Saturday, July 25, 2009

Reforming Money - Fixed Fiat Currency


I have long promised a discussion of a system of fixed fiat currency, and the discussion that follows is my first attempt at this। It is a very long discussion, and I hope that you will have the patience to plough through such volume (I guess that many will not). However, I do hope that it will prove to be an interesting potential system that might help prevent a repeat of the current economic crisis.

The fixed fiat currency system proposed here will not please any school of economics, as within the proposed system is something to cause consternation within each school. The discipline of macroeconomics is currently going through a period of turmoil as a result of the economic crisis that is engulfing the world. Leading economists such as Krugman are calling into question many of the foundations of macroeconomic theory, and debate is commencing on both the causes and solutions to the current economic crisis. The fixed fiat currency proposed here is an addition to that debate.

In order to understand the fixed fiat currency system there is a necessity to return to the basic question of what money actually is. Furthermore, once the nature of money is explained, it is apparent that any system of money must also include non-traditional forms of money, and that will mean that the proposed system must also take into account the financial system.

The proposed system is not perfect. It will not remove booms, it will not provide for social justice or any other ‘magic’ solution to the economic ills of the world. However, it offers greater stability, transparency and above all honesty and fairness. The latter notions are curiously absent from most macroeconomic discussion, which is puzzling as economics has a foundation in human endeavour.

The article is sparsely referenced, but includes ideas such as the value of labour which is rooted in the work of Karl Marx, critiques of fiat money which owe a debt to the many articles on the von Mises Institute website, and the overall theory and work of Adam Smith in the Wealth of Nations is an important overall inspiration.

There have, of course, been other sources, but none of these are specific such that they might be referenced. Overall, the majority of the considerations are the result of personal analysis and thought arrived at independently. This does not preclude the possibility of others already having come to similar conclusions or ideas, and I will apologise in advance if these ideas have been proposed by others.

Due to the relatively independent way in which this has been considered, robust but polite critiques are welcomed. It is, after all, the musings of an individual barely schooled in any economic theory.

The Nature of Money

The first point to make is that all economic activity is rooted in the value of labour. A commodity such as gold only has value once labour has dug it from the ground, and labour has moved it to the surface. Once it arrives at the surface it will be some form of labour that is utilised to move it to where it is next utilised.

For example, if a commodity is moved by truck, the truck represents a store of the value of labour of others, with the truck being a representation of a long chain of economic activity rooted in labour. From the commodities dug from the ground and being processed, the transportation, sale and processing of the commodities, the purchase by component manufacturers of the commodities and the final assembly of the truck, each step of the manufacture of components is rooted in the labour of individuals.

At the heart of all economic activity is human labour, and economics is the process of exchange of value of labour between individuals, organisations and other economic units.

Within this system of exchange of value of labour, the underlying purpose of money is very clear. It should only act as a medium through which the value of labour might be accounted, and is always representative of a store of value of labour, with an underlying contract that it might, at some future point in time, be exchanged for the value of labour of others.

Any system of money should seek to represent the value of labour in a way that is both fair and stable, such that the underlying contract is met regardless of elapsed time. Such a system implies that the value of money should be a neutral token to be used in the exchange of value of labour, such that it offers a fair exchange as determined by how individuals and organisations value the labour of each other. The purpose here is not to discuss the rights and wrongs of how one person’s labour might be valued against another, which is a debate about social justice, but rather to identify that all economic activity is the exchange of value of labour.

If we view what might constitute money as it is defined here, it is possible to see that there are two forms of money that operate within an economy. The first form of money is the issuance by government of fiat currency, which might be called ‘traditional money’ for the sake of ease of expression. This is the money that is currently created by central banks in the form of banknotes and coins, as well as by entries in the balance sheets of banks. At present, the issuance of such money is controlled by central banks according to their understanding of the underlying state of the economy, and historically has seen a progressive and continual expansion of the money supply wherever the system has been enacted.

The other form of money is IOU money. To illustrate the principle of IOU money, a simple illustration might serve to explain how it is created, and from where the value in IOU money is derived. This will also aid in understanding of the value of traditional money, as the two types of money interact throughout an economy, and traditional money is just a particular form of IOU money.

If we think of an individual (we will call him Fred) in a small town who is short of traditional money, he might visit his local pub and talk with his associates in the pub about exchanging his labour in return for pints of beer. In return for the pints of beer, Fred might promise the individuals who are buying the beer for him that he will mow their lawns which will take one hour of his labour in their garden. This means that one pint of beer = one mowed lawn, which represents one hour of labour for each pint of beer that has been purchased for him. As he is drinking beer, he is worried he will forget to whom he has offered his services, and will therefore provide a slip of paper offering one mowed lawn to be undertaken next week.

Fred, being a heavy drinker, starts to issue many IOUs and Henry has exchanged pints of beer for two IOUs. However, on reflection, Henry decides that he only needs one mowing of his lawn next week, and wonders what he might do with the IOU. He then sees a friend with a sandwich and offers the IOU to the friend, in exchange for half the sandwich. The friend accepts the IOU and provides half a sandwich.

What we are seeing is the creation of money. Fred, in offering a future commitment of his labour, is creating IOU money. It serves as money, as the IOU notes have become a recognised unit of exchange. When the person exchanged the sandwich for the IOU, he was exchanging the sandwich on the basis that the value of labour stored in the sandwich would be exchanged in the future for the value of Fred’s labour. In so doing an exchange of labour has taken place, and an underlying contract has been created. The IOU also acts as a measure/account of value of labour, as we are starting to see that one hour of labour in a garden = one pint or half a sandwich.

At the moment, Fred’s IOU money is ‘good’ money. Everybody in the pub accepts Fred’s IOUs as money, and Fred continues to drink beer in exchange for the IOU money. At the end of the first day, rather drunk, he staggers out of the pub having exchanged 15 IOUs for pints. He returns to the pub the next day and, being a heavy drinker, does the same thing. On the third day that he returns to the pub, he tries once again to make the exchange of IOUs for beer. However, as he enters the pub, he meets a cold reception.

Fred now owes 30 hours of gardening for next week. An individual in the pub has pointed out that Fred is already employed by a gardening firm, and that his ordinary working hours are 40 hours per week. This will mean that next week, Fred will need to undertake 70 hours of labour. There are doubts in the pub that he is this hard working and, just before he came into the pub, one of his IOUs was therefore hurriedly exchanged for a packet of peanuts, which are half the price of half a sandwich in traditional money. Confidence in the money being issued by Fred has fallen. The currency has devalued due to lack of confidence in Fred meeting the contract in his IOUs.

Fred is thirsty and alarmed at the lack of confidence in his IOUs. He therefore decides to take measures to restore the value of his IOU money. He explains to everyone in the pub that, if he does not meet his gardening commitments, he will instead provide the holders of the IOUs with some of his gardening tools. Whilst many people do not want the gardening tools, having the IOUs backed by the tools means that, at least, if all else fails, they might sell the tools in lieu of the labour owed. Fred’s IOU money is now backed by assets, and Fred is now able to continue exchanging IOUs for beer.

Within this scenario, it is possible to see how the value of money is created and maintained. In all cases the money is backed by, or representative of, the value of labour. Even when Fred backs his IOU money with his tools, the tools represent a store of value of labour of others. In all cases, the money is an IOU of value of labour, and the value of money is determined by the confidence in Fred’s ability to deliver that value next week.

In the case of traditional money, the same thing occurs. It is accepted on the basis that it will, at a future point in time, represent a contract for the exchange of labour. It is identical to what Fred has done, but is different in that it represents a wider pool of labour, and is abstracted away from being a single variant of value of labour. Whilst Fred’s money uses units of one hour of gardening as the base unit of measure, traditional money has no single base unit to measure against. This is different to, for example, a gold standard currency, in which the commodity becomes the base unit of measure.

We can also see in the case of Fred how money holds value when supported by an asset. If we look at a commodity standard, or the issuance of asset backed securities, we can see that asset backed money simply offers a substitute of stored value of labour in place of the future commitment of labour.

However, there is a problem with asset backed money. If we imagine that Fred is very lazy, and fails to meet his future commitment of the value of his labour, he will have to offer a large number of his tools in lieu of his labour. Many of the recipients of the tools will want to sell them, and the result will be a flood of tools being offered for sale in the local classified section of the local newspaper. However, there is no reason why there might be a sudden demand for so many tools within the town, and therefore many of the tools cannot be sold. The holders of the tools are faced with holding on to the tools in hope of later demand for the tools, or selling them at a steep discount. They believed that the tools were a substitute for the hour of gardening labour, but find out that they are not.

This point is the underlying problem with any asset backed form of money. Whilst, in the case of Fred, he has offered an assurance over and above his promise to deliver, the value of that underlying assurance does not necessarily represent the actual value of labour that is contracted in the money that he is issuing. The same point may be made for any money secured by an asset, such as gold backed currency. The value of the underlying asset is subject to fluctuation, such that it may advantage or disadvantage the holder of the money, with no reference to any labour undertaken by the holder. The same might be said for any commodity currency, such as gold coins or silver, which might be subject to variations such that each unit changes value in relation to the value of labour.

What is apparent from the example of Fred’s money is that the only real value of money resides in the meeting of the underlying contract of provision of value of labour. In other words, the only way to achieve the full value of Fred’s IOU money is for Fred to actually do the hour of gardening work promised in the IOU, which means one mowed lawn. In practical terms, therefore, any good money system should not be based in assets but in firm commitments for the fair exchange of the value of labour at a future point in time.

Current Fiat Currency Systems

In the current fiat currency system, it is apparent that the currency is neither fixed against an asset, and is not fixed against any value of labour in the economy. The issuance of the money is not referenced to the potential output of value of labour in the economy, and the supply of money is continually inflated. It is like Fred offering ever more IOUs regardless of whether he might meet the contract for each unit offered. The issue of each unit of currency does not represent the actual value of labour in the economy, and is issued independently of this.

An interesting comparison with current fiat systems is the issuance of currency in the online world of Second Life. It is a currency issued by the owners of the Second Life world, is utilised for exchange within the world and can be converted into $US through a currency exchange. Both currencies are as arbitrary as one another, as neither currency is rooted in anything. People are now earning a living in Second Life, and use the currency exchange to allow them to convert their online value of labour into ‘real world’ money.

As an example of the problem of un-rooted currency, if we were to imagine the economy has a total daily output of 100 units of labour, and Joe provides one unit of that labour, the value of Joe’s labour is worth 1% of the total value of labour in the economy. If today we have 100 units of money in circulation, Joe will be given 1 unit of money as a result of his labour, and Joe would hope to be able to exchange his money for 1% of the total value of labour the next day. However, if the units of money are increased by ten units the next day, then Joe’s 1 unit can no longer be used in exchange for the 1% of the total value of labour.

The problem arises as to where that value of Joe’s labour has gone? He undertook the labour, stored his labour in the unit of money, and some of it has now disappeared. He might reasonably think that this is unfair and unjust. He might reasonably ask where that value has gone.

The value has, of course, been transferred to the newly issued money। They have, in effect, taken some of the value of Joe’s labour from him. Whoever issued the money, they are now in a position to utilise that value of labour that has taken from Joe to exchange with the value of labour of others. In so doing, they have expropriated some of the value of Joe’s labour. Any such system is inherently unfair and unjust. The new holders of the value of Joe’s labour have not actually done anything which might justify their expropriation of his labour. If Joe’s labour was building a brick wall, and his payment was made for this task, it is not clear how someone who made no efforts or contribution to the building of the brick wall might have a portion of the value of that labour of building the brick wall.

An interesting point to note is that, once a central bank creates money, as is pointed out by the Austrian economists, the first recipients of the newly created money are banks. The earlier the money is utilised, the greater the value of the money that is retained, as it takes a while before the newly created money creates inflation in the economy. The issuance of new currency is therefore beneficial to the banks that receive it.

The problems extend beyond this. Such a system also undermines the utility of the money as a neutral account of the value of labour. If the supply of money is variable, it is not possible to calculate the relative value of labour now with the value of labour in the future with the money. How is it possible to exchange the money today at ‘x’ units of value of labour, if we do not know that we will, in the future have ‘x’ units returned to us. It makes the value of money arbitrary, and inherently unstable.

Furthermore, in the current world trading system, it is apparent that it is possible to manipulate currency issuance in order to pursue quasi-mercantilist policies. It is also possible for governments to impoverish sections of their society in order to meet state goals, and to hide fiscal imprudence through the manipulation of currency. These points will be discussed later.

Fixed Fiat Currency System

The only way that a system of money might offer both stability and fairness is to instigate a system of money that represents each individual’s actual input of value of labour into the wider economy that is utilising the money. The only way to do this is to fix the currency against the actual value of labour in the economy. This means that each unit of money becomes a token that represents ‘x’ percent of the total value of labour in the economy. In order that the token always represents such a percentage, the number of tokens must be invariant.

There are several advantages in such a system, which will be addressed later, as follows:

1. A fairer system of money, that allows more individual freedom of choice
2. Greater stability of the financial system, with a tendency towards consistent and steady price deflation
3. A system in which asset and other bubbles might be more evident, providing an early warning of the formation of bubbles
4. A more transparent world trading system that has self-balancing characteristics, and which will provide a fiscal discipline upon government
5. Allowance for a more transparent banking regulation system, and the removal of most current banking regulation.

The Problem of Currency Units

One of the potential arguments that might be provided against a fixed fiat system is that it provides for a system that will trend towards deflation (discussed later). In a situation of continual deflation, there is a potential problem with the utility of currency units. This is best illustrated with an extreme example. If we were to imagine that the Normans has instigated a fixed fiat currency in England in 1066, and there were 100,000 units of currency, each unit today would hold a value of labour that would make such units impractical for day to day usage.

As such, it would be necessary to break such units up into smaller units, to allow for the multitude of small exchanges that are necessary within an economy. The way that this might be accomplished without the inflation of the money supply is to view each unit of currency as if it were, for example, a loaf of bread. If the loaf is cut into smaller slices to share it out, the loaf of bread remains but in the form of many slices. It is still just one loaf of bread that is being shared out.

In the same way, as each individual currency unit becomes less useful, the currency would then be subdivided into smaller units, with the subdivision meaning that there is no actual change in the overall value of the original unit, just that the value is split amongst the new units. In practical terms, if we issue 100 pence in coins, we must destroy the £1 note that was divided.

Steady Deflation

One of the great advantages of a fixed fiat currency system is that it provides for a system which will achieve steady and consistent inflation. The assertion that this is advantageous might horrify many economists, and therefore requires some explanation. In particular, there appears to be a widespread belief that deflation is a ‘bad thing’. There is no evidence that this is the case, but rather there is plenty of evidence that a change in the rate of inflation or deflation, or a move from inflation to deflation is damaging.

However, before moving to the effects of change, it is worthwhile destroying some myths about deflation. The first myth is that deflation prevents individuals from making purchases, whilst they wait for better prices. In the following examples, it will be shown that the reality is that people do not delay purchases in the expectation of lower prices.

Example 1 – Fast Moving Consumer Goods

If a shampoo manufacturers were to improve their output by 5% through a manufacturing innovation each year, their output of shampoo would increase, and this would reflect in a decrease in the price of shampoo. In other words, there will be a steady and continued deflation in the price of shampoo. According to the idea that consumers will delay purchases in an environment of deflation, in such a situation, consumers would choose to walk around with greasy hair, never buying shampoo in the expectation of further price decreases. Such a proposition is fatuous.

Example 2 – Hedonic Goods

Over the last few years countries such as the UK have seen the emergence of many discount airlines, such as Easyjet. The emergence of these kinds of airlines, and the increase in competition within the sector, has seen the price of air travel deflating. Much of the utilisation of these airlines has been by consumers using the discount airlines to have cheap foreign holidays, and this can be described as a hedonic good. It is an entirely discretionary expenditure as there is no necessity to go on holiday to another country. Despite the continual deflation, there have been many years of continual expansion in the discount air travel market. The deflation has not prevented consumers from taking flights to go on holiday, but rather has had the opposite effect.

Example 3 – Computers

Personal computers (PCs) are an interesting case, as they have year on year improved performance and year on year seen deflation of actual prices. It is also an example that includes both business purchases and consumer purchases. Despite the ongoing deflation in the prices, the market for PCs has had a long period of explosive growth throughout this deflationary period. It seems that the steady deflation in prices has had no impact through the postponement of purchases.

Example 4 – Special Cases

Remaining with the example of PCs, it is possible to construct a hypothetical example of how consumers might indeed delay their purchase in expectation of deflation. If one of the large computer manufacturers were to announce that they would be introducing a new type of computer in the coming year, and that the computer was to offer twice the performance at half the cost, it is quite likely, assuming their claim were credible, that consumers might delay their purchase of computers in expectation of this future deflation.

If the thinking of those who argue against deflation is considered, such a deflation is a ‘bad thing’ as consumers withhold their money in expectation of lower prices. If this logic is followed, then the new and more effective design of computer is not a good thing for the economy, as it has created a deflation in the price of computers, and has caused a delay in the purchasing of computers. However, once the computer is introduced, it will make more computing power available to more people. How this might be a ‘bad thing’ is not entirely clear. Everyone who purchases a computer sees their wealth increase, as they are able to enjoy relatively more computing power in relation to their income. They are quite literally wealthier.

Debt and Deflation

There is an argument that suggests that deflation causes problems with the servicing of debt, as the value of the debt sees relative increases through the deflation. This is a scenario that appears to be very plausible, and can be backed by some solid calculations and formulae. However, what is missed in such arguments is that it is not deflation that is problematic, but the move from inflation to deflation. It is not the change in the value of money that is problematic, but the change in inflation/deflation from the original inflation/deflation position from the time of the issuance of the loan.

A good example of this can be seen in private mortgages on housing. If a loan is taken out in a high inflation environment, the interest rate will be relatively high. The targeted central bank interest rate will be high, and the lenders will seek to account for the high inflation by charging a rate of interest that will overcome the devaluation of the money that they are lending, such that they can achieve a positive return. If the interest rate is fixed over a period of, for example, five years and at year four the rate of inflation has fallen by a half, the holder of the debt is effectively seeing the value of their debt inflating. The earlier rate of inflation was eroding the value of their overall debt, and this was accounted for in the interest rate. However, with inflation falling, their debt value is no longer declining at the same high rate, but they are still servicing the debt as if this were the case. Their payments in relation to the actual value of the debt have increased.

If we think of this example and think of a change in the rate of inflation from 5% to 2%, and compare this with a change from 2% inflation to deflation of 1%, we can see that there is the same process taking place. In both cases we are seeing the relative burden of debt in relation to income moving in exactly the same way. In the inflation and deflation environment, interest rates will move to reflect the underlying changes in the value of money, and debt burdens will be locked into repayments that are based upon an out of date criterion.

In other words, it is not inflation or deflation that is problematic, but rather it is the change in inflation/deflation that alters the burden of the debt. As such, any monetary system should aim to achieve either stable inflation or stable deflation.

Fixed Fiat and Deflation

A fixed fiat system does not guarantee stability of deflation, but does have features which will inherently stabilise the rate of deflation. If it remembered that a fixed fiat currency is tied to the total value of labour in the economy that is issuing the currency, it is apparent why this is the case.

If output of value of labour in an economy increases, the value of labour per unit of currency will also see a commensurate increase. This is the deflationary effect of a fixed fiat currency. However, there is no guarantee of an increase in output of value of labour. For example, if there were no technological or process improvements over a period of time (unlikely), then there would be no inflation or deflation. Equally, if for example there were a natural disaster that destroyed infrastructure, then the output from the economy would fall, creating inflation.

External inflation such as an increase in commodity prices might also create inflation, though these inputs might reasonably be isolated from the overall measure of inflation/deflation in the economy. These are factors that can not be changed from within an economy, as they are resultant from both internal factors and external factors that are beyond any action in any individual country. For example, if there is a poor worldwide harvest of wheat, this might see food price inflation across the world.

No monetary policy or manipulation of the money supply will alter the amount of available wheat in the world. As such, any shift in prices of commodities might cause a temporary shift in inflation/deflation, but there is no monetary policy that might influence this. The only thing to do with such changes is monitor their effects, and try to strip out their effects from the trend of inflation and deflation.

In most cases, deflation will follow the gradual and progressive level of increased efficiency resultant from step-by-step innovations in process and technologies. However, if there were a major innovation, such as the introduction of new highly efficient technology, there might be a resultant period of relatively high deflation, as output increases rapidly such that the value of each unit of currency rapidly increases.

Real cases in history that might cause rapid deflation in a fixed fiat system would be the introduction of electricity into manufacturing, or the introduction of railways. In both cases, the introduction of the technologies resulted in higher output per unit of labour, such that there was a widespread overall increase in the value of labour across the economy. This is a positive form of deflation, as the overall output of value of labour has increased without an increase in the volume of available labour. The economy has simply become wealthier. This is best represented in the earlier argument about the introduction of a far better PC. We should wish for this kind of dramatic deflation.

Hoarding of Money in Deflation

It is possible to read in accounts of deflation the use of the word ‘hoarding’. Before discussing why people might invest in a deflationary environment, it is worth addressing the word ‘hoarding’. It is a word with particular connotations, such as the idea of a dragon hoarding gold. Within such connotations it is possible to perceive that there is an emotive meaning in that the word implies selfishness and greed. The use of such an emotive word should therefore start to ring alarm bells, as it is a rhetorical device rather than a reasoned argument.

However, there is an underlying concern that, in an environment of deflation, people will simply use cash as their method of saving, rather than using their money to invest in new productive activities. This appears to be a plausible argument.

Nevertheless, it is not as plausible as it seems. The underlying argument is that, if there is deflation, the value of cash is in any case going to increase over time, so why would an individual risk making an investment if they can just ‘sit on’ their cash and see a positive return.

The problem with this argument is that it does not account for the variable levels of risk that individuals are willing to take in order to see a return on their money. For example, in the environment pre-economic crisis, there were a range of investment opportunities, each with a relatively different level of risk. An individual in the UK might have placed their money in government bonds at a low rate of return but with very low perceived risk, or they might have invested their money in a perceived high risk and potential high reward emerging market tracker fund. We know that people invested their money in both of these investments, and this clearly demonstrates that different individuals at different points in their lives will be willing to take varying risks with their accumulated store of the value of their labour.

In a situation of steady deflation, the behaviour of individuals will not change. Some individuals will ‘sit on’ their money, and others will seek to gain a return on their money that is greater than the return provided by the deflation. The key difference in the system is that the necessity of investment is taken away, such that no individual is forced to risk their capital. If we think of an individual approaching retirement, due to continual inflation, they must risk the value of their labour stored throughout their life, if they are to retain the full value of the store. In doing so, they also risk the loss of that capital with the result that they might live through an impoverished retirement. There seems to be no reasonable justification to force such a risk on any individual.

Within a fixed fiat system of steady deflation, it is apparent that some individuals will utilise their store of labour value to invest in order to gain a return, and others will enjoy the benefits of retaining the value of their store in relative security. Whilst there are no guarantees that sitting on cash will preserve the purchasing power of that cash (e.g. the natural disaster example), the holder of the cash has the assurance that he/she will remain as wealthy relative to others under all circumstances.

Interest Rates and Investment in a Fixed Fiat System

In a period of steady deflation, how will investment actually work? It is an interesting question that is far simpler than it might first appear. If we were to imagine a steady rate of deflation of 2%, how might interest rates be determined?

As has been outlined, it is possible to ‘sit on’ cash, and that cash will then yield an annual return of 2%. In order to persuade an individual to invest, it is necessary to offer a higher yield relative to the perceived risk in the investment. In looking at the problem this way, it is apparent that investment decisions are no different to the choice that was outlined in the example of an inflationary environment. If inflation is running at a rate of 3%, an individual might seek a real return on their investment of 5%. As such, they will direct their investment to an area where they will expect a total return on their investment of 8%. If the rate of deflation is 2% they will, using the same calculation, seek an investment with a return of 3%. In both cases they are aiming for the same real return, and will make the same risk/reward calculation. There is absolutely no difference except that the individual has a choice on whether they might invest their money at all.

What if the rate of deflation was very high? The first point to understand is that a high rate of deflation means that the economy is actually very successful. It simply means that the output of the overall value of labour has seen a significant increase. In real terms, the economy is wealthier overall.

However, should the deflation reach a very high level, for example an extreme deflation of 10%, there will be a problem in presenting investments that might attract individuals to take risks. The rate of return on the investment would have to be very high, as few people would be willing to take risks when they can earn a 10% return by ‘sitting on’ their cash. The result would be that the flow of money for investment would diminish, and the speed of the growth in the output of the economy would be constrained. The question here is whether this might be a good or a bad outcome.

If the output of the economy is expanding at such a rapid rate, it is quite possible that there will be a period in which there will be ‘irrational exuberance’. The history of the many examples of how individuals might become carried away with a particular class of investment needs no retelling, from the South Sea bubble, to the more recent housing bubble.

However, there have also been other bubbles which have been resultant from the introductions of new technologies, such as the telecoms or Internet bubbles. In both cases, there were significant innovations which had potential to increase output in the economy, and in both cases early investment yielded strong returns. However, in both cases the early returns led to manias, and those manias saw significant overinvestment in the sectors, so that overinvestment took place with a resultant misallocation of resources.

In a fixed fiat currency system, the deflation that would result from the expansion in the economy would present a natural stabiliser on investment during technological innovation. It might be argued that the high deflation would ‘starve’ the new technology of capital for expansion, but the opposite view is that each innovation might be ‘digested’ before any manias developed. This is not to say that a fixed fiat system would guarantee no manias, as people will always have the potential for ‘irrational exuberance’ under any system. However, if an innovation creates dramatic deflation, the deflation might cause far greater caution in further investments, and therefore act as an automatic stabiliser.

As the drop in investment takes place, the growth in the output of the economy will start to moderate, and the economy should stabilise back towards a steadier rate of deflation. Whilst giving the extreme example of 10%, it is unlikely that there might be such extremes, as the stabilising effect is progressive and self correcting. One of the underlying strengths of the fixed fiat system is the inherent self-stabilising effect, such that investment and borrowing should be taking place in a steady rate of deflation, thereby ensuring that lending and borrowing do not see volatility such as the alterations in the costs of servicing debt burdens.

Stability of the Financial System

At the start of the discussion, it was identified that there are two types of money in an economy, broadly characterised as traditional money and IOU money. Up to this point IOU money has not been discussed, despite the important part that it plays in the system of money overall.

Whilst the fixed fiat money system might create a steady deflationary tendency, it does not account for the rise and fall in the supply of IOU money. This raises the question of how IOU money might be regulated such that there are no booms or busts due to overexpansion or contraction of this money supply. As has already been identified, there is a natural stabiliser which should ameliorate bubble forming investments and activities, but this does not fully account for expansion of IOU money. For example, if deflation is very high, it might be that one company will less willing to extend credit to another company. This is a natural circuit breaker on the economy in which fast expansion will see a commensurate contraction in credit.

However, one of the main sources of IOU money is the banking and financial system, and any stability in the monetary system must therefore ensure some stability in the creation of IOU money in the banking system. The temptation here is to introduce a system of complex regulation, and enforce various measures upon the banks. However, the use of a fixed fiat system, alongside provision of particular information, offers a simpler and more effective method of managing the banking system.

The first point is that the fixed fiat system allows individuals to hold cash at very low risk to their stored value of labour. This extremely low risk allows for the creation of what might be called ‘deposit banks’. These are banks which literally, for a small fee, will store the money of an individual, with the entire holdings of deposited money always available for return. This is so essential to the system that, if no private institution were established to offer this service, the government would need to offer such a service. The function of the deposit banks is simply to store the money, facilitate transfers and transactions, and a fee would be needed to pay for the services.

The reason for the necessity of these banks is that each individual must have a clear and available choice of a bank which does not does not risk their stored value of labour. In having this choice, individuals have real choice in the way that they risk their money.

The second element of the financial system is ‘speculative banks’, which are any banks or financial institutions which might not, on any given day, be able to return all of the deposits that they have taken. These are any financial institution that takes depositors money and uses it for any kind of investment. In all such banks, at least proportions of the deposits that are held are at risk of loss, and can not be returned on demand. The name of this type of bank is explicitly given to remind any depositors of money into the bank that they are speculating, and the banks would be regulated such that they would need to include the name speculative bank in their name.

However, the most important element of the regulation of these banks is not their name, but something more fundamental. It is essential that depositors into the speculative banks are aware of how much of their deposit is subject to risk at any particular period in time. For the sake of pragmatism, this information should be available on a daily basis, and would need to be published daily in all branches of the bank, and on the bank’s website homepage (in a specified format). In particular, each bank would need to give an exact percentage of their deposits available for withdrawal as cash on the previous day, as well as a rolling trend for the percentage. This information will ensure that every depositor is fully aware of the amount of their deposited money that is at risk. The penalties for the provision of false information would need to be severe.

The third element of the system is the provision of information about the nature of the risks being taken by the speculative banks. At present, there is no regulation that prevents the banks from paying for external assessment of their level of risk. The conflict of interest in such a system is apparent, and has been made more apparent as a result of the financial crisis. One of the problems in assessment of risk is considered to be the asymmetry of information, and it therefore necessary to ensure a system where there is well financed external assessment of the risks in individual banks. The only way of ensuring this is to regulate the usage of the information provided by external assessment agencies to ensure that each individual who uses the services of the agency is restricted to using the information for their own personal use. For example, newspapers could not report the assessment of agency ‘x’ of bank ‘y’ without the explicit permission of the agency.

The regulation would ensure that there was the available finance for an effective system of external and independent assessment of the banking system, and individual banks within the system. Even within such an independent system, errors will still be made, and any assessment would need to make a statutory declaration in a regulated format advising the recipient of this fact.

The purpose of the provision of information about the banks, and the development of deposit banks, is to provide individuals with the information about the risks that they are taking, and to make informed choices as to whether they take risk. No form of regulation can remove the risk taken in any form of investment, and the only solution to this problem is to make risk a choice, and make the nature of the risk as transparent as possible. When individuals are presented with information and choice, any guarantee of the deposits by the government no longer becomes necessary, and the financial system can be largely left to operate as the market demands.

The last element of the regulation relates to the one remaining problem that might arise in the banking system. This is the notion of the ‘too big to fail’ bank. It is apparent that, if institutions become large enough, their collapse might lead to severe problems in the economy. The existence of banks of this size is therefore a danger to the stability of the economy. It goes beyond the scope of this discussion to go into detail of how banks might be broken up and regulated in order to remove this risk, but regulation of size of banks would be a necessity.

So far, a radical system of regulation and deregulation has been presented. It is apparent that a fixed fiat system is necessary to allow the deposit banks to play their role in the system. However, this does not explain how stability in the provision of IOU money might be achieved.

In order to understand this, it is necessary to think of individuals making choice according to their own circumstance and their individual appetite for risk at various points in their life. Pension and life insurance markets give a clue to how these decisions are presented and made, and it is apparent that in aggregate the total level of risk individuals will take will remain relatively stable over time. Under the current system, any deposit into the banking system is undertaken without any heed to the levels of risk in an individual bank (excepting during the recent bank runs). The assurance of government guarantees of the banking system, and deposit guarantee schemes, means that banks are able to operate with levels of risk of which the depositors are unaware.

In the system proposed, in which levels of risk are more transparent, individuals will be confronted with clear information about the levels of risk that they are undertaking. If there is an aggregate steady level of acceptance of risk, the banking system will adapt to the informed choices of individuals, and will provide a range of options that will meet the aggregate demand for risk. As that aggregate demand will normally not see abrupt changes, any change in issuance of IOU money by the banks will be dampened to reflect the aggregate risk demand in the market. Once again, there is nothing in the system to prevent manias, although the deflationary nature of the system will ameliorate the manias. As a result, in normal time, the issuance of IOU money from financial institutions should remain relatively stable and constant.

This entire system can only be achieved in a system of a fixed fiat currency, which provides the foundation of the reformed system of banking and finance.

Government Issue of IOU Money

Another potential source of issuance of IOU money is government, typically in the form of government bonds. The purchase of these bonds can be broadly divided into domestic and overseas purchases, and each has a different impact and considerations in the consideration of financial stability.

A government issued bond, as with any form of money, is a promise to return a value of labour in the future. The key difference between a government bond and other forms of IOU money is that the government can utilise the law and tax system to force individuals to provide a proportion of their value of labour in servicing the obligations of the bond. It makes them a relatively sound form of money, as they can in principle make (within some boundaries) large claims on the value of labour in an economy.

The starting point in the consideration of the issue of bonds is the purchase of the instruments by overseas buyers. This has most curious effects on the economy that receives the bonds, and upon the perception of the state of the recipient economy. Before going on to these points, it is worth reiterating that the bonds that are issued are no different from the IOUs for gardening provided by Fred in the explanation of money, with the exception that the bonds might force Fred to work the necessary hours for repayment. Just as Fred uses the bond to allow him to consume beer, a stored value of labour, a UK bond purchased by a Japanese investor allows the UK government to consume the stored value of labour of Japanese workers.

A good way of thinking about this is to imagine that the purchase of the bond by a Japanese investor is being used to build a hospital. For the sake of simplicity, we will imagine that the bond is for the building of the hospital alone, and is only purchased by Japanese institutions. As part of the purchase, Japanese currency will arrive in the UK, and that might be used to exchange for other currencies to purchase material, services and equipment, or purchase these directly from Japan. In addition to this, some of the money will be used to pay UK contractors and suppliers. In all cases the payment is being made from the stored value of labour of Japan.

If we imagine the purchase of a piece of medical equipment from Japan, at some point in the future, the promise of the bond is that value labour of a good or service slightly greater than that purchased will be returned to Japan or whoever holds the bond. When the device is shipped to the UK from Japan, it will also generate significant activity in the economy, with an importer handling the import, a logistics company moving it to the hospital, and the contractors who install it into the hospital. At each stage of the process, the value of labour being utilised is a consumption of the Japanese value of labour that was provided in the currency exchanged for the bond. However, the impact upon the economy extends beyond these discrete actions.

For example, each of the individuals or organisations that have been paid through the issue of the bond will go on to spend the IOU money provided by the bond in the wider economy. For example, a contractor may save enough money to purchase a UK built car with cash, thereby increasing output of cars in the UK economy by one car. However, whilst he is paying for the car in what appears to traditional money, he is in fact spending the IOU money from the bond. If we think of the myriad of ways in which the bond IOU money will increase output in the economy, it is apparent that the IOU money has an effect on output far greater than the headline figure. The money from the bond becomes tied up with the traditional money in the economy, and separation of the IOU money from traditional money becomes impossible.

The issue of bonds then needs to be placed in a wider context, if we are to understand the implications and effects of the bond. If an economy is running a current account deficit, then the economy overall is being provided with goods and services over and above the output of the economy. If governments are issuing bonds and these are purchased by overseas investors, the money that then flows into the economy represents an aggregate consumption of the value of labour of the creditor country. The problem that then arises is how we might actually measure the output of the economy. As has been illustrated in the case of the hospital bond, the value of Japanese labour entering the economy becomes inextricably entwined with the economic output as a whole. It generates considerable activity throughout the economy.

If we then consider that GDP measures are a consideration of the activity within an economy, it is possible to see that the GDP figure is measuring the output of Japanese value of labour output as if it were UK value of labour output. Furthermore, the greater the issuance of bonds, the greater the activity in the economy, and the higher apparent GDP will be. Issuance of IOU money in the form of bonds will increase activity in the economy, giving an illusion of growth in the economy. This becomes particularly problematic if the sustainability of bond issuance is being measured as a percentage of GDP, as that figure will include the impact of previous bond issuance, and is not representative of the output of the UK, but is representative of the output of the UK economy and the imported value of labour of Japan (to return to the earlier example).

The GDP measure of the economy does not actually represent the output of the economy, but the measure of debt to GDP allows government to continue the issuance of more IOU money than might be sustainable.

It is here that we come to the question of how a fixed fiat system might prevent such problems. The first point is to say that a fixed fiat system will not be able to prevent governments from the issue of bonds, which is of itself a dubious practice in ordinary circumstances (though the reason for this will be left aside for this discussion). However, if a country is running an overall current account deficit, under the fixed fiat system, the country will find that money is flowing out of the country, and that there is a process of deflation taking place. This deflation will make the purchasing power of the currency increase, and will therefore make the goods and services of the country more attractive, as the currency will provide more goods and services per unit. This will mean that a current account imbalance, as soon as it appears, will start to correct itself.

However, if a government is issuing IOU money to overseas investors during a period of a current account deficit, it is immediately apparent that the government is seeking to artificially maintain the current account deficit. They are seeking to prop up consumption within the economy, and in doing so are building an unsustainable economic structure. In so doing, they are issuing money against a level of output that is already unable to service the current exchanges in value of labour between the bond issuing country and its trading partners. Without the endless confusions being caused in targeting variable interest rates, different volumes of money, such reckless behaviour will be very apparent.

In other words governments will not be able to hide irresponsible policy behind a wall of monetary policy. The current account balance between countries will become main the determinant of the relationship between their currencies. In terms of exchange rates, they will become transparent, and will alter according to trading relations, not with monetary policy. Our Japanese investor will see clearly that fiscal expansion during a current account deficit is a policy that can not be sustained, and the future repayment of the bonds must see a devaluation of the currency. No overseas investor would invest into such a poor currency.

A fixed fiat system prevents governments from borrowing more money than might be supported by the actual output of value of labour in the economy. It creates transparency and clarity about the state of the economy in relation to trading partners.

With regards to the issuance of IOU money, where the purchase is made by individuals or organisations from within the issuing economy, this is more problematic. However, there is an indicative measure of whether the government is indulging in fiscal irresponsibility which is that, within a fixed fiat system, inflation should only take place in few limited circumstances, and those circumstances can be reasonably isolated from the general trend within the economy.

Barring the impact of these circumstances, in the event of inflation, it is apparent that the government is issuing more IOU money than can be supported by the output of value of labour within the economy. Any inflation within the economy can be seen as a warning sign, and it is then a matter for the electorate to discipline the government for causing the inflation. This moves beyond economics, and is the question of how a mature democracy might function, and is therefore beyond the remit of this discussion. How or when a government might be disciplined is firmly within the realm of the relationship between governance and the democratic system.

Overall, the fixed fiat system provides clarity about the actual state of the economy, and also provides some mechanism of stabilisation of trade between countries. It is a system which should, in most situations, offer considerable stability and ensure that an economy grows in a sustainable way.

The Problem with a Fixed Fiat System

There is a problem with a fixed fiat system in a world in which the current fiat system holds sway. In particular, there is the problem that a fixed fiat currency would be very attractive to investors who have their domestic currency operating in a conventional fiat system. In particular, they will know that the value of the currency will never be eroded through the issuance of greater volume of the currency. As such, over the long term, it will appear to be a stable and secure form of money into which a person’s value of labour might be stored.

The problem that this stability represents is that it will encourage a situation in which the stability of the fixed fiat currency will be undermined by the apparent stability of the currency. It is a contradiction that requires some explanation.

If, for example, the UK switched to a fixed fiat currency, and Japan remained on a standard fiat system, then Japanese individuals would likely want to place their stored value of labour in the UK. The result of this would be to see lots of Japanese investors seeking places to put their money in the UK. For example, government bonds would appear to be attractive, offering considerable security. However, as has been detailed, the issuance of government bonds is in fact the issuance of money. As such, if the government, or other recipients, of Japanese investments accept the flood of Japanese money, the money supply will have increased, which is inflationary.

The problems that this might cause are best illustrated with the carry trade from Japan. The carry trade was resultant from the policy of quantitative easing in Japan in conjunction with low interest rates in Japan. The result of the policy was that, as fast as new traditional money was added to the Japanese money supply, money flooded out of Japan seeking higher interest rates in other countries. In so doing, the increase in the money supply helped create the asset and credit bubbles in countries such as the UK. Furthermore, the money that was being created was earning a rate of interest that helped counteract any loss of value of the Yen that should have resulted from the increased issuance. The investment of the money flowing out of Japan contributed to the positive current account balance of Japan, thereby strengthening the Yen.

In other words the targeting of interest rates and quantitative easing was a contributory factor in the development of imbalances in the world economy. It illustrates the danger in conventional fiat money systems, and these kinds of imbalances would appear in any economy with a fixed fiat system.

The only solution to this problem is that all currencies should move to a fixed fiat system. Under such a system, there would be no targeting of interest rates, as the money supply could not be manipulated, and also there would be no possibility of quantitative easing. In a world built around a fixed fiat system, the world economy would look very different. For example, if we imagine our Japanese investor, his choices will look very different.

In determining where to place his money, he will no longer be looking at the relative prospects for any individual currency in terms of monetary policy of the country, but will be looking at the fiscal policy of the country, and the output of the value of labour in the country. The interest rate in the country will no longer be set by the control of issuance of money, but by the conditions of the market in the country.

The only way such a system might be enacted would be through international agreement. For example, if the G20 were to agree to the system, and made trade with any country conditional on implementation of the system, then it would become the world currency system. The problem that arises is that the system would run counter to the quasi-mercantilist currency policies undertaken by countries like China. It would also present a constraint on governments borrowing from overseas sources, and this would force them to have to confront the underlying economic difficulties within their countries. Whether there could be any agreement in these circumstances is questionable.


So what is the key, the underlying principle behind the fixed fiat currency system? With a little reflection, it is apparent that the underlying driver behind the many benefits is the shift to something that becomes a representation of the actuality of the economy. It creates transparency, and thereby creates systems that are inherently stable. It removes power from the regulators, the central banks, the government and the financial system, and transfers and distributes that power into the wider economy. It is essentially a democratic reform.

Even if this reform of money were to found to be a sound and coherent approach to the management of money in the economy, it is unlikely that it would ever be enacted. It hurts too many interests, and those interests would fight any implementation of the system. However, if the system is workable, this paper is written and published on the basis that it is better to have an alternative system ‘out there’ in the world, rather than locked away in the thoughts of one individual.

I therefore conclude the article with two points. The first is that I am profoundly pessimistic about the prospects of any change which might remove the privilege and power of the banks, and even more pessimistic about the prospects of government accepting such reform. The second point is to reiterate the point at the start of the article. This is the musing of an individual without any schooling in economic theory. As such, thoughts, comments and critiques (hopefully polite) will be welcomed.


Note 1: I am not sure how many might reach the end of the article, but I hope at least a few will find it worth the effort. For those who do get this far, I would like to thank you for your patience.

Note 2: I use Japan as an example on several occasions for illustration and examples. This is not to single out Japan as a particular source of problems, but rather the country is used for ease and consistency.

Note 3: A couple of the examples I have used for the deflation argument have been used elsewhere (I forget where), but I also used these examples in an article a long while ago, so I have not referenced the article.

Note 4: The Austrians will object to the fixed fiat system, as they believe all currency should originate in the 'market'. I see no reason for this, and would be happy to see a commodity currency compete with the fixed fiat. I am confident about which might win over as the chosen currency used by most people. It is also noteworthy that in reality, for a commodity currency, they are actually discussing gold and silver, both of which have considerable variation in value over time. This is an inherently unstable currency. I also had a brief debate on the subject of a fixed fiat currency system on the von Mises website. They suggested any fiat currency would be subject to debasement. My pointing out that commodity currencies have been debased throughout history fell on deaf ears.

Note 5: Suggestions and further ideas are welcomed. This is, after all, the first attempt to outline this system.


  1. Sorry for no comments on previous comments. I hope, having seen the length of the post, there will be an understanding of the reason for this.

  2. An interesting article in the Telegraph:

  3. That was very interesting. You're right, of course - it'll never happen short of a disaster or a revolution.

    I'd like to comment, but I'm going to have to think about it for a while. So this note is just to thank you for taking the time to write such a thought-provoking and considered article.

  4. CE

    see this video about half way

    the author proposes to 2 solutions to the monetary/debt issues

    1. gold (or similar) based currency
    2. governments issue currency and taxation is used as a method of taking money out of the system

    some food for taught maybe


  5. The banks and governments are all lying now as they always have. How could *they* ever hold a true "fixed" amount of currency? Who would trust them?

    That is why gold or some sort of tally stick needs to be tied to currency, to ensure a more honest count of the amount of currency to the amount of its backing.

    Sadly, bankers and governments will lie about how much gold they have behind their printed paper too. (As in the US where gold holdings have not been audited since the 1950's!) And they have no problem changing the way statistics are compiled in order to suit their needs.

    I think this is why markets must be in charge of currency as they were years ago. Markets seem to find their own level eventually, self adjusting to what is, trade by trade, person by person. "Authorities" demand things to be a certain way right or wrong, timely or not...not to mention how they bow to their own needs first.

    The best approach would be if governments and banks were moral and honest, because virtually all the troubles currencies experience is basically due to "cheating".

    When casinos handle the cheating problem they do it quite well, but the result of is that the house always wins. So if banks or governments were as effective as casinos, they'd always win (even if they did not cheat)--but at the expense of their "subjects"! Almost like now except for the cheating.

    I say, let the markets have wack at it.

  6. Very good, but as you say, unlikely to be taken up by the banks or governments! The only way something like this could come about is if there was a mechanism whereby it could 'evolve' into being, without the authorities noticing, or if they did notice, being able to stop it.

    Is this a typo?:

    Steady Deflation

    One of the great advantages of a fixed fiat currency system is that it provides for a system which will achieve steady and consistent inflation.

  7. Pocmloc:

    You are quite correct. It is a typo. Thanks for the comments.

  8. Fascinating,
    Will have to re-read, but seems sensible enough that no government would ever touch it, unless forced. You are very specific that such a system would be framed and limited within national borders, but (as trust in government institutions seems to be collapsing throughout the western world) I wonder if the implementation of alternate currencies might be more likely if adopted by (f.eks) an enterprising global corporation.

    Thanks for a remarkable piece of work.

  9. Great essay. I really enjoyed it.

    I'll certainly need to re-read sections but in the meantime I still agree with the Austrians and supporters of commodity money for the following reasons:

    Money should be chosen by the market, firstly on the basis that it meets the basic requirements of money (divisible, fungible, etc) and secondly, that it does so in such a 'free' (as in freedom) way that no-one has a monopoly over its origination that they alone could debase it. Governments and their 'agents' are obviously the principal perpetrators of this form of fraud. A market-originated money has the advantage of being iteratively tested by the market as being the most suitable form of money.

    This is my main sticking point with your proposal: that governments can't be trusted with the creation of money because the form that money takes mustnecessarily be something *not* already available in the natural world. It has to be a fabrication and because government alone has the 'source code' of this fabricated money, they always have the means to inflate the money supply, unchallenged. An additional problem with such fabricated money is that it attracts counterfeiters because they are seeking the lucrative source.

    All of the deflationary benefits that come from a fixed or near-fixed money supply are also available to a gold standard. Granted, gold is continually being mined, but there is no monopoly on gold mines such as there exists monopolies of fiat monies and overall inflation is low. As you have reasoned, it doesn't matter whether we have inflation or deflation, only that a relatively sudden change to one or the other will cause problems.

    This is why I'd summarise your proposal as making an excellent case for gold. Because in gold there is no need to have a G20 global agreement beforehand. Gold has and is already working behind-the-scenes as a replacement global currency, in part or whole, and at the very least as a store of value. It's the form of money most readily chosen by the people when there is no government authority to interfere.

    This is not my 'opinion', it's not the Austrians 'opinion', nor the 'opinion' of the Chinese and all the other states now seeking the safety of gold. Gold and other precious metals just seem to transcend theory and embrace what has been proven to practical by people according to their current circumstances – as is happening now. It's about what works.


    One thing I was confused about, and I'd be happy if you could clarify... from your Fred example:

    'However, there is a problem with asset backed money. If we imagine that Fred is very lazy ... he will have to offer a large number of his tools in lieu of his labour. Many of the recipients of the tools will want to sell them ... The value of the underlying asset is subject to fluctuation, such that it may advantage or disadvantage the holder of the money, with no reference to any labour undertaken by the holder. The same might be said for any commodity currency, such as gold coins or silver, which might be subject to variations such that each unit changes value in relation to the value of labour.'

    In the example of Fred's tools/gold, if gold was the standard, to what alternative store of value are the tools/gold being compared??

    In the case of a fixed fiat money, the value is always trust in the money issuing authority, and an alternative money isn't allowed to exist. This is no different than we have today. Trust is the problem. I'd trust what other people trust if they were truly free to decide.


  10. I have just seen the first critique (on another site) as follows:

    A commodity such as gold only has value once labour has dug it from the ground, and labour has moved it to the surface.

    Wrong. "In this, as in many other points in Political-Economy, men are prone to confound cause and effect. It is not that pearls fetch a high price because men have dived for them; but on the contrary, men dive for them because they fetch a high price." --Richard Whately, "Introductory Lectures on Political Economy" IX.47 (1832)
    The mistake here is that the value in the pearl is only achieved once it has been removed from the seabed, and transported to a place where someone might want to buy it. Otherwise it has no value. The market may determine that it is wothwhile for an individual to undertake such labour, but without the labour the pearl remains without value. If we want to be complicated, we might suggest that a person might buy the seabed on which the pearl rests, as they know that there are pearls on the seabed, but in this case the purchase is because the pearl has potential value, as it is still not realised.

    Up to the moment that someone actually picks it from the seabed, the pearl can not be exchanged. The existence of the pearl, and ownership of the seabed presents a potential for the pearl to be exchanged in some future time. The pearl only has **actual** value at the moment of exchange. Up to that point, it is merely speculation on the potential value.

    What determines how one person determines what they value in exchange is not the issue. For example, why any person might value crystal healing is a mystery to me. However, others value this, such that people engage in labour to learn how to 'crystal heal' and then exchange this service for other products and services (through the intermediary of money). The demand for the healing determines the value of the labour, but the value is only realised in the exchange.

    When a person hands over the money for the crystal healing service, they are exchanging the stored value of their labour, or their future labour (if using credit),or even the stored value of another person's labour, for the labour of the healer.

    The comment, and this reply, can be found on Reddit here:

  11. Adam (and Anonymous):

    Thanks for the comments. With regards to your question about the Fred case (if I have understood it correctly), this is exactly the problem. In a standard fiat currency, we are unsure of what is compared to what.

    I agree that the value of the currency in a fixed fiat system is rooted in the trust that the issuer of the money (government) will not issue more money. The trust might be rooted in constitutional provisions, for example. Overturning a constitutional provision is difficult, though never impossible.

    Your arguments with regards to gold reflect those that were made on the Mises institute, when I first floated the ffc in the comments section there. I would refer you to Adam Smith, as follows:

    'For in every country in the world, I believe, the avarice and injustice of princesand sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had originally been contained in their coins.' (from the section on 'The Origin and Use of Money')

    Smith points out how governments have manipulated commodity currency for their own gain. We can also ask how, if a gold standard is beyond (or helps prevent) debasement, we saw the erosion of gold standards into the current fiat system.

    I would agree that implementation of a gold standard is preferable to the current fiat sytem. However, as I have pointed out, this allows the fluctuations tied to a single commodity to arbitrarily alter the stored value of labour, without any reference to the actual value of labour performed.

    You are probably right that, behind the scenes, there is discussion of some form of gold standard. I would welcome this as a move in a positive direction over the current system, but have concluded that such standards suffer from the inherent flaw that I have detailed.

    As an extreme example, let's imagine that South Africa descended into revolution or chaos, and the gold mines were destroyed/damaged. Such an event would see a massive transfer of wealth from individual to individual based upon their good or bad fortune with regards to how much gold backed currency they held. It ceases to be a neutral unit of account in the relative value of labour between individuals.

    Morevover, the regular output of gold, demand for gold as an industrial material, fashion for gold as ornamentation, all have the potential to alter the value of gold relative to other commodities, products or services. I agree that gold seems to have a cultural significance such that it always seems to have a relatively high value amongst commodities, but the problem remains that the value can vary.

    Lord Sidcup:

    Many thanks for the comments, which are always appreciated.


    I will look forward to your comments. It is very flattering that you would take the time to consider these ideas.


    Thanks for the Youtube link, which I will look at later.

  12. I do hope I'm not being dim...

    In your example of mine closure... *stop the world right now* Fred has 100 gold and Harry 50 gold. Their relative wealth is as it is. What difference does the availability of future gold make? Fred is either more productive and/or has saved more than Harry. For the duration of the mine closure, money supply is fixed. I don't see the short-term problem. I do see the long-term problem.

    I certainly don't discount the fact that people will attempt to dillute gold. This is a given and bears no more responsibilty than to check that a fiat note isn't a fake. Issuing too many gold certificates got the government/bank cartels into trouble. The 'Money As Debt II' video linked to above explains how encrypted digital gold makes certificates or any other media unnecessary.

    Regarding alternative uses for gold altering value... I take your point and it is a very good point I've not seen made so clearly before. I now understand your arbitary comment. Thank you.

    I'm sorry if my comments appear to reiterate the opinions of Misesians and thus frustrate you. I have no affiliation, but I do read their blog quite regularly along with a variety of others.

    (FYI. I've noticed a problem with the copy-paste function in this comment box. Also use of the arrow keys. I'm using FireFox on Mac.)

  13. What your missing is the transformation of physical labour to intellectual labour. The output of advanced economies is trending towards purely intellectual output, the manufacturing base to support that is irrelevant, and is obviously outsourced to those places that can provide it more cheaply.

    These earthquakes can be felt in the west as the uneducated manual workers become surplus to requirements, and they can be seen in the East as China is voraciously stealing the Intellectual output of the west.

    China and India will experience exactly the same issues as the West does, as living standard and education levels rise and internal natural resources fall they will transition to a knowledge based economy.

  14. Anonymous:

    This is an interesting point regarding intellectual labour. In the cases of China and India in particular, they are expanding education very quickly to enhance the value of their labour in aggregate, and are indeed seeking to become a 'knowledge' based economy. Much more could be said here...and apoligies therefore for a brief and perhaps not too clear reply.


    Thanks for the comments. You are not being dim at all. I will admit to struggling with this myself, and am still unsure that the example I gave fully makes sense. Here is an illustration of how (I think) it works. Please feel free to critique or poke holes in this, as it is useful to have a second opinion, and identify if this makes sense.

    Person A holds 1 unit of gold currency
    Person B holds 2 units of gold currency

    The South African mining disaster occurs, such that the value of gold doubles in relation to all commodities, goods and services. There is a chronic shortage of gold.

    One unit of gold can now therefore be exchanged for 2 toasters.

    Person A goes out and buys 2 toasters in exchange for his gold. The alteration of the value of gold increases Person A's toaster wealth by +1.

    Person B goes out and buys 4 toasters in exchange for his gold. The alteration of the value of gold increases Person B's toaster wealth by +2.

    In both cases, they are now more wealthy in the measure of toasters per person. In both cases, they have not performed more toaster's worth of value of labour, but are now able to purchase additional toasters. In the case of person B, they have gained even more 'unearned' toasters. There has been a relative redistribution of wealth between them.

    In both cases, they performed no labour to see their wealth in toasters increase, but the relative wealth increase of person B is greater. Person B is relatively more wealthy simply due to the change in the value of gold.

    In fact, nobody has created any new value of labour anywhere in the economy which might justify this new purchasing power. The deflation is resultant from the loss of output of value of labour (the mines closing down). Despite this, the gold currency units have greater purchasing power. The value of person A and person B's stored value of labour has doubled retrospectively, meaning that they now hold a greater value of the total value of labour than they originally stored.

    An interesting philosophical point that might arise if person B was saving more due to research on South Africa - did their increase in wealth result from labour or good fortune? It would be apparent that this would be an increase in wealth resultant from the labour of research. This returns to the problem of the currency being a speculative investment in a single commodity, rather than being a means of accounting for and exchanging value of labour.

    As I mentioned, I will welcome critiques and comments on this explanation. I do not think that it alters the underlying argument of the arbitrary nature of a gold currency, but it is useful to give examples that are coherent!

  15. Adam:

    Sorry, I was distracted by the mine question. Regarding the copy and paste function, please accept my apologies. I did try a new comments system recently, but it created more problems than solutions. I will see if I can find another system that might create an overall improvement (suggestions welcomed). If you have problems posting in the interim, you might as a last resort use the email address, but I recognise this is not ideal. The Blogger service has many flaws.....but once you start using it, it is difficult to shift.

    I also missed a key point in your argument that, with the closure of the mines, the money supply becomes fixed. However, gold has more use than as money, and therefore it is not fixed. There is still a use of gold for industry and ornamentation. As such, the money supply will decrease, and the value of money relative to other items increase. The same problem might apply with any commodity currency, and illustrates the fundamental problem of variability of value.

    I watched the Money as debt video and a fixed fiat currency would work as well in such a system as gold. The sytem proposed is about accurate accounting of the number of currency units in relation to gold held. Why not just use the system as an accounting method for the number of currency units in a fixed fiat system? In both cases it is a method of keeping governments 'honest', and any method of doing so is a positive under any system.

    Whether the system of digital money might work in practice is another question, but about which I do not hold a view. This is about the security and effectiveness of the supporting technology, and I confess (particular) ignorance in this area.

  16. The Labour Theory of Value is Wrong

    At the heart of all economic activity is human labour, and economics is the process of exchange of value of labour between individuals, organisations and other economic units. Within this system of exchange of value of labour, the underlying purpose of money is very clear. It should only act as a medium through which the value of labour might be accounted, and is always representative of a store of value of labour, with an underlying contract that it might, at some future point in time, be exchanged for the value of labour of others.

    The labour theory of value that you use to justify your notion that money should just allow people to "exchange the value of labour" is deeply flawed.

    It implies that the only cause of value is labour. But this can't be correct.

    Consider this situation:

    (1) One man in the south of France in a obscure region not famous for wine spends 100 hours of labour planting a vineyard, harvesting the grapes and making 50 bottles of wine.

    (2) One man in France in Bordeaux spends 100 hours of labour planting a vineyard, harvesting the grapes and making 50 bottles of wine.

    The first man sells all his 50 bottles of wine for $50 ($1 each). But the second man sells his 50 bottles of wine for $500 ($10 each), because his wine is produced in Bordeaux and is valued at a higher price than the wine produced by the first man.
    Yet, according to the labour theory of value, they have both put in precisely the same amount of labour, so the price should be the same.
    But clearly they are not. The value of the wine has a fundamental subjective cause: people value wine from Bordeaux more highly than wine from other regions.

    Consider this second situation:

    (1) One man spends 200 hours digging in a mine and finds a diamond and sells it for $1000.
    (2) Another man spends 1 hour digging and finds a diamond which he sells for $1000.

    Although they receive exactly the same price, they have put in completely different amounts of labour. If the labour theory of value were correct, than the first man would be paid 200 times more for his diamond than the second.
    But again the underlying labour time has no effect on the value of the diamond which might be determined by subjective value (people desiring diamonds for beauty) or objective value (people needing diamonds for industrial purposes) or both.

  17. The big thing about a Knowledge economy that throws a spanner (or a even hand grenade) in the works of traditional economic models is that the cost centre completely changes.

    Knowledge is *entirely* front loaded, the entire cost is in the initial R&D. Once the initial capital outlay of the R&D is done, there is a zero (or near zero cost) of selling it. If I spend a million to make some software or a drug or a song then that's my entire expenditure - I can now sell 1 or 100 or 100,000 copies of my original knowledge with no further outlay. I do not need to hire people to go mining 1's and 0's (at least directly!)

    China and India are heavily tooling up to do this, but at the moment just offer cheap knock offs.

  18. Rare Objects and Value

    Yet another problem with the labour theory of value is the existence of expensive but rare objects: for example, old paintings, statues, ancient coins, etc.

    The value of these objects is wholly independent of the original amount of labour used to produce them (often centuries ago), and there is simply a great subjective value placed on them that determines their value.

  19. Lord Keynes:

    Thanks for your comment. In response, where did I say labour is valued according to quantity? Your error is in assuming that value of labour is based upon quantity, upon hours worked, which is clearly not the case.

    Different individuals might maximise their labour (and talents) in different ways to achieve their actual value of labour. Not all of us can run BP, not all of us can be football stars, but many of us can flip a burger at Burger King. Some individuals will extract greater value from their labour in exchange than others, through innate intelligence or dilligent study of the value of labour in their market. e.g. I might find a higher rate of pay in an individual restaurant compared with a chain such as Burger King.

    How we each individually value the labour of others is just that - individual. I value a crystal healer's labour at £0 per hour, but others value it at a lot more. However, one crystal healer may achieve more value for their labour than another, simply as a result of a greater depth of understanding of their subject, better marketing skills etc.

    I mentioned at the start that this is not concerned with social justice, but with the value of money being measured according to value of labour in exchange. The nature of that exchange is a different matter, and one that I will leave others to argue about. My concern here is that money simply reflects what the underlying nature of the economy actually is. I am not examining notions of social justice, but making the system of money more stable and fair. The economic structure within which this system resides will determine the value of labour realised by individuals relative to one another, and the fixed fiat system will simply reflect this.

  20. Hi Cynicus,

    Perhaps I have made a mistake.

    I think you need to clarify your theory:

    (1) Do you believe that the only source of value is labour?
    Your statement: The first point to make is that all economic activity is rooted in the value of labour seems to suggest that you do.

    If so, then you have not explained how wine from Bordeaux produced with 100 hours of labour can be worth more than wine produced with the same amount of labour somewhere else.

    (2) Do you concede that labour is not the only source of value?

    If so, then your theory is still undermined, because you believe that at the heart of all economic activity is human labour, and economics is the process of exchange of value of labour between individuals, organisations and other economic units.

    But once you concede that the pure labour theory of value does not work, then human labour is simply not at the heart of all economic activity.

    In fact, apart from labour, one additional factor at the heart of all economic activity is the subjective desire of consumers to buy goods and services.

    Nobody asks how long it took to manufacture an I-pod, and then calculates the price of it solely on how much labour went into producing it. There is a large subjective factor that gives an I-pod its value.

  21. Lord Keynes:

    Re: Rare objects and value:

    You are quite right that objects are valued subjectively. You may wish to read Craig Miller on this subject.

    I am not proposing anywhere that value is determined by the amount of labour that has been input. In the case of the expensive and rare item, the labour input in the orignal item may be minimal. However, in order for the item to move from its (possibly) original low value to the high value now, it needs labour along the way.

    For example, an auction house needs the labour of their experts in identifying the relative rarity of the object, the auction house building is stored value of labour, the staff who manage the auction house are labour, the promotion of the event of the auction is labour and so forth. It is all of these labours that add value to the item.

    In particular, the expert must labour in order to achieve expertise, and that expertise must be promoted. It is the prouncement of the expert that determines that the item is 'rare' and 'valuable', and the expert is therefore adding the value of their labour to the object.

    For example, in the case of some paintings, the authenticity of the painting by an expert creates the value in the painting, not the quality of the work. This has been shown in the case of artists whose students issued pictures in their name. In another case, for an unknown artist, they may labour on it a long time, achieve superior quality of work, but without the added value of the expert 'thumbs up', their work will not be given a significant value in exchange.

    I have not explained this as fully as I would like and may return to the point later. For the moment I am out of time...apologies.

  22. Labour Theory of Value 2


    There appears to be a fundamental contradiction in your arguments.

    You say:

    (1) You are quite right that objects are valued subjectively, but

    (2) At the heart of all economic activity is human labour, and economics is the process of exchange of value of labour between individuals, organisations and other economic units. Within this system of exchange of value of labour, the underlying purpose of money is very clear. It should only act as a medium through which the value of labour might be accounted, and is always representative of a store of value of labour, with an underlying contract that it might, at some future point in time, be exchanged for the value of labour of others.

    But, if value is partly subjective, then the money prices of goods and services do not simply measure the value of labour. People subjectively value goods themselves, not the underlying value of labour.

    In my example of the wine made in Bordeaux, people don’t value the underlying labour, but the fact that the wine is made in Bordeaux, and comes with a label that says so.

    Also I note your analogy here:

    As an example of the problem of un-rooted currency, if we were to imagine the economy has a total daily output of 100 units of labour, and Joe provides one unit of that labour, the value of Joe’s labour is worth 1% of the total value of labour in the economy. If today we have 100 units of money in circulation, Joe will be given 1 unit of money as a result of his labour, and Joe would hope to be able to exchange his money for 1% of the total value of labour the next day.

    But this analogy is utterly dependent on the notion that the value of the goods and services in the 100-labour-unit economy is completely determined by the underlying labour. In other words, your assumption is that labour is the only source of value, which contradicts your concession above that objects are valued subjectively.

    Just because Joe provides one unit of labour a day in a 100 labour unit economy does not mean that he is entitled to claim on 1% of the economy’s labour. Whatever Joe produced with that 1 unit of labour may have a very low subjective value in the community (say, a 50 matches). Someone else may contribute only half a unit of total labour that day and make things which are given a much higher value than anything Joe produces (say, 10 televisions).
    (This issue, by the way, is completely separate from the alleged theft of the value of Joe’s money through later inflation of the money supply.)

  23. Deflation and Delayed Purchasing

    No one, to my knowledge, argues that price deflation of specific goods is a bad thing.

    Your examples of specific price deflation of particular goods would be in the context of a booming economy, with no general and sustained price deflation.

    Once you have a contraction in the economy, unemployment, lower wages, uncertainty, and general price deflation, then a deflationary spiral through delayed purchasing is still likely, even in your ideal fixed fiat currency world.

    You seem to have sidestepped the issue of sustained and general price deflation in a recessionary/depressionary environment, which involves distress selling, delayed purchasing in the expectation of lower prices, less consumption, distress selling, collapse of investment, more unemployment, continuing deflation etc.

    The point is that the economy gets trapped in a vicious circle.

  24. Lord Keynes:

    You say:

    'You seem to have sidestepped the issue of sustained and general price deflation in a recessionary/depressionary environment, which involves distress selling, delayed purchasing in the expectation of lower prices, less consumption, distress selling, collapse of investment, more unemployment, continuing deflation etc.'

    I have not sidestepped this. In particular you are associating deflation with a contraction in the economy (re-read what you have written). Steady deflation in a fixed fiat system takes place precisely through the expansion of output in the economy. Inflation takes place in the event of contraction. You are using the wrong model here. You are using commodity currency or traditional fiat models and the instability they cause.

    For your other comment I will refer you to a similar discussion on Reddit as follows:

  25. Regarding the Comments on Reddit

    Thanks, I have read the comments, but I still think the arguments of "Monximus" are quite correct.

    He himself argues that value is subjective.

    You yourself say on Reddit:

    I emphasise at the start of the article that my discussion does not encompass how value of labour between individuals might be determined. I simply accept that it is variable, and might be valued according to any number of criteria. Thus the example of the crystal healer earlier. You are right that value is a perceptive judgement - it is entirely created in our minds ... Part of the value of pearls resides in the difficulty of obtaining them and the restricted supply that is resultant from this.

    But then you have conceded that supply and demand have a major role in creating the value of goods, totally independently of the labour that went into producing them. It is not the labour of the diver that makes pearls valuable, but their limited numbers (rare nature), plus the subjective value placed on them by consumers. This factor is utterly independent of labour.

    And you yourself above have said You are quite right that objects are valued subjectively.

    That being so, something is wrong in your argument.

    If you admit that value is subjective, then value and price are not directly caused by labour. There are other factors.

  26. Labour Theory of Value 3

    I urge you to consider this argument:

    In essence, the labour theory of value claims that a commodity’s value should be based on the amount of labour that goes into producing it .… This argument is akin to an artist who insists that his paintings should command high prices because he has spent years creating them. His art may fetch a high price, or it may not. Buyers will clearly value the art based on their own criteria [i.e., their own completely subjective value], not by how much time the artist spent creating it.

    P. Sperry, B. H. Mitchell and A. Roberts, The Complete Guide to Selling your Business (2nd edn), Kogan Page, London, 2005. p. 41.

    It doesn’t matter what labour or effort an artist puts into art: it has value only when a buyer decides that he wants to buy it. And the price could be high or low, depending on how high the subjective value placed on it by the buyer is: the labour has essentially no role to play in its value.

  27. Lord Keynes:

    You seem to be ignoring the underlying point of the argument that I am presenting. I make no argument on how labour **should** be valued, but rather how it should be represented. I am puzzled at your continued pressing of the matter.

    The reality in any economy is that labour has variable value. I am simply saying that, if person A undertakes labour at value x on date 'y', then that value should be stored at value x. The rights and wrongs or how it might be valued is not the issue. Nevertheless, all value in economics commences with some kind of labour. I pointed you to Reddit because the argument about pearls clearly shows that labour creates the value in the pearls. Without labour they have no value.

    I am at a loss as to what your point might be. As I have said, I make no argument about how labour should be valued, or that there is any objective valuation of the labour of person a against person b. I make no claims that item a should have value b. I simply argue that all value commences in labour. Some add more, some less. In the case of the black pearls, the added value of the labour of the entrepreneur was huge. It increased the value of an entire asset class, and he benefited hugely from that increase. Nevertheless, it was his labour that added the value.

    It is no different from the example of the art expert who asserts a painting is authentic. The added value is huge, but still resides in labour. The labour of the expert. How labour translates into value is simply not at issue. The only issue is that different forms of labour create variable value. This is nothing to do with how the value is represented in a currency.

    Thanks, as ever, Lord Keynes, for the contribution, as I have met the same points on Reddit, and therefore the point needed to be addressed. However, I do feel that we are at cross purposes here. My proposal is nothing to do with how labour might be valued. Just that all value commences with labour. Economics is a human endeavour, so how else might value be created except by the activity of humans???

    I will leave it there, as I am not sure I can make the point any clearer. However, I would recommend that others follow the link to Reddit, as I believe that this clearly demonstrates that only through labour can value be created.

  28. Final Point


    Thanks for the challenging and stimulating discussion.

    Let me add one comment.

    There is a simple way to clarify things: I believe (curiously enough, along with the neoclassical economists and the Austrian school) that the value of goods and services can depend on many factors other than labour.

    I am simply saying that, if person A undertakes labour at value x on date 'y', then that value should be stored at value x.

    If so, then your argument doesn’t really need a labour theory of value at all: you could accept the marginal utility theory of value and still argue that the wages obtained by a person in the money amount x from the subjective value placed on his product by consumers should not lose that value through inflation at a later date.

    I pointed you to Reddit because the argument about pearls clearly shows that labour creates the value in the pearls. Without labour they have no value.

    We certainly have a fundamental difference. In my opinion, the labour does not create the value in the pearls. The value comes about through the subjective desire of people to own pearls. The intrinsic value consists of qualities they have acquired through natural processes. Nothing that the diver does through labour has created the intrinsic qualities of the pearl that people value: these qualities already existed in it in nature.

    The example of a painting above refutes the idea that only labour produces value. Any amount of labour employed by an artist will not give his painting any value whatsoever, unless someone places a subjective value on it.

    I simply argue that all value commences in labour … My proposal is nothing to do with how labour might be valued. Just that all value commences with labour. Economics is a human endeavour, so how else might value be created except by the activity of humans?

    So you reject the idea that the value of a commodity can be caused by factors other than labour?

    In my example of the wine produced by two men in different regions, is clear to me that the labour is simply not the factor that creates the higher value of the wine produced in Bordeaux. It is obvious that there are many other factors that produce value.

    Despite all the argument, this is fascinating and genuinely thought provoking debate. Hopefully, other people can give their point of view as well.

  29. I should add: thanks for being so generous with me if I have misunderstood your theory!

  30. Lord Keynes:

    You never give up.... We might value something, but its value in economics, our willingness to exchange 'x' amount of labour for it, is rooted in labour. There are many things that we might value outside of the economic sphere, such as a kind word from our wife. However, in terms of economics, value is created through labour.

    I have shown that the value of a painting is not some intrinsic quality, but is added by approval of an expert. If you doubt this, look at the shift in value of a painting when it is found not to be by a famous artist, or how the value of paintings climbs when a well know patron of the arts commences purchases.

    I do the same thing with the argument on pearls on Reddit. You say the following:
    Nothing that the diver does through labour has created the intrinsic qualities of the pearl that people value: these qualities already existed in it in nature.
    I am completely puzzled that you can still claim this in a discussion of economics. This is the original comment on Reddit from an opposing point of view which I believe I refute completely (see later):

    "It is more accurate to speak of qualities of objects (and I count services as objects), and of values as judgments by individuals of objects. This makes clear that objects possess qualities, labour enhances qualities, but persons value qualities. I would contend that nothing (including labour) possesses value in itself, only qualities which are valued by persons: value is a perceptive judgment.

    Labour did not endow the pearl with its qualities. These precede the labour invested, and inspire the efforts to obtain it. The "potential value" that you recognise rests in these qualities in that people recognise them and value them whether labour acts upon them or not.

    If the pearl were found on the beach and cost nothing to obtain, it would be valued as highly. If I dine on wild berries in the forest, where did the value come from? The motion of my hand to pluck the berry did not create it: I value it for its sweetness. My labour enabled me to value it, but my labour did not confer sweetness upon it.

    In sum, commodities possess qualities which are valued by those who obtain, possess and use them. The action of labour on those commodities may enhance their qualities, contributing to their perceived value. Labour contributes to, but rarely, if ever, exclusively confers valued qualities.

    Labour may be sine qua non in bringing an object into use, possession, or condition--or not. It is the vital role of labour in contributing to perceptions of value that leads to the erroneous conclusion that it confers value."

    Continued in next response.....

  31. My response is as follows (having yet again agreed that value is subjective):

    "However, you point to an intrinsic quality in pearls and suggest that, if a pearl were easily found on a beach it would be valued as highly. I would argue with such an assertion. If this were the case, and the pearls were easily obtained, a flood of pearls would appear on the market, as collection and distribution of the pearls would be a sure way to get rich. Whilst the first collectors might realise the high price, could the price remain so high under these circumstances? Part of the value of pearls resides in the difficulty of obtaining them and the restricted supply that is resultant from this.

    If we go one step further and imagine that pearls were found in every garden and open space, and were freely available to all in unlimited numbers, would the intrinsic value of pearls that you discuss allow them to be used in exchange at all? The pearls would still have the same qualities, but with no necessity for any labour in obtaining them (or at least so little as to be of no meaning - you could pick them up whilst walking outside at any time), they would have no value in exchange."

    The value of the pearl is entirely determined by the labour. If pearls were everywhere, their value would collapse. Their intrinsic qualities have nothing to do with their value in economics, which is entirely determined by the difficulty of their presentation to the market and the rarity.

    Sure, we can say that a pearl is intrinsically pretty, but in economic terms, this is meaningless. If you wish to split hairs over this, please feel free. This is about value in economics. I return to the value of a kind word from your wife, which can not be subject to any economic exchange. I enjoyed the sunshine today, but can not exchange that value in any way that is meaningful in economics. This is not the sphere of economics. This is argument for the sake of argument.

    What more can I say?????

  32. CE: Thanks for you clarifications above. I take your point about the alternative uses for gold. I also wonder about what distortions in market prices are of a real and lasting concern given the alternative materials available and opportunity costs now associated with using gold in goods production, assuming a gold standard.

    On digital money. It is my understanding that if encrypted money wasn't backed by something then the value of the money resides purely in the securty of the encryption algorithm itself. And because what can be encrypted can be unencrypted, given enough computer power, we are faced with an unending encryption arms race between issuers of the encryption and encryption alchemists. As ever, no-one has yet figured out how to manufacture gold. So gold or similar has to do the backing. The encryption simply serves to ensure any unit of digital currency is counted only once in the system, and can be constantly improved as computing power increases. The advantages of a digital gold currency are that the *gold* provides trust in the store of value, the *digital* enables the division of units as deflation occurs as well as encryption and distribution over the networks.

    Re: labour theory of value. CE's killer point seems to be that even the subjectivity brought to bear on the value of an item is 'labour' and represents a considerable opportunity cost, for example, choosing white pearls over black due to habit or tradition, despite the black pearls now being considered more beautiful by the wider society. The labour of subjectivity accounts for the difference between use value and exchange value, except for things like foodstuffs that have an integral value in the form of nutrition that psychology alone cannot alter.

    The Archdruid makes the case that primary goods (nature) already have multiple values within the wider ecology of primaries and that those values persist quite apart from human appraisal.

    Where Economics Fails

    The Wealth of Nature

  33. An even better proposal:

    Digital Coin

  34. Thanks for this intriguing thought experiment.

    I'm with Lord Keynes on the labour theory of value, but I don't see that its falsity automatically changes the pros and cons of the currency system you propose. Your currency would have to reflect an estimate (and it would just be an estimate, based on assumptions) of the total amount of labour available for trading in the economy, and very few people's hourly wages would correspond exactly to a nominal Labour Hour coin or note.

    I assume you would allow issuance of extra currency as the population rises? If not, you really would be building in deep deflation. If money keeps pace with population, then this might introduce a slight inflationary bias (because raw materials and capital would not be rising at the same rate) but this would probably be more than matched by long-term rises in productivity.

    More problematically, I don't see what would stop people and institutions creating money in your system by giving each other credit. (Is this effectively the same as increasing the velocity of circulation of money? It's a long, long time since I did my A-levels.) But they would be much more likely to do so during inflation than deflation. This means that some of the automatic stablisers you mention could be over-ridden, and the economy could end up with hyper-inflation or deflation despite your system.

    More difficult still, for me at least, is the relationship between production and wealth. We value both in the same currency, which means we can freely exchange assets for labour and vice versa. And the nominal value of the wealth exceeds that of production by orders of magnitude. I believe the volume of asset trading worldwide far exceeds the value of total world output of goods and services (allowing people who trade financial assets to make lots of money and buy lots of goods and services). How would you reflect this in your system? If you allow assets to be valued in the same way as production, then you'll have a currency that bears far less relation to use value of production than to exchange value of traded assets, and it will be almost impossible to tie down how much money there is around, and we'll be in much the same position we are now. If you don't allow assets and production to be valued in the same currency, how are assets to be bought or sold and how will investment be possible? Colour me confused.

  35. Adam:

    On the subject of the electronic currency, thanks for the explanation of the relative merits. I am guessing that you are in favour of the system, and it is apparent that you have looked at it/ thought about it carefully. On the basis of your thoughts, in principle I agree that this might be an advance, and would suggest that the 'arms race' is similar to that which we have seen in paper currency. With each case of counterfeiting, a new security measure is introduced.

    As a note of caution, however, better to be very confident of winning the arms race before jumping in and risk discrediting the idea. If it is a good idea but loses, it will set back the progress. What are your views on the ability to win?

    On the subject of nature in the economy, both articles you link to are thoughtful and well considered. I am afraid a philosophical response....

    I agree that 'nature' is necessary (for example in my discussion of wheat prices). However, in economic terms, nature may provide the sunshine (up to a point - see note), water (up to a point) and soil (up to a point), but economics still remains the human endeavour that takes what nature provides, and converts that into something with value in an 'economy'.

    I think that our only difference lies in the idea that there is a value aside from human appraisal. Economics is an activity that I take to be human.

    For example, a cow might value a grain in its own particular way, but it will not have any way or thought of exchanging the grain to (for example) gain a hedonistic pleasure from mating (exchanging the wheat for sex).

    I am sure that many will be tempted to post comments to the effect that animal A provides service B to animal C, such as the fish that clean sharks. These are instinctive actions, not the result of deliberation of any kind. All such fish clean sharks, and do not do so out of any calculation of value.

    Set against this, more complex forms of life, such as apes, might engage in similar activity to humans. For example investment in grooming increases later sexual contact (sorry, something I read once but no reference). This might be seen as a form of rudimentary (??) economic activity, but I am not sure that it is the point made by either you or in the Archdruid report. Whilst the ape might value something for the future potential for sex, it is difficult to say whether the ape might see this as an economic exchange in the way humans see the exchange. This is a question of philosophy of the mind, and one I will not cover in this blog.

    As such, I agree with the principle that 'nature' must provide many of the resources that will later be used in economic activity. After all, without the sun we would all die and there would therefore be no economic activity. The primary inputs are indeed essential with today's technology.

    However, such a point does not change the idea that value in a human economic system must surely see value as being determined by humans.

    As a purely philosophical point, I have a problem with the idea of nature that excludes humans. We are nature. Our cities are nature. Our technologies are nature. We can not be anything but a part of nature. We might impact upon our environment more than other parts of 'nature', but that can not alter the reality that we must be part of nature. We are part of (and therefore shape) the natural environment. We can not do anything that is 'unnatural'.

    However, I will quietly drop this point, and leave readers to contemplate how we might **not** be 'natural'.

    I hope that the response is food for thought, and appreciate the links. I have come across Archdruid before, and it is an interesting site, and often quite insightful.

    Note: Whilst nature might provide sunlight, it is also possible to grow plants using artificial light, for example.

  36. I agree with both Lord Keynes and Cynicus... the pearl (or the Bordeaux wine) has intrinsic natural qualities that people desire, and so the people are willing to exchange tokens of their labour in exchange for ownership of these shiny goods.

    However they also have the option of exchanging their labour _directly_, without tokens or even barter, by diving for pearls, or by planting vines. Therefore they make a judgement - is it better value for me to dive for the pearl, or to pay a pearl fisher to dive for me?

    I would say that the increased value of a bordeaux wine over a regional wine, or of a pearl over a smooth pebble, is exactly the difference in labour required to acquire one. If there was truly a quality difference but no labour difference, then people would do the work themselves. The fact that it is too hard for them incites them to pay for it.

    As for antiques: the same position holds. If you want a Rembrandt, you can either exchange a huge number of tokens, or you can do the labour yourself by spending a huge number of hours reading textbooks and then scouring car boot sales.

  37. Digital Coin
    "A design for a self-generating and liberated trading medium"

  38. Anonymous:

    Thanks for your comment, but I am genuinely puzzled how anyone might suggest that there is an intrinsic value in any item (in economic terms). I had thought that I had laid that fallacy to rest. As such, a challenge to anyone.....

    Please provide any item (excepting things which might have no value in exchange e.g. the kind word from your wife) and I will do the same thing as with the rare and valuable object and the pearls, and demonstrate that their value (in economics) is created in some way in human labour. As an example to set things off, the cultural phenomenon of Michael Jackson appears to transcend economic drivers.

    When a person says how wonderful the music of Michael Jackson is, it appears that they are adding value to the cultural phenomena of this pop star which will translate into economic value, and doing so without reward for their service. However, if we examine this, it is resultant from the innate talent of Michael Jackson, in conjunction with publicists, marketers and so forth, that led to the recommendation. It was the conjunction of all of the labour of these individuals that leads to the sale of Michael Jackson merchandise. Michael Jackson's talent, the talent of his management, record company etc. have undertaken labour that creates their value in the economy.

    It is not that Michael Jackson's music has an innate value without any labour on his part and the labour of others, it is that there is a machine, both direct and indirect, that seeks to turn Michael Jackson into a high value added commodity.

    When a music station plays his record, they are both exploiting the value in the creation of the music and promotion of the music (acts of labour), as well as creating value in the music through the introduction to a new audience of the music (value of labour), or confirming that it is 'good' music (value of labour in developing expertise). Selection of Michael Jackson's music is an act of labour. Playing it is an act of labour that requires all of the labour built into the infrastructure of a radio station and broadcast.

    Without such labour, his musical talent would remain like the pearl on a seabed, and would not have an economic value, or the value that might be attained would be reduced. His value resides in his talent, and the labour to create value from the talent. It is all very human. Any innate quality of his music means nothing without the labour undertaken to sing and promote the music to others.

    Without labour, it simply sits in his head, and realises no value in the economy. It is worthless. In economic terms it is just like the pearl on the seabed. If no person expends labour in finding the pearl, or Michael Jackson never sings his song, there is no economic value.

  39. Previous post continued....

    In another example, how about the value of an ink stand in Ming dynasty China. If a tradesman appeared in a particular publication of the time (called the 'Essential Criteria') then the value of their manufacture would be increased. The author laboured to be the arbiter of 'good taste' and the result was that he published, and his labour increased the value of items he favoured, in particular antiquities. His labour, his writing of the book was the determinant of value, not the intrinsic value of the items.

    It might take another manufacturer the same time to manufacture the ink stand, the ink stand might be identical to another manufacturer's ink stand but it does not determine the value. The value is determined in the labour of writing the book 'the essential criteria'. There is nothing intrinsically more valuable in the item than that which is produced by equal skill with an equal input of labour and materials, excepting the recommendation.

    Or take the case of Attic vases, which had the name of the manufacturer emblazoned on their wares. The value was not determined by the intrinsic value of the labour in the vase, but by the name that was attached to the vase. In one case, the manufacturer even advertised that his vase was reflecting the fashions of the time.

    In all of these case, the value of labour is variable, but the value is not intrinsic in the output, or any inherent attributes of the item, but in how the labour is subjectively valued and the labour that creates the value.

    The subjective value is created by a value of labour which goes beyond the process of manufacture, and is rooted in how the materials are converted into a value that is in turn rooted in relative value of human labour.

    As with the pearls, if they were to be found everywhere, they would have no value in the economy, but might have an aesthetic value to an individual that makes no impact upon the economy. It is the process of labour that determines all value, but that labour adds inconsistent value.

    At each point, how we subjectively value human labour, whether through talent, the ability to acquire scarce materials, the ability to convince others of the social cachet of item 'x', the only source of value is resultant from human labour.

    The exception I will accept is hinted at by Adam. If you are starving, the nutrition in wheat has an intrinsic value to humans. If you are thirsty water has an intrinsic value. However, these only become the realm of economics if some kind of exchange takes place. Any item that is involved in exchange enters the realm of economics, and any exchange involves labour. Somebody must at least labour to acquire the item, and then present it for exchange. At such a point, even with food and water, it has become an economic item that is represented by labour. Before that, it has no economic value.

    This is not a circular argument, as economic value must be delineated in some way. Otherwise the 'kind word of your wife' enters the realm of economics. Whilst this is a form of exchange, it makes the subject of economics as beyond any reasonable limits. All human interaction is some kind of exchange.

    The only restriction on the challenge is that I have a limit of time, and will only be able to answer the first examples as presented. I will try to answer at least three of these.

  40. pocmloc:

    I appreciate your efforts to steer a middle ground, but would anyone pay for an a pearl if they could find them all around them at any time?

    This is the key question.

    As a note, my last comment was written before seeing your post.

  41. One of the great advantages of a fixed fiat currency system is that it provides for a system which will achieve steady and consistent inflation.

    i believe you were meant to say

    One of the great advantages of a fixed fiat currency system is that it provides for a system which will achieve steady and consistent *deflation*.

  42. I understand entirely the idea that labour is the root of all economic activity. I think that all these individual examples being discussed are a red herring.

    Of course some individuals are 'lucky' or 'unlucky' in their transactions, and the value of new inventions must always be a process of trial and error for the markets. Some products have a premium price because of advertising or reputation - justified or not - but the markets will always tend towards introducing cheaper alternatives which are just as good. The 'premium' producer must work hard to maintain the reputation and high price.

    The market will *eventually* set the 'correct' average price for any item or commodity and this must be based on the value of the labour required to produce it. What else could it be based on?

  43. "No,but would anyone pay for an a pearl if they could find them all around them at any time?
    This is the key question."

    No, and hence you are right, the value comes from labour.

    But, the natural object still has value; people still want to own them - here at the coast, shells are valued; people display them in their houses. But no-one buys or sells them because they are available to be picked up on the beach. So they have 'value' to people, but they don't have financial or exchange value. They're worth 'something', but they're not worth money.

  44. Please provide any item (excepting things which might have no value in exchange e.g. the kind word from your wife) and I will do the same thing as with the rare and valuable object and the pearls, and demonstrate that their value (in economics) is created in some way in human labour.

    A man owns some land and one day notices that some wild fruit trees are growing on it. One day people come past his land notice, the fruit trees and offer him $1 for 2 pieces of fruit that they themselves will pick and keep. He agrees.
    However, he has done no work whatsoever: he did not plant the fruit trees, water them or take care of them. He simply sits in his house and takes money off people before they pick the fruit.
    The value of the fruit is not created by, or caused by, human labour at all.

  45. Lord Keynes:

    The holding of the land by an individual means somebody at some time must have undertaken some labour for it to be owned. Even if 'given' the land, without any monetary or barter exchange, somebody must have persuaded another person of why the land should go to them, or someone must have actively claimed the land.

    Even if the land were given to the person without any reason, it still required some form of title to be bestowed upon the person, such that they own the land, there must be a legal system which upholds ownership, and so forth - each stage requires human labour to make 'ownership' of the land to work.

    Even if the land is handed down through ten generations, the 'ownership' of the land is supported by the infrastructure of ownership, and that is the endeavour of human labour. It is the infrastrucure of ownership that provides the value in the berries that are sold. Without the human infrastructure, which is the drafting of law, the enforcement of law, and so forth, why would they pay the individual for the berries?

  46. The holding of the land by an individual means somebody at some time must have undertaken some labour for it to be owned.

    That labour is utterly irrelevant to the existence of the wild fruit trees which grew by chance. They could have grown on parts of the property that the owners now or in the past never even cultivated or worried about.

    It is the infrastructure of ownership that provides the value in the berries that are sold. Without the human infrastructure, which is the drafting of law, the enforcement of law, and so forth, why would they pay the individual for the berries?

    The ownership of the berries or even the land does not give the fruit value: for this argument to work, you have to believe that things that are owned will always have value.
    For instance, the stones on the man's farm will have no value, despite infrastructure of ownership, as you call it.

    In neoclassical economics,

    the value of an object or service is often seen as nothing but the price it would bring in an open and competitive market. This is determined primarily by the demand for the object relative to supply. Many neoclassical economic theories equate the value of a commodity with its price, whether the market is competitive or not. As such, everything is seen as a commodity and if there is no market to set a price then there is no economic value …. Economists such as Ludwig von Mises asserted that "value," meaning exchange value, was always the result of subjective value judgements.

    Thus the property ownership is not the cause of the berries' value, but the subjective value judgements of people who wish to have them.

  47. You have not answered the following question:

    "Without the human infrastructure, which is the drafting of law, the enforcement of law, and so forth, why would they pay the individual for the berries?"

    Ref your comment:

    "For instance, the stones on the man's farm will have no value, despite infrastructure of ownership, as you call it."

    For example, if people wished to build a wall with the stones, then the stones would have a value for exchange. As I have said, value is subjective and value is created through labour. The 'valueless' stones gain a value when turned into the wall through the labour in transportation and the labour of building the wall.

  48. "Without the human infrastructure, which is the drafting of law, the enforcement of law, and so forth, why would they pay the individual for the berries?"

    Answer: (1) the accidental fact that they happen to have grown on his land and (2) their subjective desire for the fruit.

    Without (2), they would not pay.
    The "human infrastructure of law," property rights and ownership do not create their internal subjective desire for the wild berries.

    You say:

    value is subjective and value is created through labour

    There is a fundamental contradiction here.

    If the value is subjective, then it is not created only through labour.

    It is created through the subjective desires of buyers, whose subjective valuation of a commodity can be utterly divorced from the labour that went into it (in the case of the wild fruit trees growing by accident on the man's land, there is no labour whatsoever).

    These subjective attitudes to the values of goods and services are influenced by supply and demand (that is, quantity available for sale), which together cause prices.

  49. Anyway this is all a big distraction. I suppose it shows that there are no solid arguments against the main suggestion: fixed currency. Only distracting side-issues.

  50. Surely the individual example of the berries is irrelevant. The market price for berries is set by the effort needed to produce them on average. An individual may be fortunate enough to receive a windfall, but that doesn't detract from the argument that the price is set by the typical labour involved in producing them.

  51. Ref. wild berries. Said people desiring the berries are not paying for the berries, they're paying for the right to have (limited) access to the owner's land including specifically the right to pluck the berries.

    Assuming rational people on both sides, the price for this Limited Access Right will be determined by the value of berries at the (super)market minus a discount for having to put in the labour of extracting the berries from the tree themselves.

    Granted in this case the exchange only takes places because said people value berries. Crucially however the price/value of berries as exchanged at the market is entirely determined by labour:
    - labour involved in preparing land, sowing
    - labour involved in harvesting
    - labour involved in bringing it to market

    Nevertheless, I think it is fair to say that berries can have value without the application of any labour whatsoever, but in this case it is outside the realm of economic discussion.

    I guess this is what CE is getting at that any value in the economic sense by definition involves a bare minimum amount of labour, e.g. the labour required for the seller engaging in the exchange.

    Perhaps then this is my main point in what is admittedly a thoroughly confused non-contribution to the berries debate:

    1. Economic activity/exchanges, and value in the economic sense always involve some labour, e.g. labour involved in the exchange
    2. Things can have value in a non-economic sense (random berries found, serendipitously, on common land and plucked for personal consumption; ie. no exchange)
    3. The berries value debate perhaps is a case of comparing apples with pears*. With CE using term value as per 1, and LK using the term value, at least in those instances where it involves no labour, as per 2.

    * sorry for introducing even more fruit into the berries debate.

  52. Getting back to part of the original ffc argument and away from the berries and value of labour arguments, I would like to draw attention to the Fred owing lots of asset backed gardening work to the population of his town. Given that he is clearly over consuming and it has been calculated that there is no way in hell he is ever going to do the gardening and hasn't got enough tools to give to his debtors one must argue where this leaves the townsfolk - what do they do? One could argue that they would have to accept their losses and move on, which many may well do, although being human some will get angry and annoyed and seek revenge for getting ripped off and give Fred a right good kicking. Lets just hope for the sake of our Western hides that China has the temperament of the former type of townsfolk...

  53. See my Blog on the Labour of Value

    For anyone who is interested, please see my post on my blog on why the Labour of Value is wrong:

    A sample:

    It seems to me that Cynicus Economicus has confused factors of production (or factor inputs) with value.

    It is undoubtedly true that labour is a fundamental factor of production for many goods, most notably manufactured goods.

    However, it is simply not true that it is the only factor of production: there are 3 recognized factors of production:

    (1) natural resources, including land, raw materials, water, and energy.
    (2) labour,
    (3) capital goods, and
    (4) entrepreneurship.

    Factors of production are the inputs that are combined and used to transform things into goods and services. Labour is undoubtedly a major input, and capital goods and entrepreneurship also depend on human labour to a great extent.

    But natural resources, factor (1) above, do not always depend on human labour. It is easily demonstrated that labour is not the only important input into production: for example, when farmers grow crops, there are fundamental natural inputs (soil, rain, sunlight) without which production could not occur.

  54. Lord Keynes:

    Sunlight soil etc. This is no different from the idea that the pearl was shaped by non-human hands or the 'valueless' rock you mentioned earlier being shaped by geological forces.

    In all cases, the same arguments as those already outlined apply. In the case of the rock, it will achieve value through being turned into a wall through labour. In the case of the pearl it is the difficulty of finding and recovery that gives its value (labour). I am not confusing input factors with value. I am simply pointing out that labour is required to turn input factors into value in economic terms.

    In all cases, I am talking about value in economic terms. Thus the example of a 'kind word from a wife'. This has a subjective value to the recipient, but would require, for example, the person to use his labour to turn the kind words into the words into a play or song to have economic value. Without such an input, in economic terms, the words have no value.

    The introduction of a suggestion that I am confusing factors of production with value is a red herring. Until a person takes the products of the soil etc. and does something with them, they have no value. For example, woodlands are filled with edible mushrooms which are never picked.

    They may have a potential value of £50 per kilo, but unless they are found and picked and presented for exchange, they only have potential value. Without being picked, how might they have value in economic terms?

    I will leave this debate here. The debate has simply served to distract attention from the ideas which have been outlined in the original post, which is disappointing.

  55. Mark, yes, I think the berries debate was just too easy a thing to latch onto and argue about while we digested the main substance of your piece.

    Having read it once a few days ago, the thing I'm not sure about is how Adam Smith's Invisible Hand fits into this. How is it that the Invisible Hand doesn't already circumvent the deficiencies in the current flawed bubble-prone system? Isn't the idea that the market always finds a way around any difficulty, and tends towards the optimum solution for society's benefit? Why, then, doesn't it effectively introduce its own methods for suppressing bubbles spontaneously? The fact that it doesn't, suggests to me that the free markets don't always provide the optimum solution as you believe.

  56. Lemming:

    An interesting point. However, if there is a flaw in the way that all economic activity is stored and represented, then the potential for markets not to work effectively will be greater.

    I accept that markets are not perfect, which is why I accept that there will always be manias. Even a less imperfect representation of economies and economic activity will not entirely fix the human based imperfections in a human system.

    Markets will always be imperfect in that they are subject to irrational subjective evaluations. No system can entirely remove this, but the effects might be ameliorated.

    The invisible hand of markets is therefore imperfect, but perhaps less imperfect than alternatives. The aim is to make it less imperfect whilst accepting that it can never achieve perfection.

  57. I see what you are saying. But turning it around, if we did impose a fixed fiat currency system and this didn't fit with people's tendency towards manias, wouldn't the markets perhaps find a way of circumventing that, introducing its own 'unofficial' inflatable currency somehow? As usual, I haven't thought it through fully, but I imagine that keeping the markets' more creative elements in check might involve a lot of heavy-handed regulation - which I know you are not keen on.

  58. I've just realised that I may be forgetting one of the fundamental sections of the article: IOU money. I will go back and re-read it.

  59. I believe the examples and indeed the idea of labour units of value to somewhat too simplistic and only applicable to totally agrarian pre-oil economies.

    True values should measure labour plus its reward in its efficacy in providing energy, all of which (save nuclear) is given by sunlight or stored sunlight (coal and oil). That then adds the complicaton of energy ratio (see not to mention peak oil which references are too numerous to mention.

    There is no doubt in my mind that with the continually exploding world population and declining resources, discussions about financial models need to encompass these issues or the result will be disaster and nobody will even be thinking about stability of markets.

  60. Yes, point taken: I apologize for distracting attention from the highly original and important substance of the post, which is the idea of a fixed fiat currency and how it would work.

    This is a very impressive and original contribution to the theory of money, and is (to my knowledge) not discussed or even proposed in mainstream economics.

    I accept that steady deflation in a booming economy might have advantages, and that the value of money would probably increase rather than decrease in such a system.

  61. I do encourage other interested people to debate the topic of the labour theory of value here:

    I have added an appendix in the comments section.

  62. I am under the impression that our current non-fixed fiat system is structurally dependent on growth - although I have not yet found anyone who can confirm this. Would the fixed fiat system rely on growth for stability?

    Could the new system work well in a state of permanent recession due to the global oil supply declining, say? (Or is asking free market economists about permanent recession like asking about what it's like to live in another dimension i.e. impossible to imagine?!)

  63. Lemming:

    The system will work under all conditions, as it only seeks to represent the economy, not alter it. I am still working on the idea (refining it for academic economics), and there are very limited problems with the system due to the representational nature of the money. If oil went into decline, there would be a move from steady deflation to steady inflation until such time as a replacement for oil was introduced.

    Oil is an interesting example, due to its centrality in modern economies. I am not sure any other factor might cause a steady inflationary effect, excepting massive but steady demographic change.

    Under the current system, they have no solution to this kind of problem, and would seek to remove the inflation through interest rate rises. As if that would create more oil.....


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