8- Credit Theory of Money (Part II)

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In the Part I of Credit Theory of Money, we have seen a few things:

  1. When we buy, we acquire debts; when we sell, we acquire credits. In other words, when we buy, we become debtors; when we sell, we become creditors. 
  2. We can use the credit we acquire from somebody to redeem the debts we owe from them in order to cancel our debts we owed to them. 
  3. In fact, this is how commerce is done: “Constant creation of debt and credit, and their extinction by being cancelled against one another.” (this is known as primitive law of commerce by Mitchell Innes) 

Section I: What is nominal value of credit we acquire from a debtor?

Now, we focus on this: What is different about liabilities saying: “I owed you $100” issued by a person who are very capable to sell vs the same liabilities saying: “I owed you $100” issued by a person who are less capable to sell?

Diagram

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Figure 1: Differences between face value and nominal value of liabilities.

These two liabilities have the same face value: $100.

But because both issuers have different ability to sell, the nominal value of their liabilities is different. Therefore, when we as seller, who acquires credit by accepting their liabilities as a payment for the goods and services we offered, then this means the credit we acquire also have different nominal value according to issuer’s/debtor’s ability to sell. 

Mitchell Innes quoted: “The nominal value of a credit we acquire from a debtor depends on the nominal value of credit the debtors have acquired when the debt come due.”

In other words, the nominal value of a credit we acquire from a debtor is a function of the debtor’s ability to sell or the amount of credit the debtors can acquire before the debt come due.

The first case: we accept the liabilities “I owed you $100” issued by a person who’s very capable to sell in exchange for goods and services we offered and let’s say the debt is due in a week. This means that the person has to acquire enough credit in a week to redeem the liabilities he owed to me. 

Since he’s very capable to sell, he can easily acquire IOUs worth $100 issued by other people. At the end of the week, he come back to me and handed me the IOUs he acquired from other people to redeem the debt he initially owed to me. I would say the credit I acquire from him is worth $100 because now I receives IOUs issued by other people worth $100 from him.

The second case: we accept the liabilities “I owed you $100” issued by a person who’s less capable to sell in exchange for goods and services we offered and let’s say the debt is due in a week. 

Since he’s less capable to sell, he can only acquire IOUs worth $10 issued by other people. At the end of the week, he come back to me and handed me the IOUs worth $10 he acquired from other people to redeem the debt he initially owed to me. I would say the value of the credit I initially acquire from him now degrades to $10 only, because he, as the debtor cannot get enough credit to repay his debt.

If we think deeply enough, we would say: “The value of a credit we acquire from an issuer depends on the solvency of the issuer.” 

A solvent issuer/debtor always have enough credit at the moment to meet his debt due at the moment. 

An insolvent issuer/debtor doesn’t have enough credit at the moment to meet his debt due at the moment.

When a debt is due, and the debtor doesn’t acquire sufficient credit to redeem his debt from the creditor, the creditor suffers. This is because the value of the credit the creditor acquired from the debtor will fall to an amount which is equal to the amount of credit the debtor has acquired at the moment. When this happen, we say the debtor is insolvent or “bankrupt” as he owes “too much”.

The takeaway for Section I is therefore:

  1. The quotes by Mitchell Innes: “The nominal value of a credit we acquire from a debtor depends on the nominal value of credit the debtors have acquired when the debt come due.”
  2. Value of the credit the creditor acquired from the debtor will fall to an amount which is equal to the amount of credit the debtor has acquired at the moment when the debt come due.
  3. Ability of a debtor to sell/to acquire credit is key when we decide whether to accept the liabilities issued by a person because it subsequently affects the value of the credit we acquire from them.

Section II: We acquire credit from the State when we accept the liabilities of the State (i.e. the currency), but what is the nominal value of them?

Apply the quote of Innes, we shall say: “The nominal value of the credit we acquire from the State depends on the nominal value of credit the government have acquired when the debt come due.” 

The question is: How does the State acquired credit? The government doesn’t sell! The government doesn’t produce and sell goods and services! So, how do government acquire credit?

The State acquire credit by levying tax. The State has special power to make people owe them money (make people become their debtors) simply by imposing tax liabilities onto the citizens such as imposing business tax, property tax, road tax etc.

This implies that the nominal value of the credit we acquire from the State (i.e. the nominal value of the currency) depends on the nominal value of tax the State can acquire from the citizen.

If the government can acquire more credit (tax) from the citizen, the higher the nominal value of the credit we acquire from the State. Thus, the higher the nominal value of the currency (because currency is the liabilities of the State to us, hence it’s the credit we acquire from the State).

The takeaway for Section II is:

  1. The State acquire credits by levying tax onto the citizen because the State has the special power to impose tax liabilities onto the citizen, making the citizens their debtors.

Section III: Something to think about

If we continue down the rabbit holes then we will say: “Isn’t that the nominal value of credit the State acquire from the citizen also depends on the nominal value of credit the citizen have acquired when the debt come due?”

I haven’t really seen any research paper mentioning this question yet, but if we follow what we learnt in Section I and II, it would be a “YES” to the question above.

Then I could come out with a relation like this:

Diagram

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So, the nominal value of the liabilities of the government/ the credit we acquire from the government/ the currency eventually depends on the ability of the people to produce. If the people in a country are not able to produce goods and services (perhaps due to war, natural disaster), then the nominal value of their currency will drop. 

If the people have higher productivity and is able to produce more and more, the nominal value of their currency will rise. For example: a $10 buck, which is essentially an IOUs issued by the State saying: “The State owed you $10” have a face value of $10, but its nominal value now can be >= $10, all attributed to increase in the productivity of the people.

So, perhaps the takeaway for this section is: We shouldn’t worry about our currency depreciating in value as long as we can make sure the citizens are productive, become more and more productive, therefore producing more and more goods and services. Is that true? Let me know your thoughts on this.

Conclusion for this two-part “Credit Theory of Money”:

  1. Money is liabilities and liabilities is money.
  2. When we buy, we acquire debts; when we sell, we acquire credits. In other words, when we buy, we become debtors; when we sell, we become creditors. 
  3. We can use the credit we acquire from somebody to redeem the debts we owe from them in order to cancel our debts we owed to them. 
    1. Credit redeems liabilities and nothing else does.
  4. The nominal value of a credit we acquire is not always the same as the face value of the credit. It depends on the value of credits the debtor can acquire before the debt is due.
  5. If our debtor is insolvent (i.e. cannot acquire enough credits to cancel his debt), the nominal value of credit we acquired from then will fall to the value of the credit the debtors have acquired at the moment. 

References:

  1. What is Money?

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