As many of my readers may know I consider myself a pragmatic chartalist. For those of you who aren’t quite sure what a chartalist is I will let wikipedia tell you, as its explanation is as good as any.
Chartalism is a descriptive economic theory that details the procedures and consequences of using government-issued tokens as the unit of money, i.e. fiat money. The name derives from the Latin charta, in the sense of a token or ticket. The modern theoretical body of work on chartalism is known as Modern Monetary Theory (MMT).
MMT aims to describe and analyze modern economies in which the national currency is fiat money, established and created exclusively by the government. In MMT, money enters circulation through government spending; Taxation is employed to establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation that can only be met using the government’s currency. An ongoing tax obligation, in concert with private confidence and acceptance of the currency, maintains its value. Because the government can issue its own currency at will, MMT maintains that the level of taxation relative to government spending (the government’s deficit spending or budget surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government’s activities per se.
Now I need to note from the outset that I am not an MMT purist, for one I think that current account deficits matter . I actually believe I am far more aligned with Modern Monetary Realism (MMR) which is a relatively new school of thought based on MMT from a group lead by Cullen Roche at pragmatic capitalism. That point aside, what exactly does the definition above mean ?
Well let me give you a simple example to explain.
Imagine you are the king of a country of a million people. Your aim is to protect your countrymen and ultimately make your country a stronger, wiser, and more successful nation. However to do this you have estimated you need to keep a standing army of 50,000 men. In order to feed, house, arm and cloth these men you need to acquire all sort of services including farming, building and manufacturing services all of which would take significant resources away from your army’s core function, protecting you and your country.
Being a smart king you come up with an ingenious plan.
Firstly you explain to your people that you will provide them with protective services, attempt to better their lives and enforce the rule of law, but in return you will require some of their services. Secondly, at the end of every month you give each of your soldiers 50 small circular pieces of wood with your crest on them and decree two laws in your land. Your first law is that anyone found counterfeiting or destroying your wooden pieces will be judge breaking your law. Your second law is that every person of adult age in the land must return 100 of your small wooden pieces back to you at the end of every year, failure to do so will be judged against your law.
You may now have a sense of what a “token” is in the context of chartalism. Your small valueless wooden “coins” are state money, and by issuing them and then demanding them back under both an agreement to provide state services and penalty you, as the state, have given them value.
In doing so you have created a mechanism in which you can alter the behaviour of the populace of your country because in order to get these coins people must first provide goods and services to your army. However, because you have demanded these coins from every adult in the land, people who are not directly providing services to your soldiers would still have to acquire them, directly or indirectly, from someone who has.
Obviously the king needs to make sure that the amount of coins available to the populace matches the price, demand and availability of services. Give the soldiers too many coins then some will probably overpay for services which means the demand for coins will fall with fewer services being provided. Give the soldiers too few coins and the populous will be unable to meet your demands to return them. There is no point throwing people in jail for no reason. So to maximise the effectiveness of this agreement the amount of coins in circulation must be at just the right level to maintain services to your soldiers depending on the size of your army, the size of the adult population and many other factors such as how large the harvest was that year.
There are many implications flowing from this example but to explain the basics of chartalism you really only need to understand one point. If you were concentrating you would have noticed that these coins are valuable to everyone except the king. To the king, the issuer of the coins, they are completely valueless because he can create and issue, or collect and destroy them at anytime. What is valuable to the king is services provides by the populace to his army which will hopefully keep it strong enough to defend him and his people against threats. As long as the king’s populace is satisfied enough with the services he provides measured against the threat of penalty then they will continue to provide services to his army. In that regard the “coins” are simply a mechanism to maintain this trade of services between the king and his people.
This example is the basis for understanding fiat money from a chartalist perspective. Modern society and economics may appear more complicated than the example given however, ultimately, the Australian economic landscape is defined by the example above. Yes, there are now commercial banks and wonderful things such as financial derivatives and the like, and yes the services provided by the state have moved beyond just protective services. But that doesn’t change the fact that state money and the legal system are still mechanism that supports a very similar underlying agreement between the Australian government and its citizens.
We may have moved on from those wooden coins to something a little more sophisticated, but those thin wobbly pieces of colourful plastic in your pocket serve a similar purpose, although after reading the preceding paragraphs you may now look upon it a little differently.
What you may also think on a little differently is the answer to this question.
Do you think the king cared how many coins he had left over at the end of each year ?