David Graeber on the Origins of Money

So, I was debating whether I was going to assign the first chapter of "Debt: The First 5,000 years" by the anthropologist David Graeber to you money and banking students since I had brought it up in class.  Fortunately for you, a argument on the internet has provided a very concise and clear distillation of the chapter by the author himself.  It is quite long for a blog post, but well worth the read, especially considering the alternative is reading the full 50 page chapter.  Graeber is making his points in the context of a debate (argument?), but that element of the text is minimal and easily skipped over.


Also of interest is the original interview with Graeber referred to.


This comes from Naked Capitalism.:


Last week, Robert F. Murphy published a piece on the webpage of the Von Mises Institute responding to some points I made in a recent interview on Naked Capitalism, where I mentioned that the standard economic accounts of the emergence of money from barter appears to be wildly wrong. Since this contradicted a position taken by one of the gods of the Austrian pantheon, the 19th century economist Carl Menger, Murphy apparently felt honor-bound to respond.
In a way, Murphy’s essay barely merits response. In the interview I’m simply referring to arguments made in my book, ‘Debt: The First 5000 Years’. In his response, Murphy didn’t even consult the book; in fact he later admitted he was responding at least in part not even to the interview but to an inaccurate summary of my position someone had made in another blog!
We are not, in other words, dealing with a work of scholarship. However, in the blogsphere, the quality or even intention of an argument often doesn’t matter. I have to assume Murphy was aware that all he had to do was to write something—anything really—and claim it rebutted me, and the piece would be instantly snatched up by a right-wing echo chamber, mirrored on half a dozen websites and that followers of those websites would then dutifully begin appearing across the web declaring to everyone willing to listen that my work had been rebutted. The fact that I instantly appeared on the Von Mises web page to offer a detailed response, and that Murphy has since effectively conceded, writing an elaborate climb-down saying that he had no intention to cast doubt on my argument as a whole at all, only to note that I had not definitively disproved Menger’s, has done nothing to change this. Indeed, on both US and UK Amazon, I have seen fans of Austrian economics appear to inform potential buyers that I am an economic ignoramus whose work has been entirely discredited.
I am posting this more detailed version of my reply not just to set the record straight, but because the whole question of the origins of money raises other interesting questions—not least, why any modern economist would get so worked up about the question. Let me begin by filling in some background on the current state of scholarly debate on this question, explain my own position, and show what an actual debate might have been like.
First, the history:

1) Adam Smith first proposed in ‘The Wealth of Nations’ that as soon as a division of labor appeared in human society, some specializing in hunting, for instance, others making arrowheads, people would begin swapping goods with one another (6 arrowheads for a beaver pelt, for instance.) This habit, though, would logically lead to a problem economists have since dubbed the ‘double coincidence of wants’ problem—for exchange to be possible, both sides have to have something the other is willing to accept in trade. This was assumed to eventually lead to the people stockpiling items deemed likely to be generally desirable, which would thus become ever more desirable for that reason, and eventually, become money. Barter thus gave birth to money, and money, eventually, to credit.
2) 19th century economists such as Stanley Jevons and Carl Menger [1] kept the basic framework of Smith’s argument, but developed hypothetical models of just how money might emerge from such a situation. All assumed that in all communities without money, economic life could only have taken the form of barter. Menger even spoke of members of such communities “taking their goods to market”—presuming marketplaces where a wide variety of products were available but they were simply swapped directly, in whatever way people felt advantageous.
3) Anthropologists gradually fanned out into the world and began directly observing how economies where money was not used (or anyway, not used for everyday transactions) actually worked. What they discovered was an at first bewildering variety of arrangements, ranging from competitive gift-giving to communal stockpiling to places where economic relations centered on neighbors trying to guess each other’s dreams. What they never found was any place, anywhere, where economic relations between members of community took the form economists predicted: “I’ll give you twenty chickens for that cow.” Hence in the definitive anthropological work on the subject, Cambridge anthropology professor Caroline Humphrey concludes, “No example of a barter economy, pure and simple, has ever been described, let alone the emergence from it of money; all available ethnography suggests that there never has been such a thing” [2]

a. Just in way of emphasis: economists thus predicted that all (100%) non-monetary economies would be barter economies. Empirical observation has revealed that the actual number of observable cases—out of thousands studied—is 0%.
b. Similarly, the number of documented marketplaces where people regularly appear to swap goods directly without any reference to a money of account is also zero. If any sociological prediction has ever been empirically refuted, this is it.

4) Economists have for the most part accepted the anthropological findings, if directly confronted with them, but not changed any of the assumptions that generated the false predictions. Meanwhile, all textbooks continue to report the same old sequence: first there was barter, then money, then credit—except instead of actually saying that tribal societies regularly practiced barter, they set it up as an imaginative exercise (“imagine what you would have to do if you didn’t have money!” or vaguely imply that anything actual tribal societies did do must have been barter of some kind.

So what I said was in no way controversial. When confronted on why economists continue to tell the same story, the usual response is: “Well, it’s not like you provide us with another story!” In a way they have a point. The problem is, there’s no reason there should be a single story for the origin of money. Here let me lay out my own actual argument:

1) If money is simply a mathematical system whereby one can compare proportional values, to say 1 of these is worth 17 of those, which may or may not also take the form of a circulating medium of exchange, then something along these lines must have emerged in innumerable different circumstances in human history for different reasons. Presumably money as we know it today came about through a long process of convergence.
2) However, there is every reason to believe that barter, and its attendant ‘double coincidence of wants’ problem, was not one of the circumstances through which money first emerged.

a. The great flaw of the economic model is that it assumed spot transactions. I have arrowheads, you have beaver pelts, if you don’t need arrowheads right now, no deal. But even if we presume that neighbors in a small community are exchanging items in some way, why on earth would they limit themselves to spot transactions? If your neighbor doesn’t need your arrowheads right now, he probably will at some point in the future, and even if he won’t, you’re his neighbor—you will undoubtedly have something he wants, or be able to do some sort of favor for him, eventually. But without assuming the spot trade, there’s no double coincidence of wants problem, and therefore, no need to invent money.
b. What anthropologists have in fact observed where money is not used is not a system of explicit lending and borrowing, but a very broad system of non-enumerated credits and debts. In most such societies, if a neighbor wants some possession of yours, it usually suffices simply to praise it (“what a magnificent pig!”); the response is to immediately hand it over, accompanied by much insistence that this is a gift and the donor certainly would never want anything in return. In fact, the recipient now owes him a favor. Now, he might well just sit on the favor, since it’s nice to have others beholden to you, or he might demand something of an explicitly non-material kind (“you know, my son is in love with your daughter…”) He might ask for another pig, or something he considers roughly equivalent in kind. But it’s almost impossible to see how any of this would lead to a system whereby it’s possible to measure proportional values. After all, even if, as sometimes happens, the party owing one favor heads you off by presenting you with some unwanted present, and one considers it inadequate—a few chickens, for example—one might mock him as a cheapskate, but one is unlikely to feel the need to come up with a mathematical formula to measure just how cheap you consider him to be. As a result, as Chris Gregory observed, what you ordinarily find in such ‘gift economies’ is a broad ranking of different types of goods—canoes are roughly the same as heirloom necklaces, both are superior to pigs and whale teeth, which are superior to chickens, etc—but no system whereby you can measure how many pigs equal one canoe. [3]

3) All this is not to say that barter never occurs. It is widely attested in many times and places. But it typically occurs between strangers, people who have no moral relations with one another. There is a reason why in just about all European languages, the words ‘truck and barter’ originally meant ‘to bilk, swindle, or rip off.’ [4] Still there is no reason to believe such barter would ever lead to the emergence of money. This is because barter takes three known forms:

a. Barter can take the form of occasional interactions between people never likely to meet each other again. This might involve ‘double coincidence of wants’ problems but it will not lead to the emergence of a system of money because rare and occasional events won’t lead to the emergence of a system of any kind.
b. If there are ongoing trade relations between strangers in moneyless economies, it’s because each side knows the other side has some specific product(s) they want to acquire—so there is no ‘double coincidence of wants’ problem. Rather than leading to people having to create some circulating medium of exchange (money) to facilitate transactions, such trade normally leads to the creation of a system of traditional equivalents relatively insulated from vagaries of supply and demand.
c. Sometimes, barter becomes a widespread mode of interaction when you have people used to using money in everyday transactions who are suddenly forced to carry on without it. This can happen, for instance, because the money supply dries up (Russia in the ‘90s), or because the people in question have no access to it (prisoners or denizens of POW camps.) This cannot lead to the invention of money because money has already been invented. [5]

So this is the actual argument, which Prof. Murphy could easily have ascertained with a glance at the relevant chapter of the book.
It’s easy to see from this that his counter-arguments range from extremely weak to completely irrelevant. Let me take them on in turn, such as they are

• Murphy argues that the fact that there are no documented cases of barter economies doesn’t matter, because all that is really required is for there to have been some period of history, however brief, where barter was widespread for money to have emerged. This is about the weakest argument one can possibly make. Remember, economists originally predicted all (100%) non-monetary economies would operate through barter. The actual figure of observable cases is 0%. Economists claim to be scientists. Normally, when a scientist’s premises produce such spectacularly non-predictive results, the scientist begins working on a new set of premises. Saying “but can you prove it didn’t happen sometime long long ago where there are no records?” is a classic example of special pleading. In fact, I can’t prove it didn’t. I also can’t prove that money wasn’t introduced by little green men from Mars in a similar unknown period of history. Given the weight of the evidence, the burden of proof is on the Murphys of the world to produce some plausible reason why all observable cases of moneyless societies fail to operate the way Menger predicted, and therefore, why we have any reason to believe some unknown age would have been any different; and this, he does not even attempt to do.
• Murphy then goes on to produce a straw man saying that a system where people borrow things from one another and then turn to political authorities to regulate the system would not produce money. True enough, but it seems a bit irrelevant considering (a) I never say people would be “borrowing” from each other in the way he describes, (b) I never attribute any role to political authorities in this process, and (c) rather than saying the informal system of favors I do describe would lead to the invention of money, I explicitly say that it would not.
• He then restates Menger’s argument about how money could emerge from barter, an argument that given the weight of evidence so far presented would only be relevant if there was some reason to believe money could not have emerged in any other way. He gives no such reason, other than that he cannot personally imagine money emerging any other way.
• Murphy ends by noting the famous study of how widespread barter between prisoners in POW camps seem to have led to the use of cigarettes as money—an argument which, if he had bothered to read the entire interview, let alone the book, he would have known is actually a confirmation of my argument (see 3c above) and not a refutation.

To be fair, Murphy has one other argument—he adopts the position, first proposed by Karl Marx [!], that money first emerged from barter in the process of international trade. The evidence is as follows: while the first records we have of money are administrative documents from Mesopotamia, in which money is used almost exclusively in keeping accounts within large bureaucratic organizations (Temples and Palaces), the system is based on a fixed equivalence between barley and silver, and that since silver was a trade item, this shows that Mesopotamian merchants must have been using silver as a medium of exchange in spot transactions with long-distance trade partners for that system to then be adopted as a unit of account in administrative transactions within Temples. This merits a bit more of a response—not because it is a particularly cogent argument (it’s basically circular: “since money can only have arisen through barter, if silver was money, it must have arisen through barter”), but because it raises some interesting questions about how money actually did emerge.
As I remarked above, occasional, irregular exchange between strangers will not generate a money system—since irregular, occasional exchange will not produce any kind of system. In ancient times, if you do see regular exchange between strangers, it’s because there are specific goods that each side knows they want or need. One has to bear in mind that under ancient conditions, long-distance trade was extremely dangerous. You don’t cross mountains, deserts, and oceans, risking death in a dozen different ways, so as to show up with a collection of goods you think someone might want, in order to see if they happen to have something you might want too. You show up because you know there are people who have always wanted woolens and who have always had lapis lazuli. As noted above, logically, what such a situation would lead to is a series of conventional equivalences—so many woolens for so many pieces of lapis lazuli—equivalences which are likely to be maintained despite contingencies of supply and demand, because all parties need to reduce risk in order to be able to continue to the trade at all. And once again, what logic would predict is precisely what we find. Even in periods of human history where money and markets did already exist, merchants often continue to conduct high-risk long distance trade through a system of conventional equivalents, or if money is used, administered prices, between specific commodities they know will be available, or in demand, at certain pre-established locations.
One might of course ask, could not such a system generate something like money of account—that is, the use of one or two relatively desirable commodities to measure the value of other ones, once more items were added to the mix (say, our merchant is making several stops)? The answer is yes. No doubt in certain circumstances, something like this did happen. Of course, it would have meant that money, in such cases, was first created as a means to avoid market mechanisms, and that it was not used mainly as a medium of transactions, but rather, primarily as a means of account. One could even make up an imaginary scenario whereby once you start using one divisible/portable/etc commodity as a means of establishing fixed equivalents between other ones, you could start using it for minor occasional transactions, to measure negotiated prices for spot trade swaps on the side, in a more market-driven way. All that is possible and likely as it did happen now and again—after all, we’re dealing with thousands of years here. Likely all sorts of things happened over this long period. However, there is no reason to assume that such a system would produce a concrete medium of exchange regularly used in making these transactions—in fact, given the dangers of ancient trade, insisting that some medium like silver actually be used in all transactions, rather than a credit system, would be completely irrational, since the need to carry around such a money-stuff would make one a far, far, more attractive target to potential thieves. A desert nomad band might not attack a caravan carrying lapis lazuli, especially if the only potential buyers were temples which would probably know all the active merchants and know that you had stolen the stuff (and even if you could trade for them, what are you going to do with a big pile of woolens anyway, you live in a desert?) but they’d definitely go after someone carrying around a universal equivalent. (This is presumably the reason why the great long-distance traders of the Classical World, the Phoenicians, were among the last to adopt coinage—if money was invented as a circulating medium for long-distance trade, they should have been the first.)
The other problem is that there is no reason to believe that such a mechanism—which would presumably only be used by that tiny proportion of the population who engaged in long distance trade, and who tended to treat such matters as specialized knowledge to be guarded from outsiders—could possibly create a money system used in everyday transactions within a society or any evidence that it might have done so.
The actual evidence is that in Mesopotamia—the first case we know anything about—these more widespread pricing systems in fact emerged as a side-effect of non-state bureaucracies. Again, non-state bureaucracies are a phenomenon that no economic model would even have anticipated existing. It’s off the map of economic theory. But look at the historical record and there they are. Sumerian Temples (and even many of the early Palace complexes that imitated them) were not states, did not extract taxes or maintain a monopoly of force, but did contain thousands of people engaged in agriculture, industry, fishing, and herding, people who had to be fed and provisioned, their inputs and outputs measured. All evidence that exists points to money emerging as a series of fixed equivalent between silver—the stuff used to measure fixed equivalents in long distance trade, and conveniently stockpiled in the temples themselves where it was used to make images of gods, etc.—and grain, the stuff used to pay the most important rations from temple stockpiles to its workers. Hence, as economist and Naked Capitalism contributor Michael Hudson has so brilliantly demonstrated [6], a silver shekel was fixed as the amount of silver equivalent to the numbers of bushels of barley that could provide two meals a day for a temple worker over the course of a month. Obviously such a ration system would be of no interest to a merchant.
So even if some sort of rough system of fixed equivalences, measured by silver, might have emerged in the process of trade (note again: not a system of actual silver currency emerging from barter), it was the Temple bureaucracies that actually had some reason to extend the system from a unit used to compare the value of a limited number of rare items traded long distance, used almost exclusively by members of the political or administrative elite, to something that could be used to compare the values of everyday items. The development of local markets within cities, in turn, came as a side effect of these systems, and all evidence shows they too operated primarily through credit. For instance, Sumerians, though they had the technological means to do so, never produced scales accurate enough to weigh out the tiny amounts of silver that would have been required to buy a single cask of beer, or a woolen tunic, or a hammer—the clearest indication that even once money did exist, it was not used as a medium of exchange for minor transactions, but rather as a means of keeping track of transactions made on credit.
In many times and places, one sees a similar arrangement: two sorts of money, one, a common long-distance trade item, the other, a common subsistence item—cattle, grain—that’s stockpiled, but never traded. Still, Temple bureaucracies and their ilk are something of a rarity. In their absence, how else might a system of pricing, of proportional equivalents between the values of any and all objects, potentially arise? Here again, anthropology and history both provide one compelling answer, one that again, falls off the radar of just about all economists who have ever written on the subject. That is: legal systems.
If someone makes an inadequate return you will merely mock him as a cheapskate. If you do so when he is drunk and he responds by poking your eye out, you are much more likely to demand exact compensation. And that is, again, exactly what we find. Anthropology is full of examples of societies without markets or money, but with elaborate systems of penalties for various forms of injuries or slights. And it is when someone has killed your brother, or severed your finger, that one is most likely to stickle, and say, “The law says 27 heifers of the finest quality and if they’re not of the finest quality, this means war!” It’s also the situation where there is most likely to be a need to establish proportional values: if the culprit does not have heifers, but wishes to substitute silver plates, the victim is very likely to insist that the equivalent be exact. (There is a reason the word ‘pay’ comes from a root that means ‘to pacify’.)
Again, unlike the economists’ version, this is not hypothetical. This is a description of what actually happens—and not only in the ethnographic record, but the historical one as well. The numismatist Phillip Grierson long ago pointed to the existence of such elaborate systems of equivalents in the Barbarian Law Codes of early Medieval Europe. [7]For example, Welsh and Irish codes contain extremely detailed price schedules where in the Welsh case, the exact value of every object likely to be found in someone’s house were worked out in painstaking detail, from cooking utensils to floorboards—despite the fact that there appear to have been, at the time, no markets where any such items could be bought and sold. The pricing system existed solely for the payment of damages and compensation—partly material, but particularly for insults to people’s honor, since the precise value of each man’s personal dignity could also be precisely quantified in monetary terms. One can’t help but wonder how classical economic theory would account for such a situation. Did the ancient Welsh and Irish invent money through barter at some point in the distant past, and then, having invented it, kept the money, but stopped buying and selling things to one another entirely?
The persistence of the barter myth is curious. It originally goes back to Adam Smith. Other elements of Smith’s argument have long since been abandoned by mainstream economists—the labor theory of value being only the most famous example. Why in this one case are there so many desperately trying to concoct imaginary times and places where something like this must have happened, despite the overwhelming evidence that it did not?
It seems to me because it goes back precisely to this notion of rationality that Adam Smith too embraced: that human beings are rational, calculating exchangers seeking material advantage, and that therefore it is possible to construct a scientific field that studies such behavior. The problem is that the real world seems to contradict this assumption at every turn. Thus we find that in actual villages, rather than thinking only about getting the best deal in swapping one material good for another with their neighbors, people are much more interested in who they love, who they hate, who they want to bail out of difficulties, who they want to embarrass and humiliate, etc.—not to mention the need to head off feuds.
Even when strangers met and barter did ensue, people often had a lot more on their minds than getting the largest possible number of arrowheads in exchange for the smallest number of shells. Let me end, then, by giving a couple examples from the book, of actual, documented cases of ‘primitive barter’—one of the occasional, one of the more established fixed-equivalent type.
The first example is from the Amazonian Nambikwara, as described in an early essay by the famous French anthropologist Claude Levi-Strauss. This was a simple society without much in the way of division of labor, organized into small bands that traditionally numbered at best a hundred people each. Occasionally if one band spots the cooking fires of another in their vicinity, they will send emissaries to negotiate a meeting for purposes of trade. If the offer is accepted, they will first hide their women and children in the forest, then invite the men of other band to visit camp. Each band has a chief and once everyone has been assembled, each chief gives a formal speech praising the other party and belittling his own; everyone puts aside their weapons to sing and dance together—though the dance is one that mimics military confrontation. Then, individuals from each side approach each other to trade:

If an individual wants an object he extols it by saying how fine it is. If a man values an object and wants much in exchange for it, instead of saying that it is very valuable he says that it is worthless, thus showing his desire to keep it. ‘This axe is no good, it is very old, it is very dull’, he will say… [8]

In the end, each “snatches the object out of the other’s hand”—and if one side does so too early, fights may ensue.
The whole business concludes with a great feast at which the women reappear, but this too can lead to problems, since amidst the music and good cheer, there is ample opportunity for seductions (remember, these are people who normally live in groups that contain only perhaps a dozen members of the opposite sex of around the same age of themselves. The chance to meet others is pretty thrilling.) This sometimes led to jealous quarrels. Occasionally, men would get killed, and to head off this descending into outright warfare, the usual solution was to have the killer adopt the name of the victim, which would also give him the responsibility for caring for his wife and children.
The second example is the Gunwinngu of West Arnhem land in Australia, famous for entertaining neighbors in rituals of ceremonial barter called the dzamalag. Here the threat of actual violence seems much more distant. The region is also united by both a complex marriage system and local specialization, each group producing their own trade product that they barter with the others.
In the 1940s, an anthropologist, Ronald Berndt, described one dzamalag ritual, where one group in possession of imported cloth swapped their wares with another, noted for the manufacture of serrated spears. Here too it begins as strangers, after initial negotiations, are invited to the hosts’ camp, and the men begin singing and dancing, in this case accompanied by a didjeridu. Women from the hosts’ side then come, pick out one of the men, give him a piece of cloth, and then start punching him and pulling off his clothes, finally dragging him off to the surrounding bush to have sex, while he feigns reluctance, whereon the man gives her a small gift of beads or tobacco. Gradually, all the women select partners, their husbands urging them on, whereupon the women from the other side start the process in reverse, re-obtaining many of the beads and tobacco obtained by their own husbands. The entire ceremony culminates as the visitors’ men-folk perform a coordinated dance, pretending to threaten their hosts with the spears, but finally, instead, handing the spears over to the hosts’ womenfolk, declaring: “We do not need to spear you, since we already have!” [9]
In other words, the Gunwinngu manage to take all the most thrilling elements in the Nambikwara encounters—the threat of violence, the opportunity for sexual intrigue—and turn it into an entertaining game (one that, the ethnographer remarks, is considered enormous fun for everyone involved). In such a situation, one would have to assume obtaining the optimal cloth-for-spears ratio is the last thing on most participants’ minds. (And anyway, they seem to operate on traditional fixed equivalences.)
Economists always ask us to ‘imagine’ how things must have worked before the advent of money. What such examples bring home more than anything else is just how limited their imaginations really are. When one is dealing with a world unfamiliar with money and markets, even on those rare occasions when strangers did meet explicitly in order to exchange goods, they are rarely thinking exclusively about the value of the goods. This not only demonstrates that the Homo Oeconomicus which lies at the basis of all the theorems and equations that purports to render economics a science, is not only an almost impossibly boring person—basically, a monomaniacal sociopath who can wander through an orgy thinking only about marginal rates of return—but that what economists are basically doing in telling the myth of barter, is taking a kind of behavior that is only really possible after the invention of money and markets and then projecting it backwards as the purported reason for the invention of money and markets themselves. Logically, this makes about as much sense as saying that the game of chess was invented to allow people to fulfill a pre-existing desire to checkmate their opponent’s king.

* * *

At this point, it’s easier to understand why economists feel so defensive about challenges to the Myth of Barter, and why they keep telling the same old story even though most of them know it isn’t true. If what they are really describing is not how we ‘naturally’ behave but rather how we are taught to behave by the market—well who, nowadays, is doing most of the actual teaching? Primarily, economists. The question of barter cuts to the heart of not only what an economy is—most economists still insist that an economy is essentially a vast barter system, with money a mere tool (a position all the more peculiar now that the majority of economic transactions in the world have come to consist of playing around with money in one form or another) [10]—but also, the very status of economics: is it a science that describes of how humans actually behave, or prescriptive, a way of informing them how they should? (Remember, sciences generate hypothesis about the world that can be tested against the evidence and changed or abandoned if they don’t prove to predict what’s empirically there.)
Or is economics instead a technique of operating within a world that economists themselves have largely created? Or is it, as it appears for so many of the Austrians, a kind of faith, a revealed Truth embodied in the words of great prophets (such as Von Mises) who must, by definition be correct, and whose theories must be defended whatever empirical reality throws at them—even to the extent of generating imaginary unknown periods of history where something like what was originally described ‘must have’ taken place?
REFERENCES
[1] Jevons, W. Stanley, Money and the Mechanism of Exchange. New York: Appleton and Company, 1885, and Menger, Carl, “On the origins of money.” Economic Journal 1892 v.2 no 6, pp. 239-55
[2] Humphrey, Caroline, “Barter and Economic Disintegration.” Man 1985 v.20: 48. Other anthropologists have gone even further, for instance Anne Chapman, “Barter as a Universal Mode of Exchange.” L’Homme 1980 v22 (3): 33-83), argues that if pure barter is to be defined as only about the things, and not about the people, it’s not clear that it has ever existed—as the cases cited at the end of this essay indeed illustrate.
[3] Gregory, Chris, Gifts and Commodities. New York: Academic Press (1982): pp. 48-49. On gift economies, the classic text is Mauss, Marcel, Essai sur le don. Forme et raison de l’échange dans les sociétés archaïques.” Annee sociologique, 1924 no. 1 (series 2):30-186. On spheres on exchange in general see Bohannan, Paul “Some Principles of Exchange and Investment among the Tiv,” American Anthropologist 1955 v57:60-67; Barth, Frederick, “Economic Spheres in Darfur.” Themes in Economic Anthropology, ASA Monographs (London, Tavistock) 1969 no. 6, pp. 149-174; cf Munn, Nancy, The Fame of Gawa: A Symbolic Study of Value Transformation in a Massim (Papua New Guinea) Society, 1986, Cambridge, Cambridge University Press, and Akin, David and Joel Robbins, “An Introduction to Melanesian Currencies: Agencies, Identity, and Social Reproduction” in Money and Modernity: State and Local Currencies in Melanesia (David Akin and Joel Robbins, editor), pp. 1-40. Pittsburgh: University of Pittsburgh Press.
[4] Servet, Jean-Michel, 1994 “La fable du troc,” numero spécial de la revue XVIIIe siècle, Economie et politique, n°26: 103-115
[5] The classic work on the economics of POW camps, whence this argument derives, is Radford, R. A., “The Economic Organization of a POW Camp.” Economica 1945 v.12 (48): 189-201. There is an excellent critique of the assumptions underlying it in Ingham, Geoffrey, “Further Reflections on the Ontology of Money,” Economy and Society 2006 v 36 (2): 264-65, which notes among other things the obvious point that the entire camp environment was created and maintained by a bureaucratic organization that supplied all actual necessities—food, shelter, etc—through administrative distribution.
[6] Hudson, Michael,“The Development of Money-of-Account in Sumer’s Temples.” In Creating Economic Order: Record-Keeping, Standardization and the Development of Accounting in the Ancient Near East (Michael Hudson and Cornelia Wunsch, editors, 2004), pp. 303-329. Baltimore: CDL Press.
[7] Grierson, Phillip, “The Origins of Money.” In Research in Economic Anthropology 1978, v. I, pp. 1-35. Greenwich: Journal of the Anthropological Institute Press.
[8] Levi-Strauss, Claude, “Guerre et commerce chez les Indiens d’Amérique du Sud.” Renaissance. Paris: Ecole Libre des Hautes Études, 1943 vol, 1, fascicule 1 et 2.
[9] Berndt, Ronald M., “Ceremonial Exchange in Western Arnhem Land.” Southwestern Journal of Anthropology 1951 v.7 (2): 156-176.
[10] See for instance Dillard, Dudley, “The Barter Illusion in Classical and Neoclassical Economics”, Eastern Economic Journal 1988v14 (4):299-318.

Econ 215: Money and Banking. Sunday, Fall 2011.

The material posted here is for: Econ 215: Money and Banking Fall 2011; Sunday 1:00 - 4:00. 


As you probably noticed there is a direct link to this post on the right hand side of the blog. 
I can be reached at: andrew.a.bossie@gmail.com


Office Hours: Sunday 12:00 to 1:00 If I am not in the classroom (PH154) I will be in the adjunct office in the economics department: PH300B.  I will also usually be available after class. 


Syllabus

Readings/Texts/Etc:

For the first week of class: David Graeber on the Origins of Money.

Texts about the Financial Crisis

Median Income in NYC

Assignments:

Rules:

1. Must be handed in during class.

2. Must be stapled. Assignments not stapled will lose a letter grade

3. You must answer all questions. Failure to answer one question will result in a check minus. Failure to answer more than one question will result in a zero.

4. Rules for Emailing homework assignments (emergencies only)

a. Must be a single, legible pdf or word document.

b. Must be time stamped before the beginning of class on the day it is due.

Homework Assignment  #1: Due 10/16
Homework Assignment #2: Due 10/30
Homework Assignment #3: Due 12/04
Homework Assignment #4: Due 12/11

A Brief History of the Fed and the Financial Crisis Part II: QE I and II

Here is Part I.

This post I'm going to talk about Quantitative Easing, which the Fed pursued with two different programs over the course of the last 2 1/2 years.

Quantitative Easing 1 (QEI):

Here are two other useful timelines that were written when the second round of quantitative easing (QEII) was expected:

Calculated Risk: A QE1 Timeline
WeeklyBasis: Quantitative Easing 101

Now, the model we use in class of the fed funds market predicts that once the Fed is on the flat part of the reserve demand curve (i.e. at the rate where the Fed pays interest on reserves) there is nothing left for the fed to do vis-1a-vis interest rates. If the Fed did not pay interest on reserves then the "floor" on the Fed funds rate would be at 0% because no bank will loan money at a rate lower than zero ( a negative interest rate) because then you are paying someone to borrow from you. In either case this is know as the "liquidity trap". By December of 2008 the Fed was fully "caught" in the liquidity trap.

The Fed however was not necessarily out of bullets. I'm going to repeat figure 1 from part 1:

Figure 1 (from part 1)

Again, you will notice that the fed funds rate has a very direct effect on short term rates but less of an obvious or direct effect on longer rates. Since there was clearly a problem brewing in the mortgage/housing industry the Fed set about trying to solve the problem directly. In November of 2008 the Fed announced that it would buy $600 billion in "agency backed" (top of the line?) mortgages starting in January of 2009. As the WeekBasis post above points out, before the fed bought any mortgages mortgages rates dropped by 1% in anticipation of the purchase.

Figure 2

Figure 2 shows the interest on prime mortgages. There is a very clear decline in the interest rates of mortgages. There was also a very clear decline in AAA corporate bonds and 10 year treasury bonds which are close subsitutes for mortgages (important for QEII).

It's important to understand what is going on here. The Fed is simply preforming open market purchases--which means increasing the money supply--but instead of buyin short term treasury bonds the fed is simply buying longer terms private instruments. That is to say, there is (literally) no law that says that the Fed's only focus should be on the single fed funds interest rate. Since the fed funds rate had essentially become useless as an instrument of monetary policy the Fed went directly to the source of the problem and changed mortgages rates directly. It bought down mortgages rates in an attempt to make it cheaper and easier for people to buy and/or (probably more importantly) refinance their homes.

In March the Fed announced the would purchase a total of $1.2 trillion in "agency backed" (guaranteed by Fannie and Freddie) mortgages.

QEII

The Fed had finished its mortgages purchases by March 2010. In late August Bernanke started talking about a second round of quantitative easing. In early November the Fed officially announced that it would purchase another $600 billion ($75 a month) in securities. However, QEII is slightly different that QEI. While QEI was a direct purchase of mortgages QEII is a program to purchase 10-year treasury bonds. Why? Well, the interest rate on 30-year mortgages is actually based on 10-year treasury bonds. The average mortgages is held for 10 years so fixed rate "conforming" mortgages rates are based on the 10-year treasury rate with a risk premium. That is why they track so closely to the 10-year treasury bond in figure 2.

However, it looks at least from the above graph that QEII has not had the kind of pronounced effect as QEI, at least not on mortgage rates. If anything it looks like the expectation of QEII was most of its effect. Mortgages rates went slightly lower at the end of 2010. However, the QEII effect may also be beyond an interest rate decrease. The Fed forcasting that it QEII will create 700k jobs. It is after all still increasing the money supply.

QEII is expected to end (without a commitment of more money by the Fed) in June of this year.

A Brief History of the Fed and the Financial Crisis Part I: The Federal Funds Market and the Alphabet Soup of Programs.

Lets start out by establishing what it is the Fed actually does. It is a kind of short hand for commentators to say "The Fed is lowering/raising interest rates". More careful reporters and commentators will call the federal funds (fed funds) rate what it is or call it a policy rate.

Anyway, Figure 1 shows the relationship between the fed funds rate and a couple other rates.

Figure 1: Fed Funds and Selected Rates

Figure 1 should give you an idea of the kind of effect the federal funds rate has on "interest rates" over all. It is obvious that the rate on 3-month treasury bonds tracks the fed funds rates very closely. As well, the "prime rate"--the rate at which large banks lend to their best customers-- tracks the fed funds rate very closely but has a very clear risk/liquidity premium.

The effect of the fed funds rate is less obvious for the other rates. There seems to be a general pull downwards on 10-year yields, AAA bonds, and mortgages at least until the financial meltdown. You'll also notice that these three things move together pretty closely. That will be more important in part II.

Figure2: The Federal Funds Market

Here we have the federal funds market during the 21st century. The Federal funds rate being graphed here is the effective federal Funds rate not the target rate. You can get a pretty clear idea of what the target rate is from the effective rate. However we have also a little bit of added information. Notice the two big downward spikes. The first is at the very beginning of the graph (Jan 1, 2000) and the other is around the end of the year in 2001 (9/11/2001 to be exact).

Those two spikes represent huge injections of reserves into the fed funds market. The first was an intervention by the Fed to help prevent problems from the Y2K bug that never materialized. The other is of course in response to the massive disruption to the financial system when lower Manhattan was shut down for several days.

Figure 2 also tells the story of the Federal Reserve's role in the Financial crisis. We see a very, very sharp drop in the Federal Funds rate in 2001. In January of 2001 the Fed cut the fed funds rate from 6% to 5.50%. By the end of 2001 the rate was 1.25%. In Nov 2002 the Fed cut the rate all the way down to .75%. In 2003 the Fed raised rates to 2% and then keeps rates at that level until mid 2004 when it gradually starts (best illustrated by the step pattern in the discount rate) to increase interest rates to a peak of 6.25% in mid 2006.

Those low rates from 2001 to mid 2004 along with the quantity of reserves needed to keep rates that low many people say is a big part of the creation of the housing bubble. Initially, of course, the low rates were intended to juice the economy during the 2001 recession but critics say the Fed kept rates down too long.

I'm actually somewhat agnostic about the Fed's role. They must have had something to do with the housing bubble, but I'm not sure low rates were a sufficient condition. The giant increase in global savings during this period (it basically doubled)--as far as I'm concerned--is the central player in the housing bubble. Maybe we can think of the Fed as the yeast and the global savings glut as the flour. You can make bread without yeast, but it' won't rise. Of course, there are like a million other ways to blame the Fed beyond interest rate policy, such as thier role as a regulator and their refusal to use their ability to jawbone markets.

Also included this graph is the discount rate which, as we discussed in class is supposed to be a kind of "cap" on the federal funds rate. You'll notice several upward spikes. Lets zoom in a little bit:

Figure 3: Fed Funds Market Jan 2007 to March 2011

In late 2008 there are two significant spikes above the discount rate. This is indicative of the beginning of a financial panic. Banks are all scrambling to increase their excess reserves either "just in case" or because they legitimately need them. However some financial institutions may not have wanted to seem as though they needed discount loans and so borrowed at a rate above the discount rate from other banks, not the Fed. The expansion of discount loans through 2008 like the expansion of the fed balance sheet in general is really remarkable. The Fed had already increased its discount loans by about 1800% through 2007, from 27 million to $48.7 billion. From the 4th quarter of 2007 to its peak in 2009q1 the Fed increased the borrowed monetary base to $536.3 billion, an over 100% increase. All told, of course, the Fed increased its direct lending to the financial system by 20,000%!

This is a good place to talk about some of the unprecedented things the Fed did to try to stem the financial panic. It is important to point out that much of the lending the Fed did was not necessarily about maintain the target fed funds rate but was rather the fed fulfilling it's role as "lender of last resort". Credit markets in a financial panic seize up and banks and other financial institutions find it difficult or impossible to find funding. The Fed then steps in to make sure financial institutions can stay afloat. As well, the Fed greases the wheels of the financial system to get it running again.

A portion of the increase in discount loans I'm talking about were not loans to banks per se but were rather loans to money market mutual funds through banks. The Fed instituted a loan program (AMLF) in which they loaned money to banks so that they could buy commercial paper (corporate bills) from these mutual funds. This was intended to keep the commercial paper market operating in a time when no one wanted to loan money to anyone (especially financial companies) .

Not reflected in the loans above were a variety of programs such as the Term Auction Liquidity Facility or TALF. TALF loans were loans in which the collateral is an AAA rated asset backed securities (ABS). ABS of course tipped off the crisis through mortgage backed securities, but the ABS market is much bigger than just mortgages. ABSes finance credit cards, student loans, car loans and other things. Asset backed securities are fundamental to the "shadow banking system" the segment of the financial system that does many of the things banks do (make loans) but aren't actually banks. This market was also in a state of panic which was the justification for the TALF. Related (and a much bigger program) was the Commercial Paper Funding Facility (CPFF) which was similar to AMLF, but much much bigger.

Finally, there are the Maiden Lane programs (I, II and III). Essentially, these are "shell" companies the Fed created in order to buy assets from Bear Sterns and AIG. The Fed bought some of the uglier holdings of Bear Sterns to make the sale to JP Morgan Chase more attractive (Maiden Lane I) and the Fed bought a bunch of AIG's Mortgage Back Securities (MBS) in order to give AIG the cash needed to meet their obligations (Maiden Lane II). This was over and above the $85 billion line of credit the Fed set up for AIG. Finally, Maiden Lane III was another LLC set up by the Fed (partially owned by AIG). Maiden Lane III was created to buy up the Collateralized Debt Obligations (CDO) that several banks had take out insurance policies (Credit Default Swaps, or CDOs) on. As the value of the CDOs fell, AIG was obligated to pay these banks the difference between the market value of the CDOs and "par" (what the banks paid for them) value. AIG had already paid about $35 billion (mostly out of the $85 billion the Fed had lent them), the purchase of the CDOs from the banks by the Fed made up another $29 billion or so.

Now during 2008 the Fed isn't only making loans. The Fed is also rapidly slashing the federal funds rate. The Fed had begun cutting interest rates in September of 2007 (from it's peak of 5.25%), in response to what became the recession that started in December of 2007. Just real quick: I want to point out that the financial crisis was the result of the recession not it's cause, though it certainly made the recession worse. Anyway, in January of 2008 the Fed took the dramatic step of cutting the fed funds rate by .75%, there were several other cuts from January to March but on March 18th in the wake of the Bear Sterns collapse the Fed made another dramatic cut of 75 basis points off the fed funds rate. Long story short, from September 2007 to December 2008 the Fed cut the fed funds rate from 5.25% to a "target" of 0 to 25 basis points.

About this this target of 0 to 25 basis points: Importantly missing from Figure 2 is the interest rate the fed pays on deposits by banks at the Fed. When first instituted in October of 2008 the Fed made a distinction between what it would pay for required reserves and for excess reserves but later started paying 25 basis points on all reserves. Now, it may not be obvious from figure 3, but the fed funds rate has actually been below 25 basis points (roughly speaking around 15 basis points). Using the model of the market for reserves in class we came to the conclusion that no one would lend at less than 25 basis points. However, in the real fed funds market there are non-banks that buy and sell reserves (most notably Fannie Mae and Freddie Mac). These non-banks do not have deposits at the Fed though they make overnight loans and they are apparently willing to lend reserves at around 15 basis points.

I'm going to break this post up into two posts:

Part II: Quantitative easing.

Naked Capitalism: Marshall Auerback: Bankers Gone Wild in Ireland AND Germany

Marshall Auerback: Bankers Gone Wild in Ireland AND Germany

By Marshall Auerback, a hedge fund manager and portfolio strategist who writes for New Deal 2.0.

Despite a blame-a-thon on Ireleand, Germans banks are really at the core of the eurozone catastrophe.

Much ink has been spilled in the press over the Irish problem and the laxity of the country’s southern Mediterranean counterparts in contrast to the highly “disciplined” Germans. But perhaps we have to revisit that caricature. Not only has the Irish crisis blown apart the myth of the virtues of fiscal austerity during rapidly declining economic activity, but it has also illustrated that Germany’s bankers were every bit as culpable as their Irish counterparts in helping to stoke the credit bubble.

One of the traditional rationales for the creation of the euro was that a single currency and strict Maastricht criteria would keep the profligate Mediterraneans and their Celtic equivalents in line. Instead, critics, particularly in Germany, increasingly see the European Monetary Union as a means for freeloading nations to offload their liabilities onto fitter neighbors.

Not surprisingly, this has engendered much discussion that perhaps it would serve Germany’s interests to leave the euro, rather than booting one of the Mediterranean “scroungers” out. But as Simon Johnson has pointed out, this comforting narrative of German prudence matched up against Irish profligacy doesn’t really stack up:

German banks in particular lost their composure with regard to lending to Ireland — although British, American, French and Belgian banks were not so far behind. Hypo Real Estate — now taken over by the German government — has what is likely to be the highest exposure to Irish debt.

But look at loans outstanding relative to the size of their domestic economies (using the BIS data on what they call an “ultimate risk basis”).

German banks are owed $139 billion, which is 4.2 percent of German G.D.P. [my emphasis]

Where were the German regulators? As my colleague Bill Black has noted:

They seem to have believed that ‘What happens in Vegas (Dublin) stays in Vegas (Dublin).’ Instead, their German banks came back from their riotous holidays in the PIIGS with BTDs (bank transmitted diseases). The German banks’ regulators continue to let them hide the embarrassing losses they picked up on holiday, but that cover up will collapse if any of the PIIGS default. The PIIGS will default if the EU does not bail them out, so there will be a bail out even though the German taxpayers hate to fund bailouts.

German banks’ relatively high exposure to Ireland does pose the question as to whether there is some wild, Weimar-style hyperinflationista lurking deep in the heart of every German, only able to express itself fully when away from the prying eyes of fellow citizens.

All of the rescue plans that have been introduced in Ireland or Greece thus far rest on the assumption that, with more time, the eurozone’s problem children could get their fiscal houses in order — and Europe could somehow grow its way out of trouble. But the fiscal austerity being offered as the “medicine” is turning out to be worse than the disease. It has exacerbated the downturn and unleashed a horrible debt deflation dynamic in all of the areas where it was reluctantly implemented.

But here’s the thing: these fiscal straitjackets obscure the history of how we came to today’s horrible impasse and, more specifically, the German banks’ role in helping to fuel the credit binge. Also lost is the reason why this has metastasized into a far greater crisis: as part of the eurozone, Ireland does not have the fiscal freedom to come up with a sufficiently robust government response. The UK had a comparable real estate bubble in the late 1980s, which culminated with the Soros attack on the pound in 1992 and the ejection of sterling from Exchange Rate Mechanism (the precursor to the EMU). This was a blessing in disguise. Withdrawal from the ERM saved the UK because it allowed the country sufficient latitude to reflate. Yes, the country had a major recession (in many ways a consequence of the surrender of fiscal freedom as a result of joining the ERM in the first place), but there was never a systemic risk that posed a threat to the country’s overall solvency as is the case in Ireland today. And this is exacerbating the problem in Ireland because it persists in chasing its tail repeatedly with futile fiscal austerity measures.

The truth of the matter is this: the eurozone seems rotten to the core, literally. Germany represents that core. The Germans might occupy the penthouse suite, but it is the suite of a roach motel. And we know what happens to those who enter such “establishments.”

Yes, longer term the problems currently afflicting the eurozone could be sorted via the creation of a supranational fiscal authority — a “United States of Europe”. But with each crisis (Ireland today; Portugal and Spain tomorrow; Italy and then France next?), the political forces are coalescing in a radically different direction. The Germans are becoming increasingly resentful as they perceive their country as the bailout mechanism of last resort (even though the Irish experience suggests that their bankers are also guilty of many of the same excesses as the “Celtic Tiger”). The PIIGS themselves are seeing that the benefits of euro membership have been vastly overstated and in fact now act as a cancerous influence through the Germanic embrace of austerity. (Paradoxically, it has been the “profligate” behavior of those so-called lazy Mediterraneans that has enabled Germany to retain its export-driven model, as well as allowing it to run lower budget deficits than most other countries.)

The eurozone could ultimately end up like Yugoslavia writ large. Prior to the break up of that country, the relatively rich republics, Slovenia and Croatia, resented policies that transferred wealth to the poorer republics like Serbia, Macedonia, Montenegro, or the autonomous region of Kosovo. Once Tito’s organizing genius disappeared, the links stitching the country together became frayed and eventually snapped as old grievances manifested themselves in newer forms. The same could happen to the Europe Union if it underwent a supranational fiscal union — the beginnings of which are already in evidence. I think the Germans are beginning to recognize that, which is why there is discussion about leaving the euro.

But let’s first be clear: German Chancellor Angela Merkel has persistently argued that it is essential that private investors, notably the bond holders, begin to suffer losses so that they will have the proper incentives to provide effective “private market discipline” going forward. She has further argued that it is fair that they suffer losses, given the premium yields they received and their lack of due diligence. That’s an honorable policy. But it’s like the old Irish joke of the driver who gets lost, asks for directions, and is told, “Well, I wouldn’t be starting from here.” By the same token, Ireland clearly illustrates that German banks, as well as their Mediterranean counterparts, would be big losers under the Merkel proposal. Ironically, German financial institutions could find themselves subject to the same kinds of bailouts that Chancellor Merkel and many of her counterparts in Berlin are urging on the Irish and Greeks.

As always, leave it to the Irish to come up with the most poetic response to the crisis. True, W.B. Yeats did not live to see this disaster, but his passionate “September 1913” does evoke the tragedy of today’s Ireland and the futility of the current policy responses for their people (and beyond):

Was it for this the wild geese spread
The grey wing upon every tide;
For this that all that blood was shed,
For this Edward Fitzgerald died,
And Robert Emmet and Wolfe Tone,
All that delirium of the brave?
Romantic Ireland’s dead and gone,
It’s with O’Leary in the grave.

Graves that might soon include not only the O’Learys, but also the Garcias, Texeiras, Moreaus, and Schmidts if a more rational course of action throughout the euro zone is not adopted soon.

Bankling: The History of the Gold Standard: 25 Great Web Sites to Research Its Rise and Fall

This is a pretty good list of websites:

The History of the Gold Standard: 25 Great Web Sites to Research Its Rise and Fall

The lecture is largely based on this article in particular By Lawrence H. Officer

Econ 215 Money and Banking, Fall 2009 Course Material

THE FINAL IS NOW A TAKE-HOME FINAL
Link to final: HERE


I will be posting course material here. As you probably noticed there is a direct link to this post on the right hand side of the blog.

The material posted here is for:

Economics 215 Section 1u3a
Money and Banking
Sundays 1:00- 3:40 in room PH156

I can be reached at:
andrew.a.bossie@gmail.com

Syllabus

Homework #1: Due in class Oct 11th
Homework #2: Homework Assignment #2
Homework #3: Due in class Dec 6
Homework #4: Due in class Dec 13th

Edited Question TYPO IN QUESTION a. FIXED: Replaces HW#3 Q3 and HW#4 Q1

THE FINAL IS NOW A TAKE-HOME FINAL
Link to final: HERE

Midterm Grades, listed by ID number:
UPDATED 12/07