NB: this section is long, you may prefer to read only the summary at the end of the article.
Issuing Treasuries makes people sell cash (because the yield is favourable) and so the price of cash falls (less demand for (liquid) cash)... Cash trades at a premium (to treasuries) because it is more liquid (not locked-up). It is more expensive (but not much more...)Treasuries are inflationary because (as they mature) they will soon be equivalent to cash... the Government will use tax receipts to pay off maturing Treasuries, as they fall due which means (because there are more Treasuries) the tax bill must be higher, which results in inflation. Treasuries mean the tax bill will soon be higher...
Treasuries are cash with a time delay... people assume that they are reliable and will be as good as cash, when the time comes to redeem them... for that reason cash is worth less as a result even before they come to be redeemed. If the price of cash is affected by new treasuries (each individual assumes that cash will be available at maturity) it can only be because they are inflationary
If the Government issues new debt (repayable in the future, unlike bank deposits which are repayable now) this causes a rise in prices (inflation) just as is the case with new bank deposits... Government debt is inflationary for the same reason that new bank deposits are inflationary, because (the store of) wealth has been transferred from elsewhere today. We do not "borrow from the future" just as we cannot lend to the past...
Just like bank deposits, the Government will accept Treasuries in the payment of taxes.
If people expect that Government debt can be exchanged for cash (notes and coins), if not now then certainly at maturity this will establish the value of Treasuries. If a person has no reason to doubt the credit-worthiness of the State, then a one-year treasury will be worth exactly what we would accept for the certain promise of actual cash a year from now.
So, unless we have a reason to very much value money in the present over "future" money then Treasuries will have value. Since the Government can continue to issue new Treasuries when it needs to, there is never a reason to find out whether the Government has the ability to pay... If we assume that after a year, rather than receiving cash, the Government replaces your Treasury with a new (longer-dated) Treasury, plus some cash compensation (interest) then we see that the Government never needs to find the actual money.
We know that the Government has the ability to create extra cash out of thin air so we have no reason to question their credit-worthiness.
So why do people continue to accept the treasuries, rather than reject them in the knowledge that the Government does not have sufficient money? Why would someone hand over cash in this scenario? Because to not do so would be to lose out on the interest payments that come with "investing" in Treasuries... You get paid the annual interest rate for taking the (small) risk that the Government will default on its debt, each year.
Since they can print the money this risk (of default) must surely be pretty small... If people expect a great deal of deflation in the money supply then they will be willing to accept a lower level of interest payment. If people expect inflation the Government will need to pay a higher level of interest so that people do not sell out of cash and "money" all together and purchase hard assets such as land.
So why is Government debt inflationary... if we imagine a market with a person with cash. They are able to either spend it on property (such as land) or to put it into the bank. Now they have a third option which is to buy a promise of money from the Government (a Treasury)... So the choice has widened from "do nothing" or buy house, to "do nothing", buy Treasury or buy house. If they "trust" the Government they expect, a year (say) from now that the market will contain double the quantity of cash plus the house. So immediately the cash held in the present has become worth less than before. The Government will pay whatever rate that means a person such as this will always buy the Treasury...
The Government in this way is similar to a bank in that if you asked for your money back prematurely, they would not be able to pay... It borrows from the market to pay you back. All of the people that the State borrows from expect that they will be repaid which increases the money supply because if we all think we are due a large payment of cash soon, we value liquid cash less highly.
Cash is worth less (than before Government lending) because people think they can wait for the Treasury to pay out in the future. Each person would accept (for example) £120 a year from now in exchange for £100 liquid cash (they would buy the Treasury). And if a person selling a hard asset would also accept treasuries then we see that prices will increase. If the Government is competing to buy the house, the Government will pay sufficient interest to the seller that the trade goes to the State (and houses get more "expensive"). When the Government sells a Treasury the "original" money stays in the market... which drives up the price (of the house). The cash-holder will need to pay more since they are now competing against the State...
Because the value of fiat money is derived from taxation, if Treasuries are acceptable in payment then they will have similar value to cash. For example if you have an obligation to pay a sum of taxation a year from now then the State will (it has been established) accept Government debt in payment, so then if you need to pay tax and expect the Government to continue to recognise its own debt in payment then Treasuries are an OK store of value. The value of fiat is derived from its ability to cancels a debt to the State, and treasuries provide the same function. It is similar to taxation... (pre-paid tax). Interest is the "reward" for paying taxes early... (you get a discount).
Your (liquid) money loses value because if other people pay off their future taxes there will be more for you to pay. If you hold Treasuries it means you must (consequently) pay less taxes in the future which means that (since all wealth is measured this way) those who must still pay taxes in the future (who don't have Treasuries) are relatively less wealthy.
Both cash and Treasuries offer protection from the State, if the Government issues Treasuries (supply goes up), they compete with the only other thing that performs the same function (cash) which means cash is less valuable (rising prices). If someone "feels" protected from the State (they own Treasuries) cash will be less valuable to them. Each unit now buys less protection from the State, the State asks for more (units) each year... because the market itself will exchange less for each unit because they now also have Treasuries.
Cash is nothing more than a short-dated Treasury. We would rather have the cash now (than the Treasury) but the discount is not much... In a year or so's time they will be equivalent. Treasuries will be cash soon (or at least equivalent).
More taxes will be demanded from those who do not hold Treasuries... The value of cash is the percentage of "Government safety" that can be provided by its ownership. If you own all the money you can direct the Government in whom to attack (or at least, choose whom to save). If someone else now has Treasuries, they are protected and you cannot direct aggression towards them. Cash provides less safety when more Treasuries have been issued... Assuming the violence of the State is roughly constant (it is as violent as it can be), then the value of each cash unit diminishes are more are printed because each unit avoids a smaller portion of violence.
If fifty tokens are in circulation and one token can avoid four units of violence, and the State presumes to attack eight times monthly, then to remain free costs two units per month. If more units (double, to 100 and each now buys safety from two units of violence) are in circulation (and the State is no more violent) each unit will buy less and you must pay four units per month to keep the same safety... This is inflation and it derives directly from taxation. The violence is ongoing...
Issuing a treasury protects someone in the same was as cash except that it cannot be used prior to maturity (although it has a market price)... Part of the value of cash is that it can protect from future violence as well as immediate State violence. Cash has an advantage over Treasuries only for the short time before the debt matures. Cash will buy less protection from the State (when Treasuries are issued) because someone with Treasuries now has less need for the cash, demand falls and the price drops.
But why wouldn't someone holding Treasuries still value cash just as much, after all it is a store of wealth... because they too have a price on the receipt of violence. They do not seek to avoid violence at all costs... at some point they are prepared to accept their fate. The amount of "work" they are prepared to do before they rebel (against the Government) is not infinite...
Each person has a different (level of) fear of the State... If you have Treasuries, you figure you are better off than other folks and so you worry less about acquiring cash... you only have to stay ahead of others (your place in the pecking order) you don't keep running if you have won the race, you take a rest. The State will attack the weakest in the crowd.
Because owning Treasuries makes a person feel "rich" (assuming default is unlikely), they then have less demand for cash which makes the price drop. The game is to stay ahead of the rest of the rat race... to avoid the punishment of the State. Your cash buys less if everyone has Treasuries because they are safe, your wealth has been taken from you. And it is the absolute value (not number of units of paper) which the State cares about, so your tax charge will rise. The value of (cash) fiat falls because the State has made other people safe... and so safety has been taken away from you. Other people (who have received Treasuries) stop, or slow working because the threat to them is now in the distant future... They stop competing for fiat. The smaller the number of people who want (need) the fiat, the less it is worth. If the number of people who want the money is halved then the value will fall by half also (you will need to pay twice as much in taxes, if the State is to remain the same size).
...since the "market" for the State to attack is diminished, the violence (per individual) will increase so now the state will presume to attack 16 times monthly... and each token will protect against four units as before. Now each person (who is not "rich") must pay four units per month, instead of two as before. You need to pay more (in absolute terms) because other people have been taken out of the market...
The violence of the State must now be absorbed by those who have not received new Treasuries... Each person (who still has a demand for cash) must pay more (absolute) taxes... and if the quantity of cash circulating stays the same, you must pay twice (assuming half are now "rich", and that the remainder do not rebel against the State). Effectively, the population of the State has halved (a Nation State is a population who are fearful of a singular State!)... so what happened to the value of the money? If a unit of fiat can be seen as a stake in the human capital of the population then, if the population falls (and the cash is not lost, but transferred to the remaining people), the value of each unit of fiat falls (inflation).
Deficit spending (issuing Treasuries) causes inflation because fewer people now want the money... the new debt serves the same function as cash. The Treasuries evoke the same feeling in the owner (who does not fear default) as does cash, they are a form of cash. The value of cash is tied to taxation: the state demands a fixed quantity of man-hours... if you do the labour you get given a fiat token... "work for me or give me some fiat"... Fewer men with the same number of fiat tokens means each token buys less man-hours which results in inflation.
The violence that the State is able to exert over the population remains stable even though many people have been given Treasuries... they now attack fewer people, but they aren't (yet) able to rebel... Let's say that (before issuing the Treasuries) the State does enough violence to receive 4 months' worth of labour from each person... after issuing the Treasuries, some people are free from providing the state with labour and so each other person must work for longer. Life gets more difficult for those without Treasuries, just as it does when others in the population receive extra cash. People who have received treasuries behave as they would do as if they had received cash...
Unless you have an immediate tax problem, you might as well sell your cash for Treasuries... they are just as good as cash unless you have a tax charge which must be paid before the maturity of the Treasury.
People trade not only their immediate freedom, but also their future freedom from the State. Part of the value of cash in the market is that it protects in the future, it is a "store of value"... and so when Treasuries are issued which offer the same protection, the price (to mean value) of cash falls.
The advantage of cash over Treasuries only lasts up to the maturity date of the Treasury, at that time you will be able to sell the (maturing) Treasury for the equivalent sum of cash. If you know other people will soon have "cash", then the value of your cash falls. They can wait to get the cash later... It's not so important to have cash now in this case. £100 maturing a year from now will soon be worth the same as £100 cash... you will sell your cash (at the market price) to the Govt to pay the maturing Treasury, provided you are confident that you will find a market for your Treasury (the State, to pay taxes).
Government tax receipts will be used to pay off maturing Treasuries... as they fall due. Treasuries are valuable because the market expects that they will be paid, if only though force. At least up until the point that they default... but the debts can always be paid because they retain the ability to tax people as required. The liquid cash loses value because, in the knowledge that you will have to give up your cash for taxes, you might as well have State debt... If you must pay a year from now then why not buy a one-year treasury and receive interest? They (the State) "own" your money anyway (you have it temporarily): Either give me £100 a year from now or give it to me now (buy Treasury) and receive £5 interest.
Since so many people own Treasuries, the tax bills will be much higher in the future... Let's say Govt issues 5 £100 bills with 5-year maturity. To redeem those bills, the State will need to tax £500 from the population, but if those have been sold into the market it is easy for the State to demand £500 from the holders (in taxes) by not repaying their debt. So, rather than default the State will tax other people an increased amount... The Government needs to tax more and more as time goes on which causes inflation... But people can pay it (the increased prices of taxation) because so many of them purchased Treasuries... Because taxes are going to go up so much in the future (as a result of the extra Govt debt) this causes inflation because very soon your savings are not going to be able to pay off the higher tax bills (which must be higher to redeem all the treasuries).
...issuing Treasuries causes inflation because the State will have no choice but to charge much more in taxes when the debt falls due, which means the value of each unit of fiat falls and in comparison "prices" rise.
Assuming the debt rolls over, then each year, as the debt increases, the Treasuries become just as effective as the cash in paying down taxation debts. If holding Treasuries means you are owed taxation receipts then this is just as valuable as fiat currency. If a £100 Govt bond is symbolic of the State promising to "steal" £100 from someone else, then it's almost as good as holding £100 cash. It means in a year's time the Govt will seize £100 from a taxpayer and give it to you (assuming no default risk)...
So, like a bank account it is a (delayed) multiple claim on the "same" money... eg if £1,000 of Treasuries have been issued and there is only £100 in circulation, then when the debts fall due, all parties are owed the same amount of money and there is not sufficient. Holding a treasury means that the Government have promised that quantity of money to you in the future... not "now" as is the case in banking. Someone with cash will find that they will be able to purchase a lesser amount of goods and services when people around him or her have Treasuries because they will feel that their treasuries are worth a similar sum to the cash itself. People don't need the cash because they have Treasuries... and when choosing between a treasury and cash, they will choose the Treasury if the interest rate is good enough... they are inflationary because they are valuable, and the value they give is of the same sort as that given by cash and so the currency is diluted. The value is derived from the same place the value of cash is derived from, they are both a form of protection money which is acceptable to (recognised by) the State. Even though the State does not accept treasuries (only cash) the taxpayer can sell the T-bill (for cash, at the discounted value) to pay the taxation. So people who have more than enough cash to pay the taxes can then acquire a Treasury which will mature soon. This makes money "cheaper" because the cash-holder "knows" the Treasury has a market value and so is willing to buy it which makes their position less secure than it was...
If two people owe taxes and only one of them has cash then they are in a good (bargaining) position relative to the second person, if however, the second acquires a Treasury (by whatever means) his (or her) position is now much less advantageous, they are able to get the cash by selling the Treasury and so the person with all the cash at the beginning ends up with a treasury.
There is no strong reason to hold cash (over Treasuries) providing you don't expect default... The value of T's does not come from the expectation of repayment, instead it comes from the fact that cash is not particularly preferable and so the value of treasuries is derived from the value of cash. Treasuries are valuable because cash is valuable... and they can be sold for cash because they can pay taxes in the future. Assuming no default, it is like printing cash with a "void" first year or two, cash which doesn't come into effect for a while. Is the price of cars diminished if you sell a bunch of cars that won't work for the first 6 months because they have a timer delay? Surely, yes... a special type of cash that is not recognised by the Government for the period that it is "locked up", but which then becomes the same as normal money...
Cash offers less protection (from the State) when there are more treasuries around... If we measure wealth in houses, consider a person who has cash, they can buy one house, but suddenly when someone else has Treasuries other people can afford to pay more so the house costs more cash. Rich people (who don't need to worry about taxes for a year or two) can always provide cash in exchange for Treasuries. Why wouldn't it cause inflation?
If a rich person (who don't need to worry about taxes for a year or two) is selling the house, they will be willing to accept the Treasuries and will not sell to the cash-holder unless they can provide a higher price (inflation). If the house-seller is not rich they can find someone who to make the cash less acceptable. Rich people deal in Treasuries and the quantity of Treasuries defines the price of cash since cash is always discounted in value from the treasuries... Cash is a form of short-dated Treasury. Cash can be used to buy Treasuries which are the predominant currency... Issuing new treasuries affects the price of other treasuries so then it must also affect the price of cash, if cash and treasuries maintain their previous relationship. Issuing lots of T's does not result in permanently higher yields because once a few T's have been purchased, the money is spent by the Government and it ends up back in the account of a depositor who is likely to by Treasuries (since they are cheap) and eventually the price will rise and the cash-Treasury relationship will stabilise. The person who receives the proceeds received by the person who sold the treasury will end up buying a Treasury with the proceeds. This will continue until the typical yield is again established. Each individual (and the market in aggregate) has a preference for Treasuries if they are cheap and so the cash will recycle until the "correct" price relationship is established...
This is different from a normal economy, where extra supply leads to lower prices because the demand for a particular good is not universal... The price differential (yield) is a measure of the preferences of individuals for money now vs money later, which does not change. Issuing Treasuries does not affect the yield because the market adjusts (and the price of cash falls). Issuing new Treasuries does not affect people's time preference for money. Everyone with cash will instead have some Treasuries in their portfolio (since they are cheap), issuing Treasuries makes people sell cash (it is now less valuable)... it makes cash cheaper. Future money (for a while) is at a much better price...
Cash will lose value when Treasuries are printed because other goods can easily be purchased with treasuries... People who hold Treasuries can price the cash-holders out of the market for goods and services.
Friday 3 April 2009
Update: Fiat money is a store of security... without threats (from the State, or similar) fiat currency has no use. We can do nothing with it except to pay taxes which prevent the State from damaging our property or harming our person. So the more fiat currency in our possession the greater protection we have and the longer we can survive without interference. It allows us to be left alone... Without that fear we would have need for (fiat) money. (4th April'09)
Summary: Unless the State monetises the debt (by printing money) then, at some point Treasuries will be worthless. Treasuries are valuable only if the State is credit-worthy. They cause inflation because people think they are valuable and subsequently other types of money have less value... because they either are (in the case of bank deposits), or soon will be (in the case of Treasuries) redeemable for actual cash. Because bank credit can be exchanged for cash it is as good as cash. Unless the cash-holder has a reason not to value credit, they will see extra credit as a dilution of the value of their cash.
Treasuries (and bank credit) make cash less expensive (inflation) because people think that credit is money. They think that their cash is no better than credit...
A person buying currency (by selling goods and services) is usually indifferent between cash and credit, so then as far as they are concerned (a person who thinks that credit is money) cash and credit is the same. They think that credit performs the function of cash just as well. The supply of credit or cash (together currency) has increased... Prices are determined by the supply of "credit or cash" (Treasuries are a kind of promised cash (or credit)).
Since (people think) the price of credit is pegged to that of cash (by the State), extra credit diminishes (weakens) the value of cash. Credit affects the price of cash because people think that credit is money (in the same way that fool's gold might affect the price of actual gold). If someone (the mafia?) issued IOUs (different from cash in appearance but with the same units) for cash which were generally trusted then the price of cash would fall until doubts concerning the value of the IOUs arise. Then a discrepancy between the value of cash and the IOUs (credit) would appear. If we do not trust that the IOUs will (or can) be redeemed for actual cash then they become less valuable... But the person who has been issuing the IOUs might prefer not to exchange them for actual cash (even if they have the ability to print cash) when people ask for it.
Since the IOUs (bank credit) will not be redeemed for actual cash, people have been "tricked" (better to say mislead, perhaps innocently) into thinking that they are valuable when in fact they are not...
So deficit spending (and bank lending) causes inflation (of prices) because people mistakenly think that the Government is credit-worthy (or that the State guarantee of bank deposits is reliable). And if they see no reason not to value Treasuries (or credit) they will value cash less highly in comparison... If people "think" that (behave as though) credit is money, then so long as the definition of money is derived from people's behaviours, we must say that it is.
We can understand the inflationary mechanism (of issuing bank credit) by thinking about the relationship between Scottish banknotes and "British" banknotes... when extra Scottish banknotes are issued, they have an appearance which is markedly different from English notes but with the same units. The Scottish banknotes will cause inflation among British banknotes, just as if they were the same. Similarly, a separate class of (company) shares, whilst being different in appearance will dilute the value of existing shares... Lottery tickets issued on a different colour paper will reduce the value of existing tickets (because the winnings will be shared among a greater number of people).
The difference between currency inflation and (for example) shares is that, whilst the stock clearly references ownership of a company, currency is self-referential and does not signify a share of a particular thing. If a currency can be said to represent ownership of the country then bank credit (if it is reliable) confers to the owner a similar quantity of ownership rights as cash does which is why it causes inflation (so long as the guarantee is believed). Whatever the value of cash is derived from then (so long as it is valuable) the value of credit is derived from the same place.
Wednesday 8 April 2009
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