Debt Obligations and the Need for Regulation

By Dan Kervick

Brad DeLong says he often wondered why Milton Friedman was willing to accept the need for government regulation in the world of money and banking, but not elsewhere:

In my rare coffees and phone calls with Milton Friedman, I found I could distract him whenever I was losing an argument by saying: “Why is it that the government needs to intervene and keep the flow of liquidity services provided to the economy growing along a smooth path? Why must there be a quantitative target achieved by government for the path of the liquidity services industry–commercial banking–when there must not be a quantitative target for kilowatt hours or freight-car loadings?”

DeLong reports that Friedman had no really good answer, but had a few undeveloped ideas:

He would chuckle and say it was a hard problem, but that he was confident that someday he or somebody else–maybe even me–would find a good, concise, convincing way of proving the point that a modern economy needed very heavy-handed government intervention in regulating the commercial banking industry but nowhere else. It was, he thought, something about the social waste of unnecessary bankruptcy, the catastrophic consequences of bank failures, debt deflation, and the fact that the price of liquidity services was intimately tied up with the units of account that we used to denominate our web of debt.

I think DeLong’s focus here on the concept of liquidity – roughly speaking, the ease with which some asset can be converted into cash at its current price, and the ease with which cash can be converted into something else of the seller’s choice – might be a little bit off the mark.   Rather, I believe the right concept to zero in on in connection with the monetary system and banking economy is the concept of a debt obligation, with an extra complication thrown in by the role of negotiable debt obligations.  The fact that these negotiable debt obligations are usually highly liquid is a third complicating factor that is important, but not really the heart of the matter.

We don’t live in either a barter economy or a spot transaction economy, and so a large percentage of our transactions involve a promise for future delivery on at least one side of the transaction. The promise might be for goods and services, or it might be for another kind of negotiable debt obligation like a bank deposit balance or a note.  Or it might be a promise for that peculiar modern form of non-interest-bearing, government-issued liability that is “debt” only in an honorific sense, i.e. the money issued by governments.

Debt obligations essentially involve a reference to the future.  And the future is (i) inherently hard to predict with any precision, and (ii) something about which people think with decreasing rationality the more remote it is, (iii) a mostly unknown space that people tend to fill up with fears, fantasies and wishes, and (iv) a place where surviving institutions will be run by groups of humans who are not the very same humans who made the contracts that then come to bind the former groups.  So transactions that make reference to the future are a very fertile ground for some terrible calculations based on wishful thinking, fraud, recklessness and primitive stupidity.

Yet our whole sophisticated, modern economy is based on interlacing and complex chains of promises extending deeply into this fraught and mysterious land of the future, and the ability of any one party to make good on the promises made by that party depends on the ability of numerous others to make good on the promises made to that party. So the vicissitudes of individual human irrationality and deceitfulness are knitted together into a fabric on which we all collectively depend. If individual miscalculations only affected that individual’s own life, there would be less cause for alarm. But they don’t; we’re all connected in the web of debt obligations.

The fact is that people acting alone aren’t all that bright, they aren’t all that far-seeing and they aren’t all that honest, so except for cases in which their transactions are constrained by factors that are facing them in the present moment, where all the relevant information is transparent to them and right in front of their eyes, and where the negative impacts of their own personal decisions aren’t easily offloaded to others, their actions need to be socially well-regulated on the basis of those somewhat wiser and more sober judgments coming from historical awareness and the chastisements of experience.

Cross-posted from Rugged Egalitarianism

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16 responses to “Debt Obligations and the Need for Regulation

  1. I think Friedman argued for regulation of government (the Fed), which he believed controlled the supply of money, which he believed was of utmost importance to price stability. He was also a champion of free markets and personal freedom. If he thought we could get along without a central bank, he probably would have been in favor of that. I know he was quite critical of the Fed’s open market operations in particular, and policy decisions in general, but I don’t recall him calling for its abolition. He only wanted to ban it from creating wild volatility in the supply of money.

  2. Funny, I saw your comment at de longs and posted a reply urging you to work up that comment into a blog post, and lo! you already have! though my comment at delongs is still in moderation. presience

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  4. Dan, the idea that money issued by governments is only “honorifically” debt/credit, that bonds are realer “promises for” this money, etc is your own personal view. It is not MMT. MMT considers “liability” and “debt” here as synonyms, a dollar as a kind of bond. Is money only “honorifically” a “liability” too? MMT, following Mitchell-Innes, treats state money and bank money as fundamentally the same, treated on fundamentally the same footing. That is the great virtue of the paper. In short, MMT says Mitchell-Innes is right. Dan Kervick says Mitchell-Innes is wrong.

    It was very good that in one of your first major posts on such matters made it quite clear that your view differed from standard MMT. (Taking a bit of time to dig it up.) Clearly said “Mitchell-Innes was wrong.” But people who haven’t been reading NEP for so long might not know this. As you know, IMHO, this is a crucial difference, and if this theory is developed in any determinate way, it clearly differs from MMT. It is more like Schumpeter’s legal-tender chartalism, a monetary theory of credit, not a creditary theory of money = MMT. So it becomes another road back to the commodity theory of money. Often enough, views that you criticize – like bank money being “free floating fiat currency” – while too abbreviated, appear closer to real MMT than what they are being compared to.

    Debt obligations essentially involve a reference to the future. So does money. That’s one reason why money is in a completely non-honorific, absolutely standard, normal usage a form of credit/debt. Real MMT, Mitchell Innes can easily cover transitions between monetary regimes, is a simple general theory treating both state and bank money, while your theory that attaches fundamental meaning to something less fundamental, in a way MMT does not, makes it a theory of a special case.

    The basic meaning of debt/liability/obligation/promise/whatever is not “debt for” (which provides a false teddy-bear of ‘reality’ by the object of the “for” and wrongly denies it is a credit/debt itself), but a completely real, socially, humanly real, immaterial “debt to”. Misdirecting attention to the former and belittling the latter sows confusion at best, and is just adding complication for the sake of saying something incorrect at worst.

    • If you have a hundred dollar bill, and you have paid your taxes, what does the issuer of that hundred dollar bill owe you?

      You have said that you think I am wrong, but you haven’t really explained how it goes wrong.

      If something is a genuine debt instrument issued by X, and represents a debt to Y, then there must be something X owes Y. There must be certain things that will discharge that debt. It makes no logical sense to say that I have a debt to you, but there is nothing that I owe you.

      • I think that MMT people prefer to talk about money as an ‘IOU’ rather than using the word debt. That makes sense if what government “owns” to the money holder is a favor. A favor of accepting money back in tax payments and so settling so tax oblications.Im not sure of exact definition of word ‘debt’ but it sounds to me as something more defined – something whats quantity at least can be measured.

        Warren Mosler suggests we call govt. bonds and reserves both monetary base, ie. money:

        • Well, tax obligations are explicitly measured too. If you have a tax obligation you have a quantifiable debt to the government.

          • If tax oblications were finite you would have to only pay them once and then you would be free of oblications. Tax oblications are actually infinte and tax debt of the population is infinitely large since time is infinite.

            See we are talking about the favour that any piece of legitime money can be used to free a person from his tax oblications. Because otherwise goverment would collect taxes in-kind like grains, land, property. Viewed this way accepting money is actually burden for the government it looses all these real resources for worthless pieces of paper.

      • “If you have a hundred dollar bill, and you have paid your taxes, what does the issuer of that hundred dollar bill owe you?”

        A credit against next week’s taxes?

        • What if you owe none at all. Is the bill still valuable to you?

          • Of course. It’s transferable, and good for anyone’s taxes, so those who do owe taxes will be willing to trade things for it. Things that you value.

            • Is the existence of the tax obligation, which is your liability, a genuine asset of the government?

              • A monetarily sovereign government has no need of monetary assets, but since we do government accounting just like non-sovereign entities, it would become an asset as it accrues, I suppose, just like rent would be for a landlord. It’s kind of hard for the government to know in advance, though, exactly how much to accrue, so I suppose they would do it on a cash basis, only as it is received?? The budget reports seem to be done on cash basis accounting, without accruals, unless they want to talk about “unfunded liabilities” and such. Yes, now I’m sure it’s cash basis accounting, because they use tricks like paying the September 30 payroll on October 1 in order to transfer it to the next fiscal year.

                So, no, I’d say it’s not accounted for as an asset until it is paid. As you can see, I’m figuring it out as we go. Why is this important? Landlords could use cash basis accounting, too, so they also might not “book” the rent it until it is received. Doesn’t matter, though, the tenant still owes it.

    • Well spotted, Calgacus! – that money involves a reference to the future!

    • Calgacus – ” MMT, following Mitchell-Innes, treats state money and bank money as fundamentally the same, treated on fundamentally the same footing.”

      I concur.
      But you do agree that there are some differences between the two, ĉu ne?
      One is the unit of account, the debt in which other debts are denominated, ĉu ne?
      Government money is the unit of account in which bank credit is denominated.