Saturday, October 9, 2010

A "point debt" down at the bowling alley

Extending the bowling alley analogy about how money is made and managed.

I enjoyed an essay/book by Warren Mosler, one of the advocates of MMT, the modern form of Keynesianism. Especially the point he made about the government making money pretty much the same way a bowling alley makes points .. they just make them up! (using a few rules, of course). So I thought I would try to extend this to model some more aspects of the monetary system such as banks, inflation, unemployment, and more.

Image a bowling alley, where people come to enjoy themselves and get points for doing so. At the outset, the only worth those points have is reputational- we take pleasure in winning and knowing we have won, and want to know our bowling/social status vs other people.

The point system is rather rigid. Points are created and awarded for certain accomplishments, then disappear uselessly after the game of ten frames ends. So while the alley might provide the service of tallying up and presenting the points won after every frame, the players themselves might whip them out of thin air just as easily.

This part is reminiscent of the way banking used to work. Before the federal reserve system, banks, and even individuals, used to make up their own currency, in the form of "notes" or IOUs, also called notes of hand in the case of individuals. In the 1800's, banks created their own notes, which were sort of a hybrid between bonds and currency. The Federal government first issued its own paper notes "greenbacks" only in 1861. All these were passed around, and since the banks promised to redeem them for gold, they functioned as currency, as long as the issuing bank was solvent. Thus started the tradition of banks taking super-secure names like First National Trust, and so forth, to hide the phenomenal danger they pose to customers as well as to the larger monetary system.

Bank. In this case the architecturally amazing National Farmer's Bank of Owatonna, Minnesota.
Gold was the great common denominator, so just as in the bowling alley case, once one knew how much gold one had (or how many pins one had knocked down), one knew how many dollars (or points) one had as well. It all seemed very easy, at least until the proceeds from a massive gold rush caused inflation, or foreign exchange problems caused other fluctuations, or people agitated for silver to be added to a "bimetallic" system because there wasn't enough gold to back the amount of currency needed (the so-called "cross of gold"), etc. ... Rest assured that our current floating, fiat currency system is far easier to manage!

Now let's switch gears and regard the bowling alley as something closer to a fiat currency system, where the alley generates points as it sees fit based on the health of the bowling economy. Let us also imagine that bowlers pay up front in points (not in dollars) to participate (renting shoes, balls, lanes, etc.). If they win more than they paid, they come out ahead and can save their points (minus a cut for the alley- more on that below). But if not, woe to them! The alley casts them into the dark depths and makes them oil the machinery that sets up the pins!

Let's also imagine a middle tier of bowling bankers, who sit outside the front door with desks, lamps, and green eyeshades, lending points to people who come along, after reviewing their past bowling scores and satisfying themselves that those customers will likely come out with more points than they were loaned going in. The alley lends these bankers a few points to start with- say, 10% of what the bankers plan to lend out. But the bankers get to make up the rest of the points as they go along, and if they make a string of bad loans, then a lot of customers will find themselves in the back of the alley, shining gear boxes, the bank will be out of business, the alley will be out its set of base points, fewer customers will be able to come in, and a lot of points will have gone up in smoke.

(Note that the sidewalk bankers make up points out of thin air just as the alley itself does. Only the rule is that they have to have a capital base of points of some fraction of what they are lending out. The points they create are just as good as those from the alley itself, and when the credit crash comes, those points evaporate as bowlers default and the banks go out of business when their losses exceed their capital base. Leverage like this is extremely fragile to adverse shocks, or to plain mismanagement.)

Obviously, that is where we find ourselves today. Due to lax regulation, short-termism, fraud, a race to the bottom of underwriting standards, etc.. the banking system overextended itself, and we are left holding the bag, both for the specific banks, and for the ailing economy as a whole. The deepest effect is that a huge amount of money has gone up in smoke, causing fewer customers to come in the front door to bowl (reduced demand). Now that the alley has fewer customers it will shutter some of its lanes and fire some of its employees, (unemployment), and there are more customers working menial jobs in the back, buffing the pins to a high shine (i.e. debtors are defaulting and going in to backruptcy and poverty at high rates, twiddling their thumbs, doing nothing productive).

Note that nothing real has happened, however. There are still just as many people who might like to bowl, they bowl just as well as they did before, (for some time, at least), and just as many alleys are there for them if they could get in the door. What has changed is that there is shortage of point-tokens due to the collapse of the sidewalk bankers, which led to contraction of the bowling economy.

What can the alley do? One solution is to save the bowling bankers from their self-immolation, set them up with extra points and beg them to lend again. But those who are left are scared out of their wits. They blew it big-time, and now only lend to championship bowlers who can prove statistically that they bowl >250 at least half the time. Not only that, but with some lanes temporarily closed down, (this being a very small town), several alley employees, who were being paid in points, are out of work and don't come themselves to bowl any more. They are depressed!

Something else needs to be done or the alley will have lanes closed for a very long time. It should be obvious that the quickest solution is for the alley to create and directly distribute enough extra points so that more customers start coming in again, replacing the points that went down the drain during the banker's crisis. The alley can create as many points as it likes- they are intrinsically worthless, after all. Their only purpose is to facilitate the joy of bowling that is now deficient.


But if it creates too many, then the alley will get too many customers coming in the door and too many bowlers who get in each other's way. The alley can't make more lanes, (in this scenario), so the extra points just let more people in the door to a lower-quality experience, essentially devaluing their points, which in the real world would be inflation. If the alley persisted in issuing more and more points, for whatever reason, they would create hyperinflation and essentially destroy the value of those points completely. Lines of people with plenty of points to "spend" would form outside and never get in at all!

From the bowling alley's perspective, it needs to keep just the right level of points in the system- too few, and not enough people come in the enjoy the lanes. Too many, and the points themselves become devalued, even worthless. While it was convenient for the bowling alley to use sidewalk bankers to extend points on credit to prospective customers and not take those risks itself, that system blew up in its face, with the result that it had to mop up the bankers's losses and also extend points itself to deal with the drop in bowling customers. One wonders- why have bankers at all, if they are such remarkably dangerous entities in such a system? Will the alley keep its bankers on a much shorter leash in the future, perhaps requiring 20% or even 100% capital backing? That is a question for another day.

What of all the points that have been created? Hasn't the bowling alley run up some kind of "point debt"? Not at all. Our bowling alley didn't have to get its points "from" anywhere. It just made them up. The government makes our money in just the same way, crediting and debiting electronic accounts. But one thing our government does do differently is sell public debt. Why is that? One reason is that there is a law about it, saying that if the government spends more than revenue, it has to issue debt for the difference. This is a mostly artificial system with little point, other than to hand out money to rich people who buy such bonds (in the form of future interest). It is also a relic of the gold-standard days.

The other reason is that some of this debt is essential for monetary policy & management. It helps to "drain" excess money from the system, provide a savings vehicle for the public, and set interest rates. Since that drained money only turns into the only slightly less liquid form of bonds, the functional difference isn't great, but those bonds do serve the important role of setting interest rates at various terms. Our bowlers don't think of the future, though, so no interest rates there.

Will the "point debt" have to be "repaid"? Let's assume for the moment that the bowling alley puts out a series of point-based bonds to be bought by rich bowlers who give the alley their old points in return. The alley does have to keep making small payments to the bond holders over the life of the bonds, which means making up yet a few more points over the ones they have already made up. No problem there, of course. Inflation is the only risk, can be continuously managed by a vigilant alley, and is minor considering the scale of these payments.

When these bonds come due, the alley could pay out made-up points, creating more real points in the private sphere, which could lead to point inflation. Or, it could keep issuing new bonds to replace the ones expiring. It all depends on the conditions at the time, whether inflationary or deflationary. The alley never has a problem controlling the point economy, achieving its goals of keeping the point values stable and keeping people coming to the alley at an optimal rate. The "point debt" just expresses the net position of the alley as it manages its balance of point tokens with respect to the public at large, who may have a lot of points saved up with the alley in the form of bonds.

As these bond holders age and bowl less proficiently, they will draw down their point savings to keep bowling into their golden years. The alley doesn't have to worry about "repaying" these points from some internal point vault, but does have to manage the overall level of points across the point economy. If needed, it can just make them up, or extinguish them, as needed. Its only worry is managing the current system, which, while it can be whipsawed by banking catastrophes and demand fluctuations, is ultimately manageable by the alley's point creation and extinction ability ... if it has the courage and insight to do so.

(Extinction happens through various forms of leakage, like people dying with unbequeathed points hidden in their mattresses, a fee taken off the top of shoe rentals that is not paid back out in earned points (i.e. taxes), and people using points to buy high-tech bowling balls from China, which seems to enjoy piling up bowling alley points, for reasons that are not entirely clear. The shoe taxes are not imposed to "pay the point debt", but to drain points from the economy so that a flood of points converted from savings to spending doesn't cause inflation.)

Note that the austerity response to our bowling alley depression would be to close more lanes and "tighten our belts", waiting for those bankers out front to smoke some weed and lower their cortisol levels to the point that they resume lending as normal. After all, if the customers are stuck in a depressed state, cutting point coupons from the local paper, shouldn't the bowling alley likewise tighten more, firing more workers and closing more lanes?

Unfortunately, the bankers under even this scenario have no rational incentive to lend to quite the level they did before, since they are facing poorer customers with less "point" collateral and forced to present more accurate bowling history documents, who, when they go in to bowl, tend to get lower scores and fewer points because they are out of practice (i.e. commercial bank customers have lowered economic prospects due to the general recession). The credit system alone will not and can not bring the system back to the happy days of yore. Austerity is the road to continued point penury and under-utilization of our bowling prowess!

But that all depends on what our goals were in running the bowling alley. I assume that the goal was not the piling up of points, (since they are ultimately worthless), but the enjoyment of bowling. I also assume that the goal was not to teach bowlers a lesson about Personal Point Responsibility by imposing bowling austerity due to a breakdown in the sidewalk credit system, thence consigning many to the pointless depths of the vast pin-collecting machinery. Nor was it to reduce wages at the bowling alley by making its workers more insecure. The ultimate cause of the crisis, after all, was lax lending leading to insolvency of the sidewalk bankers. Their customers doubtless grabbed more points than they were good for, but the fault was very much shared by their lenders, not to mention their regulators. Nor certainly was the fragility of the larger system their fault at all.

  • Computers ... will ... win.
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  • Bill Mitchell quote of the week:
"In other words, Summers advised the President to allow unemployment to sky-rocket but to do just enough to prevent a depression (catastrophic failure). Fiscal policy didn’t fail in the US. It just wasn’t given a chance to work when it should have been. Had the US government introduced a $US1.2 trillion stimulus and relied on multipliers to fill the identified $US2 trillion output gap things would have been very different and the job losses would have been less."

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