[OPE-L:5834] Re: (Fwd) Re: explaining inconvertible money

Duncan K. Foley (dkf2@columbia.edu)
Sat, 13 Dec 1997 18:08:31 -0500 (EST)

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Some comments on Costas' "Explaining inconvertible money"

Costas says:

>We should perhaps be more precise on what we mean by 'inconvertible
>money'. I take it to mean mostly bank-created credit-money, backed by
>bank loans and other private debt instruments. The exchange rate of
>this money with commodities (and the accounting system of prices) is
>primarily determined by the process of creation and repayment of
>credit among firms and between firms and banks (what used to be
>called issue and reflux) which regulate the quantity of credit-
>money. In that sense, credit-money is endogenous.

Duncan remarks:

This explains banknotes and bank deposits, which often circulate as means
of payment, but not "inconvertibility". Under the gold standard banknotes
and bank deposits were also "backed by bank loans and other private debt",
but the bank had a contractual commitment to pay gold at par to depositors
and noteholders on demand. As a result, banknotes and deposits circulated
at close to par. "Par" here means what Marx calls the "standard of price",
that is, the legislated equivalence between the national currency (franc,
pound, mark, dollar) and gold.

In periods of war or financial crisis banks were sometimes able to suspend
their commitment to pay gold without going out of business. In these
circumstances (for example, 1908 in New York) bank deposits "floated"
against gold (that is, a market discount opened up between payment in gold
and in deposits). The deposits were still "convertible", but not at par.

When a nation goes off the gold standard, it suspends its Treasury's
commitment to exchange the national currency for gold, and the value of the
currency becomes determined in the speculative foreign exchange market
rather than by the "standard of price". Marx treated this situation by
assuming that gold continued to be the measure of value, and that a
market-determined discount would open up establishing the gold value of the
currency. The determination of this discount is complicated by speculation,
but the theoretical analysis of prices is straightforward, since the
currency prices of commodities must be equal to the gold prices multiplied
by the market discount of the currency against gold. In the U.S. in the
"greenback era", for example, even small shopkeepers priced their
merchandise in terms of gold dollars (at par) and accepted greenbacks in
payment at the current discount established in speculative markets in New
York. The determination of commodity prices in terms of gold still rules
theoretically, and is modified in only a minor way. It is true that the
discount of the national currency against gold can be influenced by the
size of the currency issue, though this is moderated by speculation that
the nation will eventually return to convertibility at par. But currency
issue won't have anything to do with the underlying gold prices of

In all these gold standard cases the expansion and contraction of bank
credit has no impact on the prices of commodities, in contrast to the
quantity of money theory of prices, though the extension of bank credit
does have impacts on the scale of production and investment.

The difficult theoretical problem for the Marxist theory of money arises
when nations suspend their commitment to exchange the national currency for
gold at a fixed rate, and at the same time gold ceases to function as the
measure of value for the world economy, which many people believe is the
case in world capitalism today. Then there isn't any underlying gold price
to use as a theoretical reference point for commodity prices.

After some remarks on the endogeneity of bank deposits when the gold
standard is operating, Costas says:

>When reserves become mostly state-issued debt certificates, even for
>the central bank, and convertibility is suspended, reserve discipline
>ceases to operate with the external, thing-like objectivity of gold
>(though independent central banks might attempt to replicate it
>unconsciously). The quantity of credit-money is still
>regulated by credit advance and repayment, and so this money remains
>qualitatively distinct from state-issued fiat money, but the point of
>reference for prices, given by the value of gold, has gone.

Duncan remarks:

The central bank can still discipline the commercial banks, since they must
maintain convertibility of their deposits into the national currency (in
the form of cash or reserves) at par. I'm not sure what Costas means by
saying that deposits are "qualitatively distinct from state-issued fiat
money", since they are convertible at the holder's demand into the national
currency or reserves.

The phrase "fiat money", as I've remarked before, is potentially extremely
misleading. Essentially national currencies are held voluntarily as assets,
and can't actually be "forced" on anyone. In principle firms and households
could carry on their business in a foreign currency, or gold if they don't
want to use the national currency.

Costas says:

>In that context, it seems to me plausible that the quantity theory of
>money acquires a limited validity.

Duncan remarks:

A lot of people believe this. It was, for example, the argument that Ron
McKinnon at Stanford gave me when I tried to explain the Marxist theory of
money to him: he argued that what I described would work for a gold
standard world, but that the suspension of convertibility had changed the
fundamental theoretical determinations of money prices to the quantity of
money theory of prices mode. I have trouble understanding this because of
the smooth historical continuity I see between the gold standard and
post-gold standard monetary systems. Why should the quantity of money have
no influence on prices in the one case, and complete influence on prices in
the other?


>Credit advance/repayment without
>reserve discipline might result in quantities of credit-money out of
>line with the quantities of commodities, and so generate instability
>running from money to prices. If we assume that there is an asymmetry
>in how the central bank deals with bank reserves (more likely to
>provide them than to restrict them) secular inflation results. That
>strikes me as a reasonable way of approaching post-Bretton-Woods.

I'd like to understand the mechanisms behind this in more detail. It seems
to me that speculation on the external value of national currency has to
play a role in its depreciation. It also seems to me that workers and
firms, in establishing money wages and prices in the national currency, are
effectively valuing the national currency speculatively in relation to
foreign currencies.


Duncan K. Foley
Department of Economics
Barnard College
New York, NY 10027
fax: (212)-854-8947
e-mail: dkf2@columbia.edu