly it’s only even close to true for goods like cars that rapidly depreciate. It make senses that a given merchant will not sell you a good for less than what they would pay to buy it from you; but that only requires each individual merchant to have a well-defined willingness-to-pay and willingness-to-accept. It certainly does not require the arbitrary constraint that you can never sell something for more than what you bought it for.

In fact, I would probably even allow players who specialize in social skills to short-change and bamboozle merchants for profit, as this is absolutely something that happens in the real world, and was likely especially common under the very low levels of literacy and numeracy that prevailed in the Middle Ages.

To many game designers (and gamers), the ability to buy a good in one place, travel to another place, and sell that good for a higher price seems like cheating. But this practice is call being a merchant. That is literally what the entire retail industry does. The rules of your game should allow you to profit from activities that are in fact genuinely profitable real economic services in the real world.

I remember a similar complaint being raised against Skyrim shortly after its release, that one could acquire a pickaxe, collect iron ore, smelt it into steel, forge weapons out of it, and then sell the weapons for a sizeable profit. To some people, this sounded like cheating. To me, it sounds like being a blacksmith. This is especially true because Skyrim’s skill system allowed you to improve the quality of your smithed items over time, just like learning a trade through practice (though it ramped up too fast, as it didn’t take long to make yourself clearly the best blacksmith in all of Skyrim). Frankly, this makes far more sense than being able to acquire gold by adventuring through the countryside and slaughtering monsters or collecting lost items from caves. Blacksmiths were a large part of the medieval economy; spelunking adventurers were not. Indeed, it bothers me that there weren’t more opportunities like this; you couldn’t make your wealth by being a farmer, a vintner, or a carpenter, for instance.

Even if you managed to pull off pure arbitrage, providing no real services, such as by buying and selling between two merchants in the same town, or the same merchant on two consecutive days, that is also a highly profitable industry. Most of our financial system is built around it, frankly. If you manage to make your wealth selling wheat futures instead of slaying dragons, I say more power to you. After all, there were an awful lot of wheat-future traders in the Middle Ages, and to my knowledge no actually successful dragon-slayers.

Of course, if your game is about slaying dragons, it should include some slaying of dragons. And if you really don’t care about making a realistic market in your game, so be it. But I think that more realistic markets could actually offer a great deal of richness and immersion into a world without greatly increasing the difficulty or complexity of the game. A world where prices change in response to the events of the story just feels more real, more alive.

The ability to profit without violence might actually draw whole new modes of play to the game (as has indeed occurred with Skyrim, where a small but significant proportion of players have chosen to live out peaceful lives as traders or blacksmiths). I would also enrich the experience of more conventional players and helping them recover from setbacks (if the only way to make money is to fight monsters and you keep getting killed by monsters, there isn’t much you can do; but if you have the option of working as a trader or a carpenter for awhile, you could save up for better equipment and try the fighting later).

And hey, game designers: If any of you are having trouble figuring out how to implement such a thing, my consulting fees are quite affordable.

Social construction is not fact—and it is not fiction

2017-07-302017-07-27 pnrj core principles Deepak Chopra, fact, fiat currency, fiction, gender, gold, math, money, objective, race, representative currency, science, seignorage, sex, social construction, subjective

July 30, JDN 2457965

With the possible exception of politically-charged issues (especially lately in the US), most people are fairly good at distinguishing between true and false, fact and fiction. But there are certain types of ideas that can’t be neatly categorized into fact versus fiction.

First, there are subjective feelings. You can feel angry, or afraid, or sad—and really, truly feel that way—despite having no objective basis for the emotion coming from the external world. Such emotions are usually irrational, but even knowing that doesn’t make them automatically disappear. Distinguishing subjective feelings from objective facts is simple in principle, but often difficult in practice: A great many things simply “feel true” despite being utterly false. (Ask an average American which is more likely to kill them, a terrorist or the car in their garage; I bet quite a few will get the wrong answer. Indeed, if you ask them whether they’re more likely to be shot by someone else or to shoot themselves, almost literally every gun owner is going to get that answer wrong—or they wouldn’t be gun owners.)

The one I really want to focus on today is social constructions. This is a term that has been so thoroughly overused and abused by postmodernist academics (“science is a social construction”, “love is a social construction”, “math is a social construction”, “sex is a social construction”, etc.) that it has almost lost its meaning. Indeed, many people now react with automatic aversion to the term; upon hearing it, they immediately assume—understandably—that whatever is about to follow is nonsense.

But there is actually a very important core meaning to the term “social construction” that we stand to lose if we throw it away entirely. A social construction is something that exists only because we all believe in it.

Every part of that definition is important:

First, a social construction is something that exists: It’s really there, objectively. If you think it doesn’t exist, you’re wrong. It even has objective properties; you can be right or wrong in your beliefs about it, even once you agree that it exists.

Second, a social construction only exists because we all believe in it: If everyone in the world suddenly stopped believing in it, like Tinker Bell it would wink out of existence. The “we all” is important as well; a social construction doesn’t exist simply because one person, or a few people, believe in it—it requires a certain critical mass of society to believe in it. Of course, almost nothing is literally believed by everyone, so it’s more that a social construction exists insofar as people believe in it—and thus can attain a weaker or stronger kind of existence as beliefs change.

The combination of these two features makes social constructions a very weird sort of entity. They aren’t merely subjective beliefs; you can’t be wrong about what you are feeling right now (though you can certainly lie about it), but you can definitely be wrong about the social constructions of your society. But we can’t all be wrong about the social constructions of our society; once enough of our society stops believing in them, they will no longer exist. And when we have conflict over a social construction, its existence can become weaker or stronger—indeed, it can exist to some of us but not to others.

If all this sounds very bizarre and reminds you of postmodernist nonsense that might come from the Wisdom of Chopra randomizer, allow me to provide a concrete and indisputable example of a social construction that is vitally important to economics: Money.

The US dollar is a social construction. It has all sorts of well-defined objective properties, from its purchasing power in the market to its exchange rate with other currencies (also all social constructions). The markets in which it is spent are social constructions. The laws which regulate those markets are social constructions. The government which makes those laws is a social construction.

But it is not social constructions all the way down. The paper upon which the dollar was printed is a physical object with objective factual existence. It is an artifact—it was made by humans, and wouldn’t exist if we didn’t—but now that we’ve made it, it exists and would continue to exist regardless of whether we believe in it or even whether we continue to exist. The cotton from which it was made is also partly artificial, bred over centuries from a lifeform that evolved over millions of years. But the carbon atoms inside that cotton were made in a star, and that star existed and fused its carbon billions of years before any life on Earth existed, much less humans in particular. This is why the statements “math is a social construction” and “science is a social construction” are so ridiculous. Okay, sure, the institutions of science and mathematics are social constructions, but that’s trivial; nobody would dispute that, and it’s not terribly interesting. (What, you mean if everyone stopped going to MIT, there would be no MIT!?) The truths of science and mathematics were true long before we were even here—indeed, the fundamental truths of mathematics could not have failed to be true in any possible universe.

But the US dollar did not exist before human beings created it, and unlike the physical paper, the purchasing power of that dollar (which is, after all, mainly what we care about) is entirely socially constructed. If everyone in the world suddenly stopped accepting US dollars as money, the US dollar would cease to be money. If even a few million people in the US suddenly stopped accepting dollars, its value would become much more precarious, and inflation would be sure to follow.

Nor is this simply because the US dollar is a fiat currency. That makes it more obvious, to be sure; a fiat currency attains its value solely through social construction, as its physical object has negligible value. But even when we were on the gold standard, our currency was representative; the paper itself was still equally worthless. If you wanted gold, you’d have to exchange for it; and that process of exchange is entirely social construction.

And what about gold coins, one of the oldest form of money? There now the physical object might actually be useful for something, but not all that much. It’s shiny, you can make jewelry out of it, it doesn’t corrode, it can be used to replace lost teeth, it has anti-inflammatory properties—and millennia later we found out that its dense nucleus is useful for particle accelerator experiments and it is a very reliable electrical conductor useful for making microchips. But all in all, gold is really not that useful. If gold were priced based on its true usefulness, it would be extraordinarily cheap; cheaper than water, for sure, as it’s much less useful than water. Yet very few cultures have ever used water as currency (though some have used salt). Thus, most of the value of gold is itself socially constructed; you value gold not to use it, but to impress other people with the fact that you own it (or indeed to sell it to them). Stranded alone on a desert island, you’d do anything for fresh water, but gold means nothing to you. And a gold coin actually takes on additional socially-constructed value; gold coins almost always had seignorage, additional value the government received from minting them over and above the market price of the gold itself.

Economics, in fact, is largely about social constructions; or rather I should say it’s about the process of producing and distributing artifacts by means of social constructions. Artifacts like houses, cars, computers, and toasters; social constructions like money, bonds, deeds, policies, rights, corporations, and governments. Of course, there are also services, which are not quite artifacts since they stop existing when we stop doing them—though, crucially, not when we stop believing in them; your waiter still delivered your lunch even if you persist in the delusion that the lunch is not there. And there are natural resources, which existed before us (and may or may not exist after us). But these are corner cases; mostly economics is about using laws and money to distribute goods, which means using social constructions to distribute artifacts.

Other very important social constructions include race and gender. Not melanin and sex, mind you; human beings have real, biological variation in skin tone and body shape. But the concept of a race—especially the race categories we ordinarily use—is socially constructed. Nothing biological forced us to regard Kenyan and Burkinabe as the same “race” while Ainu and Navajo are different “races”; indeed, the genetic data is screaming at us in the opposite direction. Humans are sexually dimorphic, with some rare exceptions (only about 0.02% of people are intersex; about 0.3% are transgender; and no more than 5% have sex chromosome abnormalities). But the much thicker concept of gender that comes with a whole system of norms and attitudes is all socially constructed.

It’s one thing to say that perhaps males are, on average, more genetically predisposed to be systematizers than females, and thus men are more attracted to engineering and women to nursing. That could, in fact, be true, though the evidence remains quite weak. It’s quite another to say that women must not be engineers, even if they want to be, and men must not be nurses—yet the latter was, until very recently, the quite explicit and enforced norm. Standards of clothing are even more obviously socially-constructed; in Western cultures (except the Celts, for some reason), flared garments are “dresses” and hence “feminine”; in East Asian cultures, flared garments such as kimono are gender-neutral, and gender is instead expressed through clothing by subtler aspects such as being fastened on the left instead of the right. In a thousand different ways, we mark our gender by what we wear, how we speak, even how we walk—and what’s more, we enforce those gender markings. It’s not simply that males typically speak in lower pitches (which does actually have a biological basis); it’s that males who speak in higher pitches are seen as less of a man, and that is a bad thing. We have a very strict hierarchy, which is imposed in almost every culture: It is best to be a man, worse to be a woman who acts like a woman, worse still to be a woman who acts like a man, and worst of all to be a man who acts like a woman. What it means to “act like a man” or “act like a woman” varies substantially; but the core hierarchy persists.

Social constructions like these ones are in fact some of the most important things in our lives. Human beings are uniquely social animals, and we define our meaning and purpose in life largely through social constructions.

It can be tempting, therefore, to be cynical about this, and say that our lives are built around what is not real—that is, fiction. But while this may be true for religious fanatics who honestly believe that some supernatural being will reward them for their acts of devotion, it is not a fair or accurate description of someone who makes comparable sacrifices for “the United States” or “free speech” or “liberty”. These are social constructions, not fictions. They really do exist. Indeed, it is only because we are willing to make sacrifices to maintain them that they continue to exist. Free speech isn’t maintained by us saying things we want to say; it is maintained by us allowing other people to say things we don’t want to hear. Liberty is not protected by us doing whatever we feel like, but by not doing things we would be tempted to do that impose upon other people’s freedom. If in our cynicism we act as though these things are fictions, they may soon become so.

But it would be a lot easier to get this across to people, I think, if folks would stop saying idiotic things like “science is a social construction”.

What you can do to protect against credit card fraud

2017-06-182017-06-11 pnrj financial advice, financial fraud, public policy credit card, fraud, FTC, money, password, safety, security, theft

JDN 2457923

This is the second post in my ongoing series on financial fraud, but it’s also some useful personal financial advice. One of the most common forms of fraud, which I have experienced, and most Americans will experience at some point in their lives, is credit card fraud. The US leads the world in credit card fraud, accounting for 47% of all money stolen by this means. In most countries credit card fraud is declining, but not here.

The good news is that there are several things you can do to reduce both the probability of being victimized and the harm you will suffer if you are. I am of course not the first to make such recommendations; similar lists have been made by the Wall Street Journal, Consumer Reports, and even the FTC itself.

1. The first and simplest is to use fewer credit cards.

It is a good idea to have at least one credit card, because you can build a credit history this way which will help you get larger loans such as car loans and home loans later. The best thing to do is to use it for regular purchases and then pay it off as quickly as you can. The higher the interest rate, the more imperative it is to pay it quickly.

More credit cards means that you have more to keep track of, and more that can be stolen; it also generally means that you have larger total credit limits, which is a mixed blessing at best. You have more liquidity that way, to buy things you need; but you also have more temptation to buy things you don’t actually need, and more risk of losing a great deal should any of your cards be stolen.

2. Buy fewer things online, and always from reputable merchants.

This is one I certainly preach more than I practice; I probably buy as much online now as I do in person. It’s hard to beat the combination of higher convenience, wider selection, and lower prices. But buying online is the most likely way to have your credit card stolen (and it is certainly how mine was stolen a few years ago).

The US is unusual among developed countries because we still mainly use magnetic-strip cards, whereas most countries have switched to the EMV system of chip-based cards that provide more security. But this security measure is really quite overrated; it can’t protect against “card not present” fraud, which is by far the most common. Unless and until you can somehow link up the encrypted chips to your laptop in order to use them to pay online, the chips will do little to protect against fraud.

3. Monitor your bank and credit card statements regularly.

This is something you should be doing anyway. Online statements are available from just about every major bank and credit union, and you can check them at any time, any day. Watching these online statements will help you keep track of your spending, manage your budget, and, yes, protect against fraud, because the sooner you see and report a suspicious transaction the more likely you are to recover the money.

4. Use secure passwords, don’t re-use passwords, and use a secure password manager.

Most people still use remarkably insecure passwords for their online accounts. Hacking your online accounts —especially your online retail accounts, like Amazon—typically means being able to steal your credit cards. As we move into the cyberpunk future, personal security will increasingly be coextensive with online security, and until we find something better, that means good passwords.

Passwords should be long, complicated, and not easily tied to anything about you. To remember them, I highly recommend the following technique: Write a sentence of several words, and then convert the words of that sentence into letters and numbers. For example (obviously don’t use this particular example; the whole point is for passwords to be unique), the sentence “Passwords should be long, complicated, and not easily tied to anything about you.” could become the password “Psblcanet2aau”.

Human long-term memory is encoded in something very much like narrative, so you can make a password much more memorable by making it tell a story. (Literally a story if you like: “Once upon a time, in a land far away, there were seven dwarves who lived in a forest.” could form the password “1uatialfatw7dwliaf”.) If you used the whole words, it would be far too long to fit in most password systems; but by condensing it into letters, you keep it memorable while allowing it to fit. The first letters of English words are not quite random—some letters are much more common than others, for example—but as long as the password is long enough this doesn’t make it substantially easier to guess.

If you have any doubts about the security of your password, do the following: Generate a new password by the same method you used to generate that one, and then try the new password—not the old password—in an entropy checking utility such as https://howsecureismypassword.net/. The utility will tell you approximately how long it would take to guess your password by guessing random characters using current technology. This is really an upper limit—computers will get faster, and by knowing things about you, hackers can improve upon random guessing substantially—but a good password should at least be in the thousands or millions of years, while a very bad password (like the word “password” itself) can literally be in the nanoseconds. (Actually if you play around you can generate passwords that can take far longer, even “12 tredecillion years” and the like, but they are generally too long to actually use.) The reason not to use your actual password is that there is a chance, however remote, that it could be intercepted while you were doing the check. But by checking the method, you can ensure that you are generating passwords in an effective way.

After you’ve generated all these passwords, how do you remember them all? It’s unreasonable to expect you to keep them all in your head. Instead, you can just keep a few of the most important ones in your head, including a master password that you then use for a password manager like LastPass or Keeper. Password managers are frequently rated by sites like PC Mag, CNET, Consumer Affairs, and CSO. Get one that is free and top-rated; there’s no reason to pay when the free ones are just as good, and no excuse for getting any less than the best when the best ones are free.

The idea of a password manager makes some people uncomfortable—aren’t you handing your passwords over to someone else?—so let me explain it a little. You aren’t actually handing over your passwords, first of all; a reputable password manager will actually encrypt your passwords locally, and then only transmit encrypted versions of them to the site that operates the password manager. This means that no one—not the company, not even you—can access those passwords without knowing the master password, so definitely make sure you remember that master password.

In theory, it would be better to just remember different 27-character alphanumeric passwords for each site you use online. This is indisputable. Encryption isn’t perfect, and theoretically someone might be able to recover your passwords even from Keeper or LastPass. But that is astronomically unlikely, and what’s far more likely is that if you don’t use a password manager, you will forget your passwords, or re-use them and get them stolen, or else make them too simple and allow them to be guessed. A password manager allows you to maintain dozens of distinct, very complex passwords, and even update them regularly, all while remembering only one or a few. In practice, this is what provides the best security.

5. Above all, report any suspicious activity immediately.

This one I cannot emphasize enough. If you do nothing else, do this. If you ever have any reason to suspect that your credit card might have been compromised, call your bank immediately. Get them to cancel the card, send you a new one, and check any recent transactions.

Do this if you lose your wallet. Do it if you see something weird on your online statement. Do it if you bought something from an online retailer that seemed a little sketchy. Do it if you just have a weird hunch and something doesn’t feel right. The cost of doing this is a minor inconvenience; the benefit could be thousands of dollars.

If you do report a stolen card, in most cases you won’t be held liable for a penny—the credit card company will have to cover any losses. But if you don’t, you could end up making payments on interest on a balance that a thief ran up on your behalf.

If we all do this, credit card fraud could become a thing of the past. Now, about those interest rates…

The unending madness of the gold standard

2016-06-042016-05-27 pnrj cognitive science, heuristics and biases, macroeconomics, public policy Cato, Cato Institute, Charles Kadlic, Federal Reserve, gold, gold standard, macroeconomics, Medicare, monetary policy, money, Paul Volcker, Ron Paul, Social Security, Wizard of Oz, ZImbabwe

JDN 2457545

If you work in economics in any capacity (much like “How is the economy doing?” you don’t even really need to be in macroeconomics), you will encounter many people who believe in the gold standard. Many of these people will be otherwise quite intelligent and educated; they often understand economics better than most people (not that this is saying a whole lot). Yet somehow they continue to hold—and fiercely defend—this incredibly bizarre and anachronistic view of macroeconomics.

They even bring it up at the oddest times; I recently encountered someone who wrote a long and rambling post arguing for drug legalization (which I largely agree with, by the way) and concluded it with #EndTheFed, not seeming to grasp the total and utter irrelevance of this juxtaposition. It seems like it was just a conditioned response, or maybe the sort of irrelevant but consistent coda originally perfected by Cato and his “Carthago delenda est.” “Foederale Reservatum delendum est. Hey, maybe that’s why they’re called the Cato Institute.

So just how bizarre is the gold standard? Well, let’s look at what sort of arguments they use to defend it. I’ll use Charles Kadlic, prominent Libertarian blogger on Forbes, as an example, with his “Top Ten Reasons That You Should Support the ‘Gold Commission’”:

A gold standard is key to achieving a period of sustained, 4% real economic growth.

A gold standard reduces the risk of recessions and financial crises.

A gold standard would restore rising living standards to the middle-class.

A gold standard would restore long-term price stability.

A gold standard would stop the rise in energy prices.

A gold standard would be a powerful force for restoring fiscal balance to federal state and local governments.

A gold standard would help save Medicare and Social Security.

A gold standard would empower Main Street over Wall Street.

A gold standard would increase the liberty of the American people.

Creation of a gold commission will provide the forum to chart a prudent path toward a 21st century gold standard.

Number 10 can be safely ignored, as clearly Kadlic just ran out of reasons and to make a round number tacked on the implicit assumption of the entire article, namely that this ‘gold commission’ would actually realistically lead us toward a gold standard. (Without it, the other 9 reasons are just non sequitur.)

So let’s look at the other 9, shall we? Literally none of them are true. Several are outright backward.

You know a policy is bad when even one of its most prominent advocates can’t even think of a single real benefit it would have. A lot of quite bad policies do have perfectly real benefits, they’re just totally outweighed by their costs: For example, cutting the top income tax rate to 20% probably would actually contribute something to economic growth. Not a lot, and it would cut a swath through the federal budget and dramatically increase inequality—but it’s not all downside. Yet Kadlic couldn’t actually even think of one benefit of the gold standard that actually holds up. (I actually can do his work for him: I do know of one benefit of the gold standard, but as I’ll get to momentarily it’s quite small and can easily be achieved in better ways.)

First of all, it’s quite clear that the gold standard did not increase economic growth. If you cherry-pick your years properly, you can make it seem like Nixon leaving the gold standard hurt growth, but if you look at the real long-run trends in economic growth it’s clear that we had really erratic growth up until about the 1910s (the surge of government spending in WW1 and the establishment of the Federal Reserve), at which point went through a temporary surge recovering from the Great Depression and then during WW2, and finally, if you smooth out the business cycle, our growth rates have slowly trended downward as growth in productivity has gradually slowed down.

Here’s GDP growth from 1800 to 1900, when we were on the classical gold standard:

Here’s GDP growth from 1929 to today, using data from the Bureau of Economic Analysis:

Also, both of these are total GDP growth (because that is what Kadlic said), which means that part of what you’re seeing here is population growth rather than growth in income per person. Here’s GDP per person in the 1800s:

If you didn’t already know, I bet you can’t guess where on those graphs we left the gold standard, which you’d clearly be able to do if the gold standard had this dramatic “double your GDP growth” kind of effect. I can’t immediately rule out some small benefit to the gold standard just from this data, but don’t worry; more thorough economic studies have done that. Indeed, it is the mainstream consensus among economists today that the gold standard is what caused the Great Depression.

Indeed, there’s a whole subfield of historical economics research that basically amounts to “What were they thinking?” trying to explain why countries stayed on the gold standard for so long when it clearly wasn’t working. Here’s a paper trying to argue it was a costly signal of your “rectitude” in global bond markets, but I find much more compelling the argument that it was psychological: Their belief in the gold standard was simply too strong, so confirmation bias kept holding them back from what needed to be done. They were like my aforementioned #EndTheFed acquaintance.

Then we get to Kadlic’s second point: Does the gold standard reduce the risk of financial crises? Let’s also address point 4, which is closely related: Does the gold standard improve price stability? Tell that to 1929.

In fact, financial crises were more common on the classical gold standard; the period of pure fiat monetary policy was so stable that it was called the Great Moderation, until the crash in 2008 screwed it all up—and that crash occurred essentially outside the standard monetary system, in the “shadow banking system” of unregulated and virtually unlimited derivatives. Had we actually forced banks to stay within the light of the standard banking system, the Great Moderation might have continued indefinitely.

As for “price stability”, that’s sort of true if you look at the long run, because prices were as likely to go down as they were to go up. But that isn’t what we mean by “price stability”. A system with good price stability will have a low but positive and steady level of inflation, and will therefore exhibit some long-run increases in price levels; it won’t have prices jump up and down erratically and end up on average the same.

For jump up and down is what prices did on the gold standard, as you can see from FRED:

This is something we could have predicted in advance; the price of any given product jumps up and down over time, and gold is just one product among many. Tying prices to gold makes no more sense than tying them to any other commodity.

As for stopping the rise in energy prices, energy prices aren’t rising. Even if they were (and they could at some point), the only way the gold standard would stop that is by triggering deflation (and therefore recession) in the rest of the economy.

Regarding number 6, I don’t see how the fiscal balance of federal and state governments is improved by periodic bouts of deflation that make their debt unpayable.

As for number 7, saving Medicare and Social Security, their payments out are tied to inflation and their payments in are tied to nominal GDP, so overall inflation has very little effect on their long-term stability. In any case, the problem with Medicare is spiraling medical costs (which Obamacare has done a lot to fix), and the problem with Social Security is just the stupid arbitrary cap on the income subject to payroll tax; the gold standard would do very little to solve either of those problems, though I guess it would make the nominal income cap less binding by triggering deflation, which is just about the worst way to avoid a price ceiling I’ve ever heard.

Regarding 8 and 9, I don’t even understand why Kadlic thinks that going to a gold standard would empower individuals over banks (does it seem like individuals were empowered over banks in the “Robber Baron Era”?), or what in the world it has to do with giving people more liberty (all that… freedom… you lose… when the Fed… stabilizes… prices?), so I don’t even know where to begin on those assertions. You know what empowers people over banks? The Consumer Financial Protection Bureau. You know what would enhance liberty? Ending mass incarceration. Libertarians fight tooth and nail against the former; sometimes they get behind the latter, but sometimes they don’t; Gary Johnson for some bizarre reason believes in privatization of prisons, which are directly linked to the surge in US incarceration.

The only benefit I’ve been able to come up with for the gold standard is as a commitment mechanism, something the Federal Reserve could do to guarantee its future behavior and thereby reduce the fear that it will suddenly change course on its past promises. This would make forward guidance a lot more effective at changing long-term interest rates, because people would have reason to believe that the Fed means what it says when it projects its decisions 30 years out.

But there are much simpler and better commitment mechanisms the Fed could use. They could commit to a Taylor Rule or nominal GDP targeting, both of which mainstream economists have been clamoring for for decades. There are some definite downsides to both proposals, but also some important upsides; and in any case they’re both obviously better than the gold standard and serve the same forward guidance function.

Indeed, it’s really quite baffling that so many people believe in the gold standard. It cries out for some sort of psychological explanation, as to just what cognitive heuristic is failing when otherwise-intelligent and highly-educated people get monetary policy so deeply, deeply wrong. A lot of them don’t even to seem grasp when or how we left the gold standard; it really happened when FDR suspended gold convertibility in 1933. After that on the Bretton Woods system only national governments could exchange money for gold, and the Nixon shock that people normally think of as “ending the gold standard” was just the final nail in the coffin, and clearly necessary since inflation was rapidly eating through our gold reserves.

A lot of it seems to come down to a deep distrust of government, especially federal government (I still do not grok why the likes of Ron Paul think state governments are so much more trustworthy than the federal government); the Federal Reserve is a government agency (sort of) and is therefore not to be trusted—and look, it has federal right there in the name.

But why do people hate government so much? Why do they think politicians are much less honest than they actually are? Part of it could have to do with the terrifying expansion of surveillance and weakening of civil liberties in the face of any perceived outside threat (Sedition Act, PATRIOT ACT, basically the same thing), but often the same people defending those programs are the ones who otherwise constantly complain about Big Government. Why do polls consistently show that people don’t trust the government, but want it to do more?

I think a lot of this comes down to the vague meaning of the word “government” and the associations we make with particular questions about it. When I ask “Do you trust the government?” you think of the NSA and the Vietnam War and Watergate, and you answer “No.” But when I ask “Do you want the government to do more?” you think of the failure at Katrina, the refusal to expand Medicaid, the pitiful attempts at reducing carbon emissions, and you answer “Yes.” When I ask if you like the military, your conditioned reaction is to say the patriotic thing, “Yes.” But if I ask whether you like the wars we’ve been fighting lately, you think about the hundreds of thousands of people killed and the wanton destruction to achieve no apparent actual objective, and you say “No.” Most people don’t come to these polls with thought-out opinions they want to express; the questions evoke emotional responses in them and they answer accordingly. You can also evoke different responses by asking “Should we cut government spending?” (People say “Yes.”) versus asking “Should we cut military spending, Social Security, or Medicare?” (People say “No.”) The former evokes a sense of abstract government taking your tax money; the latter evokes the realization that this money is used for public services you value.

So, the gold standard has acquired positive emotional vibes, and the Fed has acquired negative emotional vibes.

The former is fairly easy to explain: “good as gold” is an ancient saying, and “the gold standard” is even a saying we use in general to describe the right way of doing something (“the gold standard in prostate cancer treatment”). Humans have always had a weird relationship with gold; something about its timeless and noncorroding shine mesmerizes us. That’s why you occasionally get proposals for a silver standard, but no one ever seems to advocate an oil standard, an iron standard, or a lumber standard, which would make about as much sense.

The latter is a bit more difficult to explain: What did the Fed ever do to you? But I think it might have something to do with the complexity of sound monetary policy, and the resulting air of technocratic mystery surrounding it. Moreover, the Fed actively cultivates this image, by using “open-market operations” and “quantitative easing” to “target interest rates”, instead of just saying, “We’re printing money.” There may be some good reasons to do it this way, but a lot of it really does seem to be intended to obscure the truth from the uninitiated and perpetuate the myth that they are almost superhuman. “It’s all very complicated, you see; you wouldn’t understand.” People are hoarding their money, so there’s not enough money in circulation, so prices are falling, so you’re printing more money and trying to get it into circulation. That’s really not that complicated. Indeed, if it were, we wouldn’t be able to write a simple equation like a Taylor Rule or nominal GDP targeting in order to automate it!

The reason so many people become gold bugs after taking a couple of undergraduate courses in economics, then, is that this teaches them enough that they feel they have seen through the veil; the curtain has been pulled open and the all-powerful Wizard revealed to be an ordinary man at a control panel. (Spoilers? The movie came out in 1939. Actually, it was kind of about the gold standard.) “What? You’ve just been printing money all this time? But that is surely madness!” They don’t actually understand why printing money is actually a perfectly sensible thing to do on many occasions, and it feels to them a lot like what would happen if they just went around printing money (counterfeiting) or what a sufficiently corrupt government could do if they printed unlimited amounts (which is why they keep bringing up Zimbabwe). They now grasp what is happening, but not why. A little learning is a dangerous thing.

Now as for why Paul Volcker wants to go back to Bretton Woods? That, I cannot say. He’s definitely got more than a little learning. At least he doesn’t want to go back to the classical gold standard.

Tax incidence revisited, part 3: Taxation and the value of money

2015-11-252015-11-21 pnrj critique of neoclassical economics, public policy debasement, gold standard, Modern Monetary Theory, monetary policy, money, money supply, seigniorage, tax incidence, taxation, taxes

JDN 2457352

Our journey through the world of taxes continues. I’ve already talked about how taxes have upsides and downsides, as well as how taxes directly affect prices and “before-tax” prices are almost meaningless.

Now it’s time to get into something that even a lot of economists don’t quite seem to grasp, yet which turns out to be fundamental to what taxes truly are.

In the usual way of thinking, it works something like this: We have an economy, through which a bunch of money flows, and then the government comes in and takes some of that money in the form of taxes. They do this because they want to spend money on a variety of services, from military defense to public schools, and in order to afford doing that they need money, so they take in taxes.

This view is not simply wrong—it’s almost literally backwards. Money is not something the economy had that the government comes in and takes. Money is something that the government creates and then adds to the economy to make it function more efficiently. Taxes are not the government taking out money that they need to use; taxes are the government regulating the quantity of money in the system in order to stabilize its value. The government could spend as much money as they wanted without collecting a cent in taxes (not should, but could—it would be a bad idea, but definitely possible); taxes do not exist to fund the government, but to regulate the money supply.

Indeed—and this is the really vital and counter-intuitive point—without taxes, money would have no value.

There is an old myth of how money came into existence that involves bartering: People used to trade goods for other goods, and then people found that gold was particularly good for trading, and started using it for everything, and then eventually people started making paper notes to trade for gold, and voila, money was born.

In fact, such a “barter economy” has never been documented to exist. It probably did once or twice, just given the enormous variety of human cultures; but it was never widespread. Ancient economies were based on family sharing, gifts, and debts of honor.

It is true that gold and silver emerged as the first forms of money, “commodity money”, but they did not emerge endogenously out of trading that was already happening—they were created by the actions of governments. The real value of the gold or silver may have helped things along, but it was not the primary reason why people wanted to hold the money. Money has been based upon government for over 3000 years—the history of money and civilization as we know it. “Fiat money” is basically a redundancy; almost all money, even in a gold standard system, is ultimately fiat money.

The primary reason why people wanted the money was so that they could use it to pay taxes.

It’s really quite simple, actually.

When there is a rule imposed by the government that you will be punished if you don’t turn up on April 15 with at least $4,287 pieces of green paper marked “US Dollar”, you will try to acquire $4,287 pieces of green paper marked “US Dollar”. You will not care whether those notes are exchangeable for gold or silver; you will not care that they were printed by the government originally. Because you will be punished if you don’t come up with those pieces of paper, you will try to get some.

If someone else has some pieces of green paper marked “US Dollar”, and knows that you need them to avoid being punished on April 15, they will offer them to you—provided that you give them something they want in return. Perhaps it’s a favor you could do for them, or something you own that they’d like to have. You will be willing to make this exchange, in order to avoid being punished on April 15.
Thus, taxation gives money value, and allows purchases to occur.

Once you establish a monetary system, it becomes self-sustaining. If you know other people will accept money as payment, you are more willing to accept money as payment because you know that you can go spend it with those people. “Legal tender” also helps this process along—the government threatens to punish people who refuse to accept money as payment. In practice, however, this sort of law is rarely enforced, and doesn’t need to be, because taxation by itself is sufficient to form the basis of the monetary system.

It’s deeply ironic that people who complain about printing money often say we are “debasing” the currency; when you think carefully about what debasement was, it clearly shows that the value of money never really resided in the gold or silver itself. If a government can successfully extract revenue from its monetary system by changing the amount of gold or silver in each coin, then the value of those coins can’t be in the gold and silver—it has to be in the power of the government. You can’t make a profit by dividing a commodity into smaller pieces and then selling the pieces. (Okay, you sort of can, by buying in bulk and selling at retail. But that’s not what we’re talking about. You can’t make money by buying 100 50-gallon barrels of oil and then selling them as 125 40-gallon barrels of oil; it’s the same amount of oil.)

Similarly, the fact that there is such a thing as seigniorage—the value of currency in excess of its cost to create—shows that governments impart value to their money. Indeed, one of the reasons for debasement was to realign the value of coins with the value of the metals in the coins, which wouldn’t be necessary if those were simply by definition the same thing.

Taxation serves another important function in the monetary system, which is to regulate the supply of money. The government adds money to the economy by spending, and removes it by taxing; if they add more than they remove—a deficit—the money supply increases, while if they remove more than they add—a surplus—the money supply decreases. In order to maintain stable prices, you want the money supply to increase at approximately the rate of growth; for moderate inflation (which is probably better than actual price stability), you want the money supply to increase slightly faster than the rate of growth. Thus, in general we want the government deficit as a portion of GDP to be slightly larger than the growth rate of the economy. Thus, our current deficit of 2.8% of GDP is actually about where it should be, and we have no particular reason to want to decrease it. (This is somewhat oversimplified, because it ignores the contribution of the Federal Reserve, interest rates, and bank-created money. Most of the money in the world is actually not created by the government, but by banks which are restrained to greater or lesser extent by the government.)

Even a lot of people who try to explain modern monetary theory mistakenly speak as though there was a fundamental shift when we fully abandoned the gold standard in the 1970s. (This is a good explanation overall, but it makes this very error.) But in fact a gold standard really isn’t money “backed” by anything—gold is not what gives the money value, gold is almost worthless by itself. It’s pretty and it doesn’t corrode, but otherwise, what exactly can you do with it? Being tied to money is what made gold valuable, not the other way around. To see this, imagine a world where you have 20,000 tons of gold, but you know that you can never sell it. No one will ever purchase a single ounce. Would you feel particularly rich in that scenario? I think not. Now suppose you have a virtually limitless quantity of pieces of paper that you know people will accept for anything you would ever wish to buy. They are backed by nothing, they are just pieces of paper—but you are now rich, by the standard definition of the word. I can even make the analogy remove the exchange value of money and just use taxation: if you know that in two days you will be imprisoned if you don’t have this particular piece of paper, for the next two days you will guard that piece of paper with your life. It won’t bother you that you can’t exchange that piece of paper for anything else—you wouldn’t even want to. If instead someone else has it, you’ll be willing to do some rather large favors for them in order to get it.

Whenever people try to tell me that our money is “worthless” because it’s based on fiat instead of backed by gold (this happens surprisingly often), I always make them an offer: If you truly believe that our money is worthless, I’ll gladly take any you have off of your hands. I will even provide you with something of real value in return, such as an empty aluminum can or a pair of socks. If they truly believe that fiat money is worthless, they should eagerly accept my offer—yet oddly, nobody ever does.

This does actually create a rather interesting argument against progressive taxation: If the goal of taxation is simply to control inflation, shouldn’t we tax people based only on their spending? Well, if that were the only goal, maybe. But we also have other goals, such as maintaining employment and controlling inequality. Progressive taxation may actually take a larger amount of money out of the system than would be necessary simply to control inflation; but it does so in order to ensure that the super-rich do not become even more rich and powerful.

Governments are limited by real constraints of power and resources, but they they have no monetary constraints other than those they impose themselves. There is definitely something strongly coercive about taxation, and therefore about a monetary system which is built upon taxation. Unfortunately, I don’t know of any good alternatives. We might be able to come up with one: Perhaps people could donate to public goods in a mutually-enforced way similar to Kickstarter, but nobody has yet made that practical; or maybe the government could restructure itself to make a profit by selling private goods at the same time as it provides public goods, but then we have all the downsides of nationalized businesses. For the time being, the only system which has been shown to work to provide public goods and maintain long-term monetary stability is a system in which the government taxes and spends.

A gold standard is just a fiat monetary system in which the central bank arbitrarily decides that their money supply will be directly linked to the supply of an arbitrarily chosen commodity. At best, this could be some sort of commitment strategy to ensure that they don’t create vastly too much or too little money; but at worst, it prevents them from actually creating the right amount of money—and the gold standard was basically what caused the Great Depression. A gold standard is no more sensible a means of backing your currency than would be a standard requiring only prime-numbered interest rates, or one which requires you to print exactly as much money per minute as the price of a Ferrari.

No, the real thing that backs our money is the existence of the tax system. Far from taxation being “taking your hard-earned money”, without taxes money itself could not exist.

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