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Noah Smith's Sanity Requires That He Stop Reading Steve Williamson: Foundations of Monetary Theory Weblogging

Noah Smith:

Noahpinion: Money is just little green pieces of paper!: Have you ever heard people say that "money is just little green pieces of paper"? Well, that is exactly what Steve Williamson claims in this post. Most of the post is an anti-Krugman volley, but buried in one of Steve's points is the following extremely interesting claim:

What is a bubble? You certainly can't know it's a bubble by just looking at it. You need a model. (i) Write down a model that determines asset prices. (ii) Determine what the actual underlying payoffs are on each asset. (iii) Calculate each asset's "fundamental," which is the expected present value of these underlying payoffs, using the appropriate discount factors. (iv) The difference between the asset's actual price and the fundamental is the bubble. Money, for example, is a pure bubble, as its fundamental is zero.

Can this be true?… [M]y answer is: No…. [M]ost financial assets entitle you only to a stream of money…. If money has a fundamental value of zero… the fundamental value of every bond… is precisely zero. That's a weird way of thinking about the world…. [Williamson's claim] seems to hinge on the definition of "fundamental value"…. So what is "fundamental value"? Is it consumption value? If that's the case, then a toaster has zero fundamental value, since you can't eat a toaster…. So does a toaster have zero fundamental value, or is its fundamental value equal to the discounted expected consumption value of the toast that you will use it to produce?… If the toaster has fundamental value, the money should too…

Indeed. Noah is, of course, correct.

A toaster has fundamental value because it performs the useful service of making toast. Money has a fundamental value because it performs the useful service of enabling transactions. Money is a substitute for trust. In the absence of money, you can transact only with people with whom (a) you have an (unlikely) double coincidence of wants, or (b) you have an ongoing non-economic relationship that enables you to trust each other to make your credit good. In the presence of money, you can transact with damn near everybody. This increase in the scope of potential market transaction partners is immensely valuable. This is the service flow that money provides. This gives it "fundamental value".

You could try to reinterpret Williamson as saying something that is not so silly, but it would be fruitless: you could not get very far. You would wind up getting to claims that are almost as silly as the original money-is-a-bubble claim:

  1. Perhaps what Williamson might mean by "money is a bubble" is: "while money is not a bubble and has market value because it provides the fundamental-value service flow of enabling transactions, there is an equilibrium in which money has zero value and thus provides no useful transaction-enabling service flow and has no fundamental value--and if everybody thought that we would be in that equilibrium tomorrow we would be in that equilibrium today". Unfortunately for Williamson, that is simply wrong. The government demands that taxes be paid to it in cash, not in chickens or plutonium. So as long as you owe taxes, you should buy up cash from people who think it is valueless--for money has real use-value to you even if nobody is willing to accept it at a positive price in the marketplace.

  2. Perhaps what Williamson might mean by "money is a bubble" is: "while money is not a bubble, the government can drive the value of money to zero by printing near-infinite amounts of it". While this is true, it is not very interesting: the government could, after all, drive the value of toasters to zero by manufacturing near-infinite quantities of them as well.