"While economists tolerate models that are not constrained by accounting identities because, for some reason, economists do not seem constrained by the need for their models of the economy to conform to reality, any engineer whose model for a bridge requires that two plus three equal seven would find it hard to build bridges(...)"
To choose just one of many money quotes (if you'll excuse the pun). Really insightful post.
Money's essentially an arrangement between people. If say you do a sketch on a bit of paper and I buy it off you for $1m in the form of another bit of paper saying IOU $1m then in a sense you have $1m in Tim bonds and can then use that to buy a car with another IOU backed by my bonds, or cash backed by them if someone will lend you the cash. The whole thing can fall apart if one loses confidence in the value of the debts though. What you see in the markets with currency creation and crises are all essentially more complicated variations of the above.
This is a kind of an economist's version of events. It's not wrong, but it is a narrative so it's useful for thinking about things in ways that economists are interested in, not necessarily every way.
Debt as the origin of money kind of dates to the time when economists were thinking about these things more than the time when money was invented. Money was invented lots of times. A common form is when there is a lot of trade and people start trading in particular things specifically for their tradability. Those things are then money. No promises involved.
In some cases there is evidence of promises as early money. Cattle or wheat and traded for clay artifacts and traded back at will could. This allowed traders to exchange clay coins instead of actual goods which is ore convenient. But, I think this is an exception.
Modern money often evolved from promises to pay bearers gold or other currencies and eventually the promise was removed.
Back to the narrative…
For my own narrative, I think of money like this. Money is a tool for massive and complex cooperation in large groups, a fundamentally human talent. It's emergent and the behavior that encourages its emergence is massive and complex cooperation in ways that require it, trade basically. If enough trade is happening, I think money emerges in some form and it enables even more trade.
I think you just took a step backwards by declaring money as "emergent". The two models sketched before were providing additional details - what particular conditions cause money to appear and why. Saying it sort of emerges when there's enough trade is zooming out.
Something that bugs me about this article is the lack of distinction between monetary and real phenomena; "savings and investment must always be equal"
I agree with that if you're talking about real goods, but not if you're talking about money because you can always invent the money such that the amount of savings at t-.00001 isn't the same as the amount of investment at t+.00001 with the difference being the amount of money created.
Similarly savings and investment must always be equal doesn't seem universally true at any one instant; it's more of a causal relationship. Only what is saved can be invested, but it is not automatically invested. As money banks have reserves which they don't invest and in real terms there are huge amounts of steel inventory just sitting in warehouses not being used (invested) in making products at any one time. It can be invested in making a factory in the future, or consumed by making say cars. But it's not automatically invested by virtue of not being consumed, it can just continue to be saved.
The equality remains true in the pure, absolute sense. The scenarios you cite are cases where it appears to be violated, but the equality works out anyway.
For starters, money is not investment or savings, it's a way of keeping account. If you create money and nothing else changes, there is implicit inflation as the money supply gets larger and chases the same supply of good and services.
That's really the point of the article: if you understand that the identity is true, you can parse where endogenous money'comes from': how is wealth being transferred (which depends both on the state of the economy and the form of endogenous money).
But the point remains, axiomatically, that money is an accounting unit. Do not confuse it with the goods and services it represents; that's a failure of abstraction and makes it impossible to really understand inflation, financial repression, and endogenous money.
> The equality remains true in the pure, absolute sense. The scenarios you cite are cases where it appears to be violated, but the equality works out anyway.
OK so if I save 5 tons of steel but I don't put it to work, it's savings but not investment, right? Or is that not how it works?
I get that all investment had to at one point have been savings (instead of consumption) but not all savings is investment is it? If I "save" those 5 tons of steel for years but then eventually end up making them into washing machines they were savings, but then they became consumption.
Maybe in these cases the steel isn't "saved" because it isn't "invested" and the only things that can be considered savings are those which are invested. OK, sure. Then what is a bunch of stuff sitting around not being consumed or invested? Is it in purgatory?
No, savings == investment because they're two sides of the same thing, like corresponding entries in two ledgers. If one entity saves (that is, produces more than they consume + invest), those 'savings' are realized elsewhere in the economy where some other entity 'spends' more than it produces. That excess spending is either consumption or investment.
Therefore, net savings == net investment, where net savings means all savings - all consumption.
To engage with your specific example: steel that sits in a warehouse is 'investment' that earns zero return; if it eventually gets thrown away it's either consumption or investment with a loss of principal. If it's turned into washing machines, it's investment that realizes a return (that return could be negative if the price of steel goes down in the interim).
Does that make sense? I'm not really the best person to explain this stuff, since I haven't studied it formally. Much of what I read assumes a working knowledge, which I've cobbled together from mpettis and others.
Like all of professor Pettis's posts, this one requires pretty deep background or a lot of reading to follow completely... But it's well worth it.
If you think you understand what's going on in China's economy, you should be sure to read Pettis exhaustively (Andy Xie is good reading, too).
The general punchline: expect massively lower GDP growth in China. Not "below 7% low," more like below 3% at best, if the economy is managed correctly. Big caveat because the government's actions lately are pretty poor.
His analysis of the Chinese economy is similar balance sheet economics. Great stuff.
Very briefly, because the bulk of GDP growth (and GDP) has been investment, either in infrastructure out production capacity (in support of exports). Great way to industrialize, but it's not sustainable as China starts to have more capacity than the world can consume, and if continued investment in infrastructure doesn't result in higher long term productivity (cf ghost cities).
The'correct' way forward is to rebalance toward domestic consumption: make the Chinese people richer, and sell more to themselves. The balance sheet argument says consumption must therefore grow faster than investment, which should probably contract (we're well past the point of a dollar of investment producing a dollar of future productivity), but since consumption is starting from a relatively small base it has to grow impossibly fast to maintain the current growth levels.
Critical to this argument is Pettis's concept of 'financial repression,' that a lot of the uneconomic behavior and investing is a result of below-inflation deposits rates that have made household wealth shrink at the expense of cheap capital for business, particularly large and inefficient state owned enterprises. That implicit subsidy meant a lot of malinvestment was rational, but also implied an unsustainable environment.
Current global contraction is maybe the pin pricing the bubble, because what's ultimately unsustainable is the world's capacity to absorb Chinese production. In other words, demand-side softness, which is a global problem.
Sorry, that's not brief, nor is it necessarily easy to understand, but it's a complex issue that manner economists and China watchers don't necessarily understand (I'm assuming Pettis if correct, just in the strength of his arguments and other references agreeing; IANA economist)...
I don't disagree, but one could have said (speculated on) the same thing 2 years ago. Also, there is still a lot of other market share China can steal from others (which of course causes GDP decline in those countries).
I wouldn't say there's a ton of market share to be grabbed: the global economy is suffering from a savings glut. Chinese manufacturing dominates entire industries, and already other countries in Asia are offering lower-cost alternatives for labor (e.g., textiles in Vietnam).
In practice, China has driven down the cost of many finished goods (while driving up the cost of commodities) through its investment in manufacturing capacity and infrastructure. Its latest investments were probably non-economic; in other words, they will never pay back the principal due to overbuilding both capacity and infrastructure.
On the infrastructure side, there are entire cities with almost no inhabitants. These 'ghost cities' exist as hedges against principal-robbing inflation -- Chinese households have used property as a stable store of savings since traditional bank deposits and investment vehicles return below-inflation rates of return. This has inflated multiple speculative bubbles in Chinese real estate; the actual reckoning probably has yet to arrive.
On the capacity side, it's the same story. To choose a single, specific example: over 50% of Chinese steel capacity is lying idle; there have simply been too many factories built in the past ten years. The price of solar in the past few years has dropped precipitously because of Chinese over-investment in production capacity -- just ask Solyndra. The price of solar plummeted below what anyone predicted because of China's state capitalism, and a mandate to gobble the market share in the solar industry. (In this case, at least, there are positive externalities.) Chinese solar panel manufacturers are not making profits due to the intense competition and oversupply in the market.
The list is long. So no, there's isn't much 'market share' left to steal. China needs to build its domestic consumption share of the economy, by building its service sector and stoking domestic demand -- basically by making its citizens richer and selling to themselves. That's the only way forward, at least according to Professor Pettis.
is that nominal GDP or real GDP? If nominal, should we also expect massively less real GDP? I should read it, but he used too many ","s .. hurts my brain.
Real. The isn't a statement about exchange rates or currency, it's a statement about the real state of the Chinese economy (even though parent post is definitely about monetary issues). We should expect Chinese growth to average 3% or less in real terms for the next ~decade if Pettis is correct. How's that for a bold economic prediction?
To choose just one of many money quotes (if you'll excuse the pun). Really insightful post.