Fiat Bling

I visited a country where people wore paper money as jewelry. Richer people wore larger denomination notes, to signal how wealthy they were, and poorer people wore smaller denomination notes. Only the very poorest wore none at all.

Then I learned the paper money wasn't used as money. They only produced one homogeneous good called "corn", so didn't need a medium of exchange. What I thought was money was in fact bling.

Bling was issued by the central bank. It wasn't bling unless it had the authorised signature of the central bank's governor, and wearing forged bling was severely punished by ridicule. The governor's signature was performative; the Governor said "Fiat bling", and there was bling.

Commercial banks also issued bling. But commercial bank bling was convertible on demand, at par, into central bank bling. And commercial banks need sufficient assets (central bank bling, corn, promises to pay future corn or bling) to give people confidence that convertibility could be maintained.

Different banks issued bling in different colours. And different people preferred different colours, with some preferring a mix of colours. So the varieties of bling were substitutes, but imperfect substitutes.

It is easy to understand that commercial bank bling would be valuable, given commercial banks' promise to maintain convertibility at par into central bank bling. But what made central bank bling valuable? In the olden days central bank bling had been redeemable for gold, but fashions had changed, so paper bling had replaced gold bling (it was more comfortable), and gold convertibility had been suspended, temporarily at first, and then permanently.

What made fiat bling valuable was simply demand and supply. The demand for bling (Md = P.L(Y,r), where Md is the stock of bling demanded, P the price of corn in terms of bling, Y the level of corn income, and r the nominal interest rate on loans of bling, and thus the opportunity cost of wearing bling), together with a central bank that limited the supply of bling, created an equilibrium with a positive stock of bling (M > 0) with a positive value (P < infinity). Some academic theorists worried about a possible second equilibrium, in which a self-fulfilling belief that fiat bling was worthless would cause people to stop wanting to wear worthless bling; but normal people's customary belief that fiat bling was valuable prevented that happening. Plus they knew the central bank had enough assets to buy back all the bling if it really needed to.)

There are many ways the central bank could limit the supply of bling. Simply fixing Ms (or the growth rate of Ms) would be one way. But the central bank in this country instead chose to control the rate of interest r at which it would lend bling. If the price of corn in terms of bling was rising too quickly, the central bank would raise r to discourage borrowing of bling; and if the price of corn in terms of bling was rising too slowly the central bank would cut r to encourage borrowing of bling. So the stock of bling in public hands was determined by the stock of bling demanded at the rate of interest set by the central bank.

A shortage or surplus of bling might affect people's ability to signal their wealth. But central bank policy didn't affect the rest of the economy. Self-sufficient people kept on consuming the corn they produced regardless of anything the central bank did, lending or borrowing corn between themselves depending on who had a relatively better or worse harvest. The only thing that caused aggregate production to fall was bad weather across the whole country.

Comments

[Market Fiscalist]

I can imagine schools of bling theory emerging:

Free Blingers accuse the CB of causing periodic shortages/excesses of bling by getting the interest rate wrong. Scrap the CB and let private banks issue fractional reserve bling backed by gold and these shortages/excesses will be eliminated.

Modern Bling Theory says that setting the interest rate only determines the amount of interest paid out and has no effect on the quantity bling in circulation (which is exogonous).

Market Blingers say that interest rates are no guide to the stance of bling policy and the CB should really target a level of bling based on stabilizing people's predictions of how much bling they think they will wear next year.

Austrians develop a bling cycle theory showing that if interest rates are too low then people start wearing bling in too roundabout a way and this eventually causes a slump when people run out of places to store all the bling.

[Nick Rowe]

MF: LOL! And the Fiscal Theory of the value of Bling says it's determined by the Present Value of budget surpluses, because bling bonds are as good as bling.

[Antonio de Sousa]

I'm sure this is a metaphor for something, but alas it has been 26 years since I cracked an economics text. Although I follow this blog regularly because, or in spite of ;-), of the personalities.

But on a serious note, I just finished reading about MMT "Modern Monetary Theory" and I'm starting to question whether holding cash or any nominal instruments is going to fund my standard of living for the next 25 years (I have no defined benefits pension). If I understand correctly, the metaphor means hold tangible assets, but the largest tangible assets people can hold is real-estate and in my view the value of this asset class is wildly inflated.

[Roger Sparks]

My reaction to the 'bling' story is positive with the devil lurking in the details. Here are a couple of suggested detail improvements:

1. "positive value (P < infinity)" should be "positive value (P <= infinity). This to allow sellers to demand a price higher than buyers are willing to pay. A price higher than a reachable price may as well be priced at an infinitely high level.

2. A paragraph suggesting that government, to accomplish the needs of government, can override central bank decisions. A posted rate of interest is of no concern to a determined government which can borrow from the CB to pay interest cost just as it can borrow to accomplish any other perceived need.

3. It is probably past the scope of this post to point out that bling can be 'forced' onto the public faster than players can spend it. A generous government finds this easy to accomplish. In other words and perspective, if loans create money and repayment destroys money, the only way to eliminate money is to repay all loans.

Thanks for another thought provoking post.

[Mike Sproul]

But what if another country's bling started to be used in your country?
Then the demand for domestic bling would drop, and if the central bank wanted bling to hold its value, the central bank would have to use its assets to buy back enough bling to keep bling's value stable.
PROBLEM: The central bank couldn't buy back its bling unless it had assets, so it is ultimately the central bank's ASSETS that gave bling its value---not the supply and demand for bling.

[Kaleberg]

This actually sounds like a sensible proposal. If the government provides everyone with housing, food, education, health care, transportation and so on. Then, money just becomes bling, a means of signalling wealth, sort of like sports trophies.

[djb]

either way their economy still has a currency, ie corn and since "bling" maintains its value relative as corn then it too will probably be used as a currency

now if the parable is defending the idea that a commodity with an inherent value is the best currency rather that fiat money they are going backwards in time, and will have to start worrying about the currencies convenience as medium of exchange and its ability to maintain its store of value. The idea that corn for example will maintain a stable value is unrealistic because if it was truly the currency then people would focus on producing more, even to the detriment of the production of other essential items.

so then the alternative is consider all essential items as currencies, and the we are back to a barter situation

the real argument being attempted here is perhaps that fiat money has no real value, it is the commodities itself that have the value

and so we can just get rid of fiat money and everything will be fine?

fiat money has developed for a reason, an economy using fiat money is far advanced over a barter economy

and advanced over representative money (like goal standard) and precious metals

because it is fiat money that facilitates production of commodities the most

[Roger Sparks]

While musing about bling and corn this afternoon, I thought about the one commodity economy. Hmmm. Is labor a commodity? If so, this would be a two commodity economy.

How might two commodities change the story?

One idea that came to mind was that labor precedes most other commodities so most money is needed to first pay obligations to labor. Once labor is performed, we could have corn available as a second commodity.

I understand that MMT thinks of taxes as being a principal driver giving money value. If labor is indeed a commodity, then acceptance of bling(money) as payment for labor performed would serve as a signal of acceptance of a standard value, strongly reinforcing any value due to taxation. Universal acceptance by labor would establish a broadly based bling acceptance value.

It would take a major rewrite of Nick's post to incorporate labor-as-a-commodity.

[john]

Coin is bling.

[Scott Sumner]

I think that's right. In a commodity economy with no sticky wages, a monetary shock has no real effects.

But if nominal wages are sticky?