Back in 1998 Paul Krugman wrote an interesting article [1] recounting
the story of a baby sitting collective on Capitol Hill to draw lessons about
how a money system works and what problems can befall a mismanaged system. The article describes an arrangement where a
group of parents, mainly lawyers and economists, created a babysitting group, and to facilitate its operation they also created a fixed amount of script that parents would use to pay for baby sitting time. Krugman goes on to describe how at first the couples hoarded script, so they would have some on hand just in case they needed it, so
little actual baby sitting was taking place.
Then, recognizing the problem, the group tried to regulate the use of
script by requiring a minimal amount of going out per month, but that didn’t work. Then they expanded the amount of script by releasing another lot of script into circulation, and the result was a kind of
inflation where some parents were going out too much and paying the script far more than
they were to provide sitting services. Neither situation was
optimal, so the lesson that we are supposed to take from this story is that fiat money needs to be carefully managed by a
disinterested authority. Krugman was, of
course, making a comparison to a real national money system, and the central
bank that manages it, and how the wisdom and independence of the central bank coupled with a
flexible money supply was necessary for a functioning money system. Another view is that this example is a perfect exposition on
why a fiat money system is so unworkable.
It also prompts some thoughts about what is money, and how should it work?
At first glance the whole idea of issuing script, which
Krugman calls a “fairly natural solution”, is kind of bizarre to ordinary
folks. It’s the kind of solution that
overly educated people might try (this author not included). The obvious thing that regular people would
do is issue IOUs. E.g. Betty sits for
Kathy for one hour, so Kathy issues Betty an IOU that says Kathy owes one hour
of babysitting and signs it. Each IOU
lists the person who owes and is signed to show authenticity. Betty holds on to this IOU for when she needs
a sitter. Betty then sits for Ann for an
hour and gets an IOU with Ann’s name on it.
Similarly, other parents do the same.
Kamal sits for Jane and gets an IOU from Jane with her name on it.
Later, Betty needed a sitter and called Ann, who sat for an
hour. Betty gave the IOU with Ann’s name
on it to Ann in payment, which Ann then ripped up as the IOU was satisfied.
Then something a bit different happens. Betty needs a sitter and neither Ann or Kathy
are available, so she calls Jane who agrees to sit. Betty, instead of issuing her own IOU, gives
Jane one of the IOUs that she collected previously. In this case, the one from Kathy. So now Kathy owes Jane an hour of sitting
rather than to Betty. In effect, Betty
has used the IOU as a kind of money.
This IOU money is specifically tied to the real economy
(baby sitter economy). It was created by
performing real work (one hour of sitting).
These IOUs are not conjured into existence like the fiat script of the
Capitol Hill group (or our money today) that is disconnected from the real economy. In the IOU system of money, any amount may be
issued by simply performing more real work (hours of sitting). And any number of IOUs may be redeemed by
appointment with the appropriate sitter.
Neither action causes recessions or booms. Any time you need some IOUs you just need to
do some work (sitting for others), and you get paid in the IOUs.
In this system money, the IOUs, are created by new work and
destroyed by redeeming for work. So, the
supply fluctuates as needed. The supply
is not controlled by a central authority like the script was controlled by the
Capitol Hill group. So, one never needs
to appeal to an outside authority to get IOUs.
Now, this situation is not perfect. Perhaps the value of an hour of babysitting
is different for various people? Maybe
sometimes, say around holidays, its hard to find someone willing to
babysit? Maybe some people will babysit
at a time of high demand for greater compensation, say sit one hour but get
paid IOUs worth two hours? The two
parties just need to agree on the deal. In this case two IOUs are issued for an hour each. Regardless of the deal, the IOUs are still each worth one hour of babysitting. In any case,
the situation is self-rectifying and does not lead either shortages or
surpluses of IOUs.
Another problem is that the IOUs are tied to specific
individuals. Those that owe babysitting
time. So, while the IOUs can be
exchanged among the members of the economy (the sitter group), the specific
person listed on an IOU must be available to perform the owed sitting duty. But, that is not such a problem in practice as you must call around to find someone willing to sit anyway.
Perhaps this idea of the IOU is the lesson for a money system? Money that is based on production in the real
economy. Money that represents real economic activity rather than moving around financial instruments.
Money, in all cases, is
essentially an IOU. Money itself has
little value to the holder in that it can’t be eaten, worn, lived in, provide
transportation, etc. So, it’s a holder of value for acquiring those things in the future. But, unlike script, work or creation of real value, proceeds the creation of the IOU money, whereas script is simply issued and taken for granted that it has value by fiat.
The moral then is: don’t have a fiat currency that is
independent of the real economy with a central bank that tightens and eases as
it sees fit. Rather, have a currency
that is tied to actual, productive economic activity.
How could this work in practice? One way is to have the federal government
issue currency rather than debt. The
currency would pay for the expenses of the government and flow into the
economy. As Thomas Edison said “If the Nation can issue a dollar bond it can issue a dollar
bill. The element that makes the bond good makes the bill good also.” [2] (For those readers who say, hey that’s just
MMT. That’s almost right. This is equivalent to MMT with the condition
that the Fed buys up all the bonds issued by the government.) The government would pay for all the services it provides by printing currency and spending it into the economy. It would also require all taxes to be paid in the some currency. The government could carry out Keynesian stimulus if it pleases by spending more (issuing more money) during a downturn, and spending less (withdrawing money) during a boom. Banks would simply be loan arrangers that take deposits, pool them, determine credit worthiness and lend the money without a fractional reserve system of money multiplication. Commercial banks would be separate from other, speculative, institutions to ensure that only sound loans are made into the real economy. Investment banks would simply pool investors money to make investments.
[2] New York Times, December 4 and 6,
1921
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