Monday, November 11, 2013

When Does New Money Become Capital?

We economist, both professional and amateur, will all agree that money can be created.  If we limit our discussion to fiat money, the sources become more limited but will generally include government and banks.  Counterfeiters are ruled out, not because they cannot create money, but because the money they create will be destroyed by government.

The question we would like to consider here is: When does newly created money become "capital"?

For purposes of this post, "capital" will be considered as money or assets that has been withheld from consumptive purpose, with a goal of improving the future earnings or well being of the owner.  This definition must be considered as short term for the simple reason that every construction of mankind is, in the end, returned to dust.  In other words, all capital construction will at some future time be considered as worthless, making every human activity "consumptive" in the long run.  Despite this limitation, capital will be considered as money or effort that is held with a goal of  "improving the future earnings or well being of the owner".

Economist usually think of money in terms of exchange.  Money is an intermediary that facilitates trade.  Money has convenience value.  Money provides a bridge between production of disparate products and services. In common, all of these descriptions describe a dynamic role for money; money is more vaporous than real.

A vaporous concept of money, vigorously reinforced by hand-to-mouth spending patterns of some people, stands in stark contrast to the idea of money is "capital". Is there a bridge between two paradoxical perceptions of money?

We can add another property of money that may help answer this question.  Money has a physical presence that endures in time.  This is not to deny that money that has been created must be susceptible to decreation (Note 1); money created by government can be recaptured and withdrawn by taxation; money created by bank loans will be decreated when the loan is repaid.

The long-time-duration of money hints that the vaporous concept of money is simply incorrect.  Consider that a hand-to-mouth spending pattern is merely a passing of money from owner to new owner; the money has survived the transaction.  In fact, it is logical to deduct that money will pass from hand to hand until decreated, or, come to rest as capital in the hands of a long term holder such as a pension fund.

Should we then say that money only becomes "capital" when it resides in the hands of a pension fund or other long term holder?  Such a limitation would color money by ownership, thereby placing a political component into the economic model by relational nuance.

Should we say that money is "capital" at the moment it is created?  While very logical, this carries it's own political component.  Government, in yearly deficits, is creating money, thereby giving away the capital wealth of the country and diluting wealth that was previously given away.

Scott Sumner has a provocative post found at "Is economics (mostly) the study of public policy".

The way we think of money, is it more "vaporous" or more "capital",  gets built into our models and descriptions in subtle ways.  This difference in concepts at very basic levels can partially explain why macroeconomic perceptions are so diverse.

The decision of how (and when) to consider money, as vaporous or capital, is left to the reader.

Note 1.  "decreate" is a word devised to emphasize that creation has an opposite pole which is the destruction of whatever has been created.  Destruction is not certain, only a possibility.

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