My one sentence explanation of Chartalism is:
Modern money is a state-defined unit of account for transactions in the economy, and this money is given value by the taxing power of the State.
The implication of this is that money is not something that evolves from private sector activities; for example barter. The "modern" qualifier implies that we are talking about post-Industrial Revolution economies; for example there were monies in the medieval period which were not associated with a functioning State. (For a primer on what a "unit of account" is, I have one here.)
It should be noted that this focus on the State makes this viewpoint controversial amongst libertarian-leaning economists. As a result, even though I think the viewpoint is largely self-evident, it cannot be viewed as a consensus opinion.
I don't have time to discuss the historical genesis of various monies currently in use; the historical record shows a complicated evolution. Instead, the importance of Chartalism to me is the following point: why do we not see the significant rise of new private monies in "modern" (developed) economies?
To clarify one point immediately - yes, most money in the modern economy is private. For example, bank deposits*. However, this private money is denominated in the state currency (e.g., Canadian dollars), and the ultimate settlement amongst these private monies is done via state money (notes and coin, or central bank balances). This is what is implied by Chartalism. We generally do not see private currencies with new denominations, other than a few "funny money" schemes in the fringes like Bitcoin.
Why not? The Chartalist answer is: this is primarily the result of taxes. Taxes create the demand for currencies, which would otherwise have no value in exchange. Legal strictures such as legal tender laws are of secondary importance (legal tender laws are the primary explanation according to many economists).
How is this so? Imagine that people attempt to use the ultimate in private transactions: barter. Although some people think they can do barter transactions and avoid a tax liability, the reality is that barter transactions generate tax liabilities for both sides as if it was a pair of transactions for cash. I realise that individuals often do barter transactions precisely to avoid tax, but corporations can find legitimate uses for barter. They avoid the need for financing, and they may not need fear the tax implications (if they are a money-losing startup, for example).
There are a number of factors within modern tax systems that discourage the rise of private currencies:
- Businesses need to acquire the state currency to pay income tax and Value Added Tax liabilities. If revenues came in the form of other currencies, they need to continuously exchange for the state currency.
- A significant portion of worker salaries are deducted at source. Since salaries are the largest component of business expenses in capitalist economies, this creates a massive need for state currency at each pay period.
- Workers income tax preparation would be a nightmare if pay was given in a different currency. All pay would have to be converted at the exchange rates prevailing at the time. A shift in the rate of exchange could wipe out citizens who were unable to hedge this risk.
There are Institutional effects as well. Accounting and risk hedging is a nightmare in a multi-currency system. Additionally, most entities within the economy are enmeshed in a web of debt obligations already denominated in the state currency. A risk-averse worker with a CAD-denominated mortgage is not going to jump at the chance to get paid in some other currency with a very uncertain exchange versus CAD over the next 25 years. These preexisting Institutions create a very large barrier to entry for new currencies.
These tax effects are far more dominant than things like legal tender laws. Legal tender laws were really enacted to protect against entities with market power paying back debts with dubious goods. For example, preventing powerful tobacco farmers from paying off receivables with tobacco when there is a glut on the tobacco market.
You need to live in a place isolated from foreign borders (like a significant portion of the United States...) to think legal tender laws are significant in practice. For example, the main habitable areas of Canada are strung out along the U.S.border, and it is easier to spend U.S. money than it is to spend Canadian $50 and $100 notes in many retail establishments (since these high denomination notes are the main targets of counterfeiters). A great number of Canadian businesses and customers actually end up invoicing each other in U.S. dollars, since they will often post prices in USD for the convenience of their primary customers across the border. Meanwhile, I am unaware of any attempts to bring prosecution under legal tender laws.
* Insert outrage from the "fractional reserve lending is evil" crowd.
L. Randall Wray: Understanding Modern Money: The Key to Full Employment and Price Stability, Edward Elgar Publishing, 1998 (non-affiliate link).
(c) Brian Romanchuk 2013
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