When fake money becomes real
Anything can be money as long as you find someone willing to accept it
Józef Piłsudski | Source: Library of Congress Prints and Photographs Division
The year was May 1935, when Józef Piłsudski, Founder of Poland’s military force during the first World War and then Poland’s Chief of State during the interwar period died of cancer. Piłsudski was regarded as a great statesman and a brilliant military strategist. Although when he died, Poland was in an economically dire state. Piłsudski’s successors, military men themselves, were left with the arduous task pulling Poland’s out of it. They summoned professors from a local institute to explain to them how economics works.
Michal Kalecki
In his 2016 paper¹, Jan Toporowski, Professor of Economics at SOAS University of London, has narrated an encounter from one of those meetings where a professor told a story to the army men in order to simplify economics and monetary theory in terms that can be understood by them. Toporowski attributes the story to renowned Polish economist Michał Kalecki, although Kalecki himself was not present in those meetings and was probably in England at that time.
The story below is verbatim from Toporowski’s 2016 paper¹ and is a fascinating read.
‘In an impoverished Jewish shtetl in Eastern Poland, whose residents were mired in debt and living on credit, a wealthy and pious Jew arrived one day and checked into the local inn, taking care to pay his hotel bill in advance. On Friday, to avoid breaking the Sabbath injunction against carrying money, he handed over to the inn-keeper for safe-keeping a $100 note. Early on Sunday, the wealthy and pious Jew left the inn before the inn-keeper had had a chance to return the banknote. After a few days, the inn-keeper decided that the wealthy Jew was not going to return. So he took the $100 note and used it to clear his debt with the local butcher. The butcher was delighted and gave the note for safe-keeping to his wife. She used it to clear her debts with a local seamstress who made up dresses for her. The seamstress was delighted and took the money to repay her rent arrears with her landlord. The landlord was pleased to get his rent at last and gave the money to pay his mistress, who had been giving him her favours without any return for far too long. The mistress was pleased because she could now use the note to clear off her debt at the local inn where she occasionally rented rooms. So it was that the bank-note finally returned to the inn-keeper. Although no new trade or production had occurred, nor any income been created, the debts in the shtetl had been cleared, and everyone looked forward to the future with renewed optimism. A couple of weeks later, the wealthy and pious Jew returned to the inn, and the inn-keeper was able to return to him his $100 note. To his amazement and dismay, the wealthy Jew took the note, set fire to it, and used it to light his cigarette. On seeing the inn- keeper’s dismay the wealthy Jew laughed and told him that the banknote was forged anyway.’
If you are thinking this story is about fraud, you are not wrong. But more importantly, it is about a closed economic system with no financial intermediaries and one which is facing excessive levels of debt leading to suppressed productivity. Topowski makes an argument that this ‘Kalecki’s Fable’ teaches us that “monetary circulation in the debt system is necessary to manage and refinance debt” and I don't disagree with him.
But to me, this story also teaches the first very fundamental concept of money:
Anything can be money as long as you find someone willing to accept it.
This is a debatable statement, but I am willing to put up a fight to prove it is philosophically true.
To do this, let's perform a thought experiment. In this essay and those in the future, I am going to make this imaginary village from the story my petri dish to test established monetary theories as well as statements such as the one I just made above.
Let’s begin with imagining that the traveler from the story had never returned and had not destroyed the $100 note and had never told the innkeeper about its counterfeit nature. The note would have continued to circulate in the village. Even if the villagers had, at some point realized that the note is a forgery, there is a chance they would have all agreed, that since it is helping them manage liquidity and settle their debts and break their credit gridlock, they can continue to accept it as legal tender amongst themselves thus miraculously making the ‘fake’ note, real money.
It is easy to hypothesize this because in this example we are talking about a $100 currency note, which is inherently worthless, it is after all just a piece of paper, whose value is conferred on it by the issuing authority, which in most cases is the Central bank of a country. But this inherently worthless piece of paper made valuable by a government authority only remains valuable till the people continue to believe in the authority of their government and the money issued by them. So if the villagers decide to accept a fake $100 currency note, which in this context is fake only because ‘it is not printed by the organization which otherwise has a monopoly on printing currency notes’, they are very much in their right to do so.
The collective belief of people is what can make money out of something and anything.
Now, let’s go back hundreds of years back in time and visit our village when there were no $100 notes or coins and definitely no central banks. This would have been an idyllic little community when everyone either grows, hunts, or gathers for their subsistence. Trade is very limited and when it does happen there is either barter or when credit is extended, it is based on trust that the other will repay when they can without any collateral, financial instruments, or intermediaries.
Now imagine that I need 10 chickens from Bob from the village today and he needs potatoes from me but the harvest is a month away. Bob gives chicken to me in exchange for a fixed amount of potatoes when I harvest them in a month. Remember this is a very small tight-knit community so such deals are not unheard of. This debt can only be settled by the transfer of potatoes from me to Bob after a month. Even if my harvest is destroyed by a flood but I do have surplus broccoli that I can give Bob instead of potatoes, that's not good enough, it has to be potatoes probably because he has no use for broccoli as he does for potatoes and hence broccoli is not valuable to Bob.
Now let's say that within a week of our deal, Bob wants to buy exotic spices from a traveling merchant caravan passing by. The traders would love nothing more than some potatoes but I am the only one in the village who grows them. I don't care for spices but Bob does and his fair share of potatoes that he can use for the spice deal are still a few weeks away. In accounting terms, the potatoes that I owe Bob are my liability and his asset. But Bob won't physically have the potatoes before the caravan leaves. Remember Bob trusts me but the traveling merchants don't. So they won't sell him spices till they don't actually see potatoes. If only Bob had something that was valuable to the merchants, he would have had his spices. But his trust in me is worthless in this scenario.
Now imagine that there have been a lot of deals like the ones between me and Bob that have happened amongst citizens of the village leading to a web of debt or I Owe Yous(IOUs) to be accumulated and the only way to settle is to actually provide delivery of the physical goods or services in some cases. If the delivery is delayed or canceled of any one deal for any reason, it can very easily bring the whole economy to a standstill. You see this is the context of Kalecki’s fable. The solution came in the form of a collectively accepted and transferrable means of payment and settling their debt.
The take away from this essay is :
It is our belief that makes something money even if the object used as money is inherently worthless. This can explain the decline in the inherent value of objects used as money as we went from using precious metals to paper to bits of digital data as money.
Anything can be money as long as you find someone willing to accept it
One of the basic functions of money is to settle debts or in more familiar terms-to make payments. This was exactly the D.C court’s grounds when they dismissed Larry Dean Harmon’s argument that Bitcoin is not money. Bitcoin is money because people accept it as a form of payment.
Payments are what money does.
Next week, I will present another historical event, revisit the village for another thought experiment, and analyze more properties and functions of money.
Further Reading
If you are interested in reading an analysis of Kalecki’s Fable as it applies payment settlement systems or clearinghouses, read this post by Nathan Tankus.
If you are interested in reading a real-life incident that may have been the inspiration for Kalecki’s fable, read about how Alves Reis pulled off a mindblowing scam and may have helped Portugal’s economy in the process.
References
[1] Toporowski, Jan (2016) ‘A Kalecki Fable on Debt and the Monetary Transmission Mechanism.’ Review of Keynesian Economics, 4 (2). pp. 224–228.
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