Nick Rowe Ignores, But Does Not Refute, the Law of Reflux

In yet another splendid post, Nick Rowe once again explains what makes money – the medium of exchange – so special. Money – the medium of exchange – is the only commodity that is traded in every market. Unlike every other commodity, each of which has a market of its very own, in which it – and only it – is traded (for money!), money has no market of its own, because money — the medium of exchange — is traded in every other market.

This distinction is valid and every important, and Nick is right to emphasize it, even obsess about it. Here’s how Nick described it his post:

1. If you want to increase the stock of land in your portfolio, there’s only one way to do it. You must increase the flow of land into your portfolio, by buying more land.

If you want to increase the stock of bonds in your portfolio, there’s only one way to do it. You must increase the flow of bonds into your portfolio, by buying more bonds.

If you want to increase the stock of equities in your portfolio, there’s only one way to do it. You must increase the flow of equities into your portfolio, by buying more equities.

But if you want to increase the stock of money in your portfolio, there are two ways to do it. You can increase the flow of money into your portfolio, by buying more money (selling more other things for money). Or you can decrease the flow of money out of your portfolio, by selling less money (buying less other things for money).

An individual who wants to increase his stock of money will still have a flow of money out of his portfolio. But he will plan to have a bigger flow in than flow out.

OK, let’s think about this for a second. Again, I totally agree with Nick that money is traded in every market. But is it really the case that there is no market in which only money is traded? If there is no market in which only money is traded, how do we explain the quantity of money in existence at any moment of time as the result of an economic process? Is it – I mean the quantity of money — just like an external fact of nature that is inexplicable in terms of economic theory?

Well, actually, the answer is: maybe it is, and maybe it’s not. Sometimes, we do just take the quantity of money to be an exogenous variable determined by some outside – noneconomic – force, aka the Monetary Authority, which, exercising its discretion, determines – judiciously or arbitrarily, take your pick – The Quantity of Money. But sometimes we acknowledge that the quantity of money is actually determined by economic forces, and is not a purely exogenous variable; we say that money is endogenous. And sometimes we do both; we distinguish between outside (exogenous) money and inside (endogenous) money.

But if we do acknowledge that there is – or that there might be – an economic process that determines what the quantity of money is, how can we not also acknowledge that there is – or might be — some market – a market dedicated to money, and nothing but money – in which the quantity of money is determined? Let’s now pick up where I left off in Nick’s post:

2. There is a market where land is exchanged for money; a market where bonds are exchanged for money; a market where equities are exchanged for money; and markets where all other goods and services are exchanged for money. “The money market” (singular) is an oxymoron. The money markets (plural) are all those markets. A monetary exchange economy is not an economy with one central Walrasian market where anything can be exchanged for anything else. Every market is a money market, in a monetary exchange economy.

An excess demand for land is observed in the land market. An excess demand for bonds is observed in the bond market. An excess demand for equities is observed in the equity market. An excess demand for money might be observed in any market.

Yes, an excess demand for money might be observed in any market, as people tried to shed, or to accumulate, money by altering their spending on other commodities. But is there no other way in which people wishing to hold more or less money than they now hold could obtain, or dispose of, money as desired?

Well, to answer that question, it helps to ask another question: what is the economic process that brings (inside) money – i.e., the money created by a presumably explicable process of economic activity — into existence? And the answer is that ordinary people exchange their liabilities with banks (or similar entities) and in return they receive the special liabilities of the banks. The difference between the liabilities of ordinary individuals and the special liabilities of banks is that the liabilities of ordinary individuals are not acceptable as payment for stuff, but the special liabilities of banks are acceptable as payment for stuff. In other words, special bank liabilities are a medium of exchange; they are (inside) money. So if I am holding less (more) money than I would like to hold, I can adjust the amount I am holding by altering my spending patterns in the ways that Nick lists in his post, or I can enter into a transaction with a bank to increase (decrease) the amount of money that I am holding. This is a perfectly well-defined market in which the public exchanges “money-backing” instruments (their IOUs) with which the banks create the monetary instruments that the banks give the public in return.

Whenever the total amount of (inside) money held by the non-bank public does not equal the total amount of (inside) money in existence, there are market forces operating by which the non-bank public and the banks can enter into transactions whereby the amount of (inside) money is adjusted to eliminate the excess demand for (supply of) (inside) money. This adjustment process does not operate instantaneously, and sometimes it may even operate dysfunctionally, but, whether it operates well or not so well, the process does operate, and we ignore it at our peril.

The rest of Nick’s post dwells on the problems caused by “price stickiness.” I may try to write another post soon about “price stickiness,” so I will just make a brief further comment about one further statement made by Nick:

Unable to increase the flow of money into their portfolios, each individual reduces the flow of money out of his portfolio.

And my comment is simply that Nick is begging the question here. He is assuming that there is no market mechanism by which individuals can increase the flow of money into their portfolios. But that is clearly not true, because most of the money in the hands of the public now was created by a process in which individuals increased the flow of money into their portfolios by exchanging their own “money-backing” IOUs with banks in return for the “monetary” IOUs created by banks.

The endogenous process by which the quantity of monetary IOUs created by the banking system corresponds to the amount of monetary IOUs that the public wants to hold at any moment of time is what is known as the Law of Reflux. Nick may believe — and may even be right — that the Law of Reflux is invalid, but if that is what Nick believes, he needs to make an argument, not assume a conclusion.

27 Responses to “Nick Rowe Ignores, But Does Not Refute, the Law of Reflux”


  1. 1 Mike Sproul September 14, 2016 at 12:50 pm

    People nowadays can create and retire credit card dollars almost instantly, and in huge amounts. This makes the Law of Reflux even more effective.

  2. 2 Nick Rowe September 14, 2016 at 2:37 pm

    David:

    Thanks!

    You are right. But I would re-state your point a little differently:

    In my (implicit) model, money appears in every market, but is neither created or destroyed in any market. It flows out of the buyer’s pocket, into the seller’s pocket, leaving the total stock the same.

    And you want to add a market for some good X, where banks (maybe central and/or commercial) buy and sell X in that market. And when they buy X the banks not only sell money but *create* money. And when they sell X the banks not only buy money they *destroy* money. Which makes good sense. Because that money came from somewhere, and can disappear to that same place.

    In the real world, X is nearly always (non-monetary) IOUs.
    Though sometimes I find it a useful thought experiment to imagine that X is land. The banks own land on the asset side of their balance sheets. (One advantage of assuming that X is land is that by setting a price at which it will buy or sell land we have a coherent monetary policy with a long run nominal anchor. If X is IOUs and banks set a rate of interest, we get the Wicksellian cumulative process and the system eventually explodes or implodes.)

    I will collect my thoughts, and try to write up a response.

  3. 3 JKH September 14, 2016 at 2:49 pm

    thank you, James Tobin 1963

    …. um, I mean David Glasner 2016

    both excellent

  4. 4 David Glasner September 14, 2016 at 5:14 pm

    Mike, I think that’s correct, although I am not sure how outstanding credit card balances are reflected in the monetary aggregates.

    Nick, I am not sure exactly what model you are referring to, but I believe that a pure inside money model is very problematic. That’s why I think Wicksell’s pure credit model is unstable. It would not be unstable with an outside money (alpha money, remember?) to anchor the price level. Looking forward to your response.

    JKH, Thank you so much. High praise indeed. I consider Tobin’s 1963 paper one of the greatest monetary theory papers ever written.

  5. 5 Nick Rowe September 14, 2016 at 6:40 pm

    Some papers are wrong, easy to attack, but barely worth attacking.

    Tobin 63 is wrong (IMO), hard to attack, but well worth attacking.

    Yep. David is playing Tobin (very well), and I’m trying to play Yeager. With a dash of Clower and Laidler in there too. I had Tobin in mind as I wrote my post (as David no doubt guessed).

  6. 6 Mike Sproul September 14, 2016 at 7:51 pm

    ” I am not sure how outstanding credit card balances are reflected in the monetary aggregates.”

    Officially, credit card balances aren’t counted because credit card dollars are normally paid off with checking account dollars. In the 1840’s, checking account dollars weren’t counted because they were normally paid off with paper dollars. In the early 1700’s, paper dollars weren’t counted because they were normally paid off with a coin.

    So it seems that it takes economists about 100 years to recognize a new kind of money. Based on this, I predict that economists will start counting credit card dollars as money in the year 2050.

  7. 7 Nick Rowe September 15, 2016 at 3:57 am

    If I buy apples for $100 from Mike, using my credit card, and Mike buys bananas for $100 from me, using his credit card, do the two $100 balances get cancelled out?

  8. 8 JKH September 15, 2016 at 4:46 am

    The reason credit card balances are not reflected in monetary aggregates is that they are most definitely not a monetary item – they are loans.

    e.g. any Canadian bank will have credit card balances on the asset side of the balance sheet – like other loans. Merchants who accept credit card payments will be credited with corresponding money in their bank deposit accounts. That’s new money that’s associated with the increase in credit card balances – just as happens with any other new loan in the banking system. But that money is not the credit card balance. It’s the initial bank liability item that offsets new credit card asset balances, both appearing essentially at the same time on the aggregate banking system balance sheet. Those money balances start circulating around the system just like any other money – and dare I say, subject to the type of dynamic that Tobin described in his 1963 paper, like all money balances.

    Non-bank credit card operators have credit card balances on the asset side of their balance sheets as well. The difference from banks is that those operators require a bank deposit account (an asset) of what is essentially pre-existing money (at the time) to manage the outs and ins of money extended and repaid in conjunction with increases and decreases in those credit card balances. That said, the balance sheets of those non-bank operators will no doubt include some form of bank credit as a liability, which has the marginal effect of increasing the aggregate money supply, that also being subject to Tobinesque rebalancing and reconfiguration of asset and liability types over time.

    Credit card balances are not money balances. To interpret credit card balances as monetary would be double counting the money balances initially created by bank credit card operators or recirculated by non-bank credit card operators.

  9. 9 Mike Sproul September 15, 2016 at 7:55 am

    Nick and JKH

    ASSETS…………………………………………….LIABILITIES
    1) 100 oz silver deposited……………..100 paper dollars issued
    2) IOU worth 200 oz………………………200 paper dollars lent
    3) IOU worth 300 oz………………………300 checking account dollars lent
    4) IOU worth 400 oz………………………400 credit card dollars lent

    The paper dollars issued in line 2 are issued on loan. People used to say they weren’t money, but merely “money substitutes” or “economizing expedients”. Since they would be paid off in “real money” (coins), people figured that counting both coins and paper was double-counting. After about 100 years, people finally realized that as one paper dollar is paid off, another is issued on a new loan, and the permanent float of paper dollars that is never really paid off does in fact count as money.

    The checking account dollars issued in line 3 are also issued on loan. People told the same story about loans, economizing expedients, double-counting, etc, until another 100 years passed and the re-learned the lesson of permanent floats.

    The credit card dollars issued in line 4 are issued on loan. Blah blah, economizing expedients, double counting, permanent float, and so it will go until the 100th anniversary of credit cards comes in 2050.

  10. 10 Rob Rawlings September 15, 2016 at 8:58 am

    The punchline of Nick’s post is that if prices and the money supply get out of line , and prices are sticky, then we may get a recession.

    The assumption appears to be that for a set of parameters in an economy (including the demand to hold money) there is unique relationship between the price level and the money supply.

    If prices are sticky then one needs to look for flexibility in the money supply. In Nick’s world this normally seems to come from the central bank adjusting the quantity of base money and letting the economy work the rest out itself.

    Implicit in the theory of reflex, and endogenous money appears to be the idea that in a free-banking world the quantity of money would adjust to the price level with no CB help needed. The way I am thinking about this is that as long as their is a commonly accepted unit of account (for example: equivalent to a keratin bundle of goods or commodities) there will be forces in the economy that will align the supply of money to the price level. These forces will be centered around the activities of banks creating credit money. via borrowing and lending activities, and this will lead to the quantity of money adjusting to the demand to hold it along the lines described in the Tobin article.

  11. 11 JKH September 15, 2016 at 9:50 am

    Mike S.,

    That’s a bank balance sheet of assets and liabilities you’re depicting – central or commercial, in general it doesn’t matter – but commercial for the modern practical case.

    Leaving aside the differing amounts, your # 3 and # 4 are the same. That is implicit in the point of my comment.

    When credit cards are used to make payments, the result is a bank credit card asset and a bank deposit liability (for bank owned credit card operations; the non-bank owned is a trivial modification as I described).

    The dollars that are produced by a credit card draw down are not “credit card dollars”. They’re the same type of dollars that are produced by any other type of commercial bank credit draw down – including for example corporate loans or residential mortgages.

    The credit card characteristic starts and ends with the bank credit card asset. The dollars produced by any of these bank credit activities are totally fungible.

  12. 12 Mike Sproul September 15, 2016 at 2:12 pm

    JKH:
    You say that lines 3 and 4 are the same, and I agree. It makes no difference if a dollar exists as a printed piece of paper, or as a computer blip in a checking account, or a computer blip in a credit card account. Each kind of dollar can be created by loan, and can be retired by the repayment of a loan. A paper or checking account dollar might pass through 5-10 hands before being retired as part of a loan repayment, and a credit card dollar might pass through only two sets of hands before being retired. But while they exist they are money, just like paper dollars or checking account dollars. There is a permanent float of a few trillion credit card dollars, which should be counted as part of the money supply.

  13. 13 JKH September 15, 2016 at 3:49 pm

    Mike S.,

    That’s just not correct. Again, you’re double counting.

    For example, the Royal Bank at the end of its last fiscal year had approximately $ 15 billion in outstanding credit card debt on its books as an asset.

    You can think of this as the total cumulative net drawdown of Royal Bank credit card debt over time – up to that point in time – of money that has been created in conjunction with credit card debt, then flowed out to create new bank deposits held by vendor recipient depositors at various banks, with all of that being net of the cumulative repayment of balances by the same credit card customers. Over time, the result has been a still growing $ 15 billion net credit card balance asset portfolio on the Royal Bank balance sheet. This reflects an underlying process of ongoing gross draw downs and gross repayments, at high velocity, while the net balance grows steadily on a long term trend line. In this sense, it is a roughly predictable net growth pattern over time, and banks spend considerable resources in researching customer behavior at the individual and aggregate portfolio level in order to track and understand it as a dynamic portfolio of revolving credit.

    As a cumulative net drawdown over time, the money effect that is created is already out there in the banking system somewhere. The gross balances that are created anew are out there as additions to vendor deposit accounts, and the gross balances that credit card customers use to repay whatever balances they wish to repay are out there in their bank deposit accounts just prior to repayment – de facto according to the amounts they are capable of paying. So the entire money supply effect exists on the liability side of the banking system, quite separate from the balance sheet item that is the credit card balances in banks’ asset portfolios. There is no hidden “float” as you infer. The word “float” is used liberally in many banking contexts. If you want to use it in this case, the float corresponding to credit card activity exists in an aggregate way separate from the credit card asset balances, as a corresponding component of the liability side of banking. Unpacking exactly where is impossible, given the complexity of funds flows, but has to be there as a mere fact of how the associated funds flow and how corresponding accounting entries are made.

    F.Y.I. – Royal Bank demand deposit liabilities at the same date totaled $ 312 billion. While there is obviously no requirement that either the money proceeds from new credit card draw downs or the balances used to repay credit card debt will exist within the same issuing bank at any point in time, this numerical contrast within one major bank provides an idea of the proportionality of the thing.

  14. 14 Mike Sproul September 15, 2016 at 7:13 pm

    JKH:
    Sorry, I should have said a few billion, not a few trillion. But of course our disagreement is not over billions vs. trillions, but over whether to count credit card dollars as money at all.

    Let me counter your argument with a simple case: A shopkeeper sells $1000 worth of goods to credit card customers each month. At the same time, he buys $1000 worth of other goods on his own credit card. At the end of the month, his credit card company offsets the two $1000 amounts, and he owes nothing. Clearly, the $1000 he receives from his customers is not added to his bank deposit. But nevertheless, credit card dollars have been created, spent, and retired. The same transactions could have been done with everyone using nothing but checking accounts, or with everyone using nothing but paper dollars.

    So, just to check whether we are talking at cross purposes: Would you agree that in this simplified case, credit card dollars have just as much claim to be money as do checking account dollars or paper dollars?

  15. 15 JKH September 16, 2016 at 12:29 am

    Mike S.,

    Let’s use some dates in your example.

    Suppose first that these are all bank credit card operation examples.

    Assume for simplicity that all goods transactions take place on the 1st of the month.

    And all credit card bills are paid on the 30th of the month.

    (Also assume for simplicity no “debit float” or “credit float” for banks at the operational level. This is a true type of (potential) short term operational bank float, in which there is delay between the date of a customer/merchant real time transaction and its date as recorded on any of the credit card balance, the bank deposit account, or the bank reserve account. This has little to do with the substance of the example, but simplifies the dating to make it operationally simultaneous, in effect.)

    So on the 1st, the banks’ credit card balance increases by $ 1,000, due to customer transactions. And the merchant’s bank deposit balance increases by $ 1,000 (no operational float assumption). That means the money supply increases by $ 1,000.

    The merchant also uses his credit card in the same amount for his own goods purchase transaction.

    By assumption, the merchant does not use his new bank deposit balance of $ 1,000 to make this purchase. He uses his credit card. The same thing happens. The money supply increases by another $ 1,000, that money ending up in the deposit account of another merchant who was the vendor in this case.

    So total money supply has increased by $ 2,000.

    The first merchant has $ 1,000 in his bank deposit account for the entire month, because he was credited $ 1,000 by his bank for his customer transactions and he did not spend from that deposit balance. He spent $ 1,000 from his card, which increases somebody else’s balance with new money created by his card transaction.

    So for the entire month, there is a total of $ 2,000 in credit card balances on the books of banks (owed to them) and a $ 2,000 increase in money supply.

    At the end of the month, everybody pays off their credit card bill, and the money supply shrinks back to its original amount.

    Start again next month.

    In this theoretical example, there is a temporary decrease immediately followed by an increase in aggregate credit card balances due to repayment on the 30th and then draw down on the 1st. But that is not an issue in reality. Because of multiple draw down dates and multiple repayment dates over a large population of customers, there is an average stability to the aggregate size of credit card balances outstanding. For example, this payment date diversification effect mutes any significant concentration effect due to repayments precisely on due date, because individual customers in fact repay over many different dates. In any event, such blips in the size of outstanding credit becomes an averaging effect in the measurement of those balances and the corresponding money supply. Over time, there is a growth in the relatively non-volatile aggregate bank balance of credit (e.g. currently $ 15 billion and growing in the case of the Royal Bank). The money supply effect of that cumulative net number already exists in the measured money supply, as I described, and that is separate from the recording of the actual credit card balance which exists as a bank asset. Therefore, the credit card balance itself should not be counted as part of the money supply – because the money supply consequence is already accounted for in the deposit liability balances created by net credit card usage and consequent outstanding balances over time. And as I say, that is a relatively smooth, up-trending number due to the portfolio effect of netting new draw downs and repayments over time by many different customers, and a natural growth in the underlying size of the business outstanding.

    Again, there is a difference between “credit card dollars” as that term might in theory be used in the medium of account sense to describe the outstanding credit card balance on the books of the bank as an asset (it typically isn’t used that way, because it is awkward and potentially ambiguous), and the dollars that are created as new money supply in the medium of exchange sense when credit cards are used to make payments. The latter dollars fully capture the money supply implication of credit cards. (I.e. bringing “credit card dollars” as you seem to use the term into that measure is just double counting the money supply consequence.) And those latter dollars are typically chequing account dollars, so there is *no* distinction in type between those dollars and the type of money supply dollars that are created when a bank extends a new residential mortgage or a new corporate loan.

    (This is hard work. I hope we’re getting closer.)

  16. 16 Mike Sproul September 16, 2016 at 8:27 pm

    JKH:
    Return to that money-issuing bank:

    ASSETS…………………………………………….LIABILITIES
    1) 100 oz silver deposited……………..100 paper dollars issued
    2) IOU worth 200 oz………………………200 paper dollars lent
    3) IOU worth 300 oz………………………300 checking account dollars lent
    4) IOU worth 400 oz………………………400 credit card dollars lent

    Your argument would go that the $400 from line 4 is paid to a merchant and shows up as 400 checking account dollars in the merchant’s account, and on this basis you say that if we counted both the 400 credit card dollars and the 400 checking account dollars, we would be guilty of double-counting. But we have to remember that the 400 credit card dollars are created when the credit card is swiped, and they are retired when the merchant gets his 400 checking account dollars. The 400 checking account dollars are created the moment the 400 credit card dollars are retired, so there is no double-counting. There is only $400 created, not $800..

    That’s why I imagined the case of the merchant who used his own credit card sales to pay off his credit card charges. Suppose that among this bank’s $400 worth of credit card customers, there is a merchant who sells $50 of goods to his credit card customers while at the same time he buys $50 of goods on his own credit card. At the end of the month the credit card company offsets the two $50 charges and the credit card dollars are retired. The $50 does not show up in anyone’s checking account. Fifty credit card dollars were created during the month and retired at the end of the month. At any given time, there will be a permanent float of credit card dollars ($400 total in this case) that are constantly being created and retired. As you pointed out, the $50 ups and downs smooth out over time.

    The same argument you use to claim that credit card dollars are not money could be used (and in the 1840’s, actually was used) to deny that checking account dollars are money, and could even be used to deny that paper dollars are money. In both cases, the eventual recognition that there is a permanent float of paper dollars and checking account dollars forced economists to recognize them as money.

  17. 17 JKH September 16, 2016 at 10:18 pm

    Mike S.,

    “But we have to remember that the 400 credit card dollars are created when the credit card is swiped, and they are retired when the merchant gets his 400 checking account dollars. The 400 checking account dollars are created the moment the 400 credit card dollars are retired, so there is no double-counting. There is only $400 created, not $800.”

    Sorry, I can’t parse this paragraph, because the terminology just doesn’t compute with me. But it was my point that there is no such separate thing as “credit card dollars” in the sense of a money supply effect – because the money supply effect is fully captured in the fact that $ 400 in checking account balances are created as a result of the incurrence of $ 400 in credit card debt. The outstanding credit card balance of $ 400 is separate from the $ 400 checking account balance. The first is a borrower’s debt and a bank’s loan. The second is bank money – just like any other bank money. As per my example, both might be created on the 1st of the month and extinguished on the last of month, with the law of large numbers and date diversification having the effect of eliminating most of that occasional bumpiness in outstanding portfolio balances over time. And in the case of such an example, it was also my point that “there is only $400 created, not $800” – precisely because the money supply effect is fully captured in the associated checking account dollars, and not with something in addition to that referred to as “credit card dollars”. So we may be communicating at cross purposes somehow as far as that’s concerned.

    “Suppose that among this bank’s $400 worth of credit card customers …”

    I think I agree with that paragraph. We keep changing the examples and the numbers, so it makes the discussion somewhat awkward. In this one, you’ve assume all activity is a subset of the $ 400, but I think we’re agreeing in the sense of the cycle as you describe it.

    I guess one of my main points is that I find the use of the term “credit card dollars” to be very ambiguous. There is for one thing a credit card balance, which is a bank asset (in the case of bank owned credit card operations). And then there is a checking account balance created as a result of the credit card transaction, and that checking account balance is a bank liability. The money supply effect of credit cards is fully captured by that checking account balance. It was captured for the entire month in my micro example, except for the last day. And that last day effect gets muted in a large portfolio, as I think we may agree. So there is no need to reference “credit card money”, whatever is meant by that. Those checking account balances as money supply are indistinguishable from any other checking account balances created by banks. Credit cards are not special and should not be isolated as something special in the measurement of any related money supply. That was my second main point, and my original point. I’m not sure you agree with that, although I’m also not sure why my explanation shouldn’t be understandable.

    “The same argument you use to claim that credit card dollars are not money …”

    I’m not claiming that – because I find the term “credit card dollars” to be ambiguous, as I described above, and therefore meaningless in the context of my interpretation of how this works. So nobody is using my argument. I think I’ve explained my point of view in the sense that “credit card dollars” is a term that has no meaning for me – since the dollars in question for money supply purposes are checking account dollars resulting from credit card spending and corresponding debt creation, and those dollars are no different in substance than the checking account dollars created when a new mortgage or a new corporate loan is drawn down. The tracking of the money supply then aggregates all such dollars created by banks.

    Having said all that, I am interested in your view on the evolution of the monetary system in the way you are thinking of it as a historical sequence. But I must say for me to understand that would requires a tabula rasa reboot – starting with my own understanding and explanation of the money supply effect of the credit card business in the way it works now – and from that starting point I would then have to understand your explanation of the next step in the evolution. Specifically, what is it that is going to displace the current process of creating bank (checking account) money when credit cards are used to pay for goods and services?

  18. 18 Mike Sproul September 17, 2016 at 10:23 am

    JKH:
    You might be old enough to remember paper credit card slips. The cashier would place your credit card in a credit card imprinter the size of a Kleenex box, put a paper slip with 3 carbon copies on top of your card, and roll the top part of the imprinter over your card, imprinting your credit card numbers on the slip. After entering a dollar amount ($50, say) on the slip, you would sign it, keeping one copy as your receipt. The merchant kept the original.

    That original slip is what I mean by a “credit card dollar”. I don’t know the processing details, but I presume the merchant would accumulate slips until the end of the month, piling up his credit card dollars in his cash box. The merchant would then present the slips to the credit card company. The credit card company would wait for (I guess) 60 days, until it had presumably been paid by its customer, and then the merchant would get his money deposited in his checking account.

    The credit card dollars are created and spent the moment the customer signs the slip, and they disappear (are retired) the moment the payment from the credit card company shows up in the merchant’s checking account. Fifty checking account dollars are created only after the $50 credit card dollars are retired, so there is no double-counting. It is as if the customer, standing there at the cashier, was able to call his banker, ask the banker to print and lend $50 of bank notes, and the bank instantly sends those newly-printed notes to the customer, who pays them to the merchant. The merchant then redeems the notes with the banker. Traditional bank notes, of course, would pass through several hands before being redeemed at the bank, while a credit card dollar would normally be spent only once. But merchants could, and sometimes probably do, use those credit card dollars to buy things, so that the credit card dollars could theoretically pass through many hands, just like bank notes.

    I think we agree up to this point.

    The trouble starts when we imagine the merchant who uses his own 50 credit card dollars to pay his $50 in credit card charges. Then there are no checking account dollars corresponding to the 50 credit card dollars. I’d say that at this point, you have to start counting credit card dollars as money on their own, while you have been saying “The money supply effect of credit cards is fully captured by that checking account balance.”

    This is actually the same issue that arose when paper money was invented. As long as everyone who received a paper dollar in payment for goods, redeemed that dollar at the bank for a coin, then the money supply could be said to equal the amount of coins. But then people started to let the paper dollars circulate for long periods without being redeemed in coin, and they were finally forced to include paper dollars in the money supply. The same thing happened when checking accounts were invented.

    My own personal monetary theory reboot happened over 5 years, from 1989-1994, when my doubts about the quantity theory became strong enough that I started reading John Fullarton, Thomas Tooke, Charles Bosanquet, and so on. I collected some of the key material on my website:

    http://www.csun.edu/~hceco008/realbills.htm

  19. 19 JKH September 17, 2016 at 11:59 pm

    And here’s a New York Times article:

    http://boss.blogs.nytimes.com/2013/03/25/what-you-need-to-know-about-credit-card-processing/

    “Despite that risk, the acquiring bank will put the transacted funds in the merchant’s account a couple of days after the transaction is reported.”

    Again that timing reference seems to confirm a pretty short operational float time for purposes of the money supply effect that results from credit card transactions.

    Thanks for the link to your website.

  20. 20 JKH September 18, 2016 at 12:00 am

    comment administration – that’s the second part of a comment that was filtered out twice now

  21. 21 JKH September 18, 2016 at 12:04 am

    TRYING AGAIN IN 3 PARTS:

    NOTE – I have posted this comment for the third time, this time in 3 parts, to separate out 2 links that I’m guessing may have triggered a filter in the comment administration the first time around

    Mike S.,

    It looks like your examples and the idea of separate “credit card dollars” are premised largely on the assumption of a very long float period between the time a merchant accepts a credit card payment and the time he gets credit in his bank deposit account. And within that long float period is the potential for the kinds of offsets you describe in the context of “credit card money”, which I see now why you are depicting as a result separate from checking account money, due to such a lengthy float period.

    I must say I’m shocked by the length of the float periods you are suggesting, but I’m not close enough to it these days to confirm for sure how this actually works inside the bank. I would have thought that systems for large retailers in particular are set up now in such a way as to compress the float period for credit card payment clearing to about the same length as the float period for posting a credit card charge to a customer account – i.e. one or two business days. There is simply no reason in today’s digital age for that not to be the case. Small convenience retailers – maybe less so, depending on their systems. That is the reason why I am largely ignoring such float in identifying a money supply effect that is separate, distinct and complete for purposes of interpreting the place of credit cards in measuring aggregate money supply. So I understand what you’re saying now, roughly at least, on the basis of those kinds of long float lags. But again I would have thought that such float in fact is far more compressed these days. My interpretation is premised on that assumption.

    I googled the question and couldn’t find a great deal. That’s not surprising, since the technology of the merchant end of credit card operations would naturally be more opaque than the same for the customer, given the proprietary nature of banking arrangements for enterprises. The customer float period is of course a mere one or two business days in most cases, which we can all see from the difference between our own activity and the date of posting.

    I did find a couple of references from Google:

  22. 22 JKH September 18, 2016 at 12:13 am

    The comment administration won’t accept the first link

    But it infers that the same card reading technology that gets authorization from the customer’s bank actually causes the payment from the customer’s bank to the merchant’s bank (see step 5 and 6) in the same sort of time sequence. Indeed, that’s what I have implicitly been assuming, I think. If that’s the case, then my own premise is correct in explaining why “credit card dollars” are essentially a moot notion for the purposes of identifying money supply in the modern age.

  23. 23 JKH September 18, 2016 at 12:15 am

    Followed by the New York Times article reference that I posted as one piece above

    END

  24. 24 Oliver September 20, 2016 at 7:45 am

    @ Nick Rowe:
    If I buy apples for $100 from Mike, using my credit card, and Mike buys bananas for $100 from me, using his credit card, do the two $100 balances get cancelled out?

    You can’t tell. It depends one whether any of the money gets zsedto pay down credit card debt. Assuming balances if $0 each at the beginning, total balances at the end could be anywhere between $0 and $200 (max $100 each) after both transactions you mention. You can imagine having a credit card with a different bank than the checking account Mike pays into and vice versa. The only thing that is clear is that total credit card debt will equal total positive balances. Those are the items that cancel out, not your and Mike’s checking account balances.

    @ David Glasner
    Why do you consider a pure credit economy unstable? Can you point me to anything you (or anyone else) have written on that subject?

  25. 25 Mike Sproul September 20, 2016 at 4:39 pm

    JKH
    I was only guessing about the 60 day delay in sending funds to the merchant, but a little googling says that the funds are put in the merchant’s bank after 1-2 days, but the funds are subject to a hold of up to 180 days, just in case the customer cries foul, or the merchant is running a scam. It’s debatable whether checking account dollars with a hold on them should be counted as money. It’s also debatable whether credit card dollars with a hold on them should be counted as money. But for uncomplicated transactions, it’s still the case that the checking account dollar is created as the credit card dollar is retired.

    Sorry to drag you back to the T account again:

    ASSETS…………………………………………….LIABILITIES
    1) 100 oz silver deposited……………..100 paper dollars issued
    2) IOU worth 200 oz………………………200 paper dollars lent
    3) IOU worth 300 oz………………………300 checking account dollars lent
    4) IOU worth 400 oz………………………400 credit card dollars lent

    So maybe of the 400 credit card dollars shown, 240 of them will be retired as 240 new checking account dollars are created, and one could argue that the other 160 credit card dollars will be paid through some offset transaction, and so are not matched by any checking account dollars. So one could argue that only the 160 credit card dollars should be considered as money.

    But if that’s the case, then not all checking account dollars should be counted as money either, since some of them will be paid with paper dollars. Or take it further and argue that not all 200 paper dollars should be counted as money, since some of them will be paid in coins.

    But when economists add up the money supply, they count all 200 paper dollars and all 300 checking account dollars. For the sake of consistency, they should also count all 400 credit card dollars.

    Something I should have said earlier: The question of whether something is or is not money does not admit of a clear answer. But there’s another question: Whose liability are all those dollars? On this there is no dispute. The 400 credit card dollars are the liability of the credit card company, and the 300 checking account dollars are the liability of the issuing banks, as are the 300 paper dollars. Since I am a backing theorist, and not a quantity theorist, the question about liability is the one that matters to me, and not the question of what is money and what isn’t.

  26. 26 JKH September 22, 2016 at 3:43 am

    Mike S.

    Let’s leave it there for now.

    Thanks for the discussion.


  1. 1 Price Stickiness Is a Symptom not a Cause | Uneasy Money Trackback on September 28, 2016 at 9:53 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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