John Locke- Quantity Theory of Money

happy senior businessman counting money while sitting at table with laptop
Photo by Andrea Piacquadio on Pexels.com

 

 

One of the age-old questions in the field of economics is whether or not money is neutral.  In other words, the introduction of new money into the economy only has a nominal impact [1]. It only raises prices and does not impact variables on employment or output (Cecchetti, P.1) [2]. The lack of influence of an increase in the amount of money on the aggregate economy is a core assumption of the Quantity Theory of Money.  An economic theory that was exposited by no other than John Locke. Locke is renowned for his moral philosophy and political theory often is overlooked in terms of his early contributions to economics.

 

In a broad application, the theory simply entails that the quantity of money is the key factor in the “changes in purchasing power” (Humphery, 1974, P.1) [3]. The theory stipulates that introducing new money will decrease the value of the currency resulting in higher prices (Humphery, 1974, P.1) [4]. This observation pertaining to alterations in purchasing power is generally widely accepted.

M= Stock of Money

P= Price Level (Humphery, 1974, P. 1) [5].

 

Locke explicitly detailed back in 1691 that the Price Level (P) is “always proportional” to the stock of money (M) (Humphery. 1974, P.4) [6].  Locke’s assumption the effects of introducing new money may have considered its impact on prices. However, it also assumes even that the changes in prices throughout the economy would be uniform. It is reasonable to question whether this assumption falls into the same folly that many other economic models suffer from. That is the gulf between theory and actual application. Wouldn’t it be possible for some actors in the economy to have access to the new money prior to the rise in prices?  Shouldn’t be also be considered that how the money is distributed could only magnify such potential effects? Whether due to the mechanism of distribution or institutional advantages.

….The mistake of this plausible way of Reasoning will be easily discovered, when we consider that the measure of the value of money, in proportion to anything purchasable by it, is the quantity of the ready Money we have, in comparison with the quantity of that thing and its Vent; or which amounts to the same thing, The price of any commodity rises or falls, by the proportion of the number of Buyers and Sellers; This rule holds Universally in all Things that are to be bought and Sold, bateing now and then an extravagant Phancy of some particular Person, which never amounts to so considerable a part of Trade as to make anything in the account worthy to be thought an exceprion to this Rule.  (Locke, 1691, P. 16) [7].

 

Locke may have been a brilliant thinker and the grandfather of liberalism, that does not make him above reproach.  The likes of David Hume and Richard Cantillon expressed disagreements with the assumptions of Locke.  Hume’s postulations are so similar to those of Cantillon that some have levied accusations of plagiarism (Bilo, 2015, P.4) [8]. I will provide no further commentary on that claim. Both Hume and Cantillon did not see the role of money in the economy as being neutral. It can be argued that this is not a realistic view of the function of money. Cantillon suggests that the point of injection of new money and the velocity of circulation plays a role in its impact (Thorton, 2006, P.4) [9]. A point that is clearly neglected in Locke’s account of the role of newly introduced currency. If money was neutral how additional quantities are introduced would not matter.

 

Both Hume and Cantillon noticed other factors that clearly demonstrated the nonneutral nature of money. Which include the following:

(1) the lag of money wages behind prices which temporarily reduces real wages, thereby encouraging increased demand for labor ; (2) the stimulus to output occasioned by inflation-induced reductions in real debt burdens which shift real income from unproductive creditor-rentiers to the productive debtor- entrepreneurs ; (3) so-called “forced-saving” effects, i.e., changes in the fraction of the economy’s resources diverted from consumption into capital formation owing to price-induced redistributions of income among socio-economic classes having different propensities to save and invest; and (4) the stimulus to investment spending imparted by a temporary reduction in the loan rate of interest below the profit rate on real capital. (Humphery. 1974, P.4) [10].

 

All of the listed observations are clearly distortions caused by the unequal distribution of new money throughout the economy. Those who have access to the new money first reap the advantage of the lower prices. As the reverberations of the new money have not echoed throughout the economy. In other words, prices have not increased to reflect the depreciation in the value of the currency. If the new money is introduced through highly centralized institutions this discrepancy will be quite salient. Versus being more evenly distributed. Those with early access to the new money will spend it prior to the rise in prices.  Such consequences being indicative of Cantillon’s eponymous theory the Cantillon Effect.

 

It is possible that Locke may have potentially oversimplified the more intricate impact that introducing more money has on the economy.  However, empirical research has not always yield findings congenial to Cantillon’s finding (Wagner & Daley, 2004, P. 8) [11]. Veteran economists Richard Wagner and Steven Daley suggest that “…comparative statics of monetary or macro aggregates.. “are inappropriate for studying Cantillon Effects. Rather we should focus on the “… structural composition of economic activity..” (Wagner & Daley, 2004. P.17) [12]. Despite my paucity of economic credentials, I would wholeheartedly agree. Locke’s Quantity Theory of Money lacks an acknowledgment of how money is circulated. If new money is distributed unevenly the adverse ramifications of inflation will be felt differently.

 

 

 

 

 

Gresham’s Law Explained

 

pexels-photo-3943748.jpeg
Photo by cottonbro on Pexels.com

 

Much like the physical sciences, economics has immutable laws. The Law of Supply and Demand is equally as well known as Newton’s Law of Gravity. In this essay, I will expound upon an economic law that is not as well known to the general public. Arguably, it is just as important as the Law of Supply and Demand. That is Gresham’s Law. Have you ever wonder why people invest in gold or tend to hang on to their cryptocurrency? Outside of legal constraints and vendors opting not accepting such mediums of exchange, Gresham’s Law provides some insight.

 

Colloquially Gresham’s Law has been oversimplified to being defined as “bad” money drives out “good” money. Essentially the introduction of “bad” money will replace “good” money in circulation. It is important to clarify what is meant by “good” and “bad” money.  Bad money is a currency that has a higher nominal value than intrinsic value, making it overvalued (Sparavigna, 2014, P.1) [1]. Vice versa is true of “good” money or undervalued currency. Gresham’s law does not come into effect until legal-tender laws designate that both varieties of money have the same exchange value (Sparavigna, 2014, P.1) [2]. The undervalued currency tends to exit circulation in one of two ways. People either start to hoard the undervalued money (Sparavigna, 2014, P.3) [3]. The undervalued currency leaves circulation through exportation. In the case of monetary metals, the coins are melted down and the bullion is sold abroad (Fetter, 1922, P.46)[4].

 

The general premise behind Gresham’s Law predates its namesake. Tudor-era financier Sir Thomas Gresham. One of the earliest recorded observations of what became known as Gresham’s Law dates back to ancient Greece. In Aristophane’s play  The Frogs a parallel is drawn between the substitution of gold coins for copper coins and the declining quality in politicians (Sullivan, 2005, P.5) [5]. In the 1300s King Charles, the Fifth of France enlisted the help Nicole Oresme to resolve the economic instability caused by the fluctuation in the value of the French coinage. Oresme made the observation that when two coins present having the same face value but different intrinsic value, the higher value coin leaves circulation. The coins of a higher metal content were melted down and the bullion was sold abroad. Oresme believed that government-sanctioned monetary laws should prevent currency debasement (Sparavigna, 2014, P.6) [6].

 

Another theorist who posited a nascent form of Gresham’s Law was no other than Copernicus. He perceived money as ultimately as an estimated indicator of value. If the value was artificially manipulated would cause disruptions in the market (Sparavigna, 2014, P.7) [7]. Copernicus suggested from a policy standpoint that any new money introduced into circulation should be of the same nominal and intrinsic value as the old money. If not the old currency will move out of circulation (Sparavigna, 2014, P.7) [8].  Then there was Sir Thomas Gresham whom this economic law is named after. In 1858,  Henry Dunning Macleod officially named this economic phenomenon after Gresham (Sparavigna, 2014, P.1) [9]. Gresham famously wrote a letter to Queen Elizabeth concerning how reducing the weight of minted coinage encouraged the export of the older coins. Despite popular misconception and clumsy interpretation of Gresham’s letter, there was a stipulation. Good doesn’t necessarily drive out bad. Bad money will remain in circulation providing that the “baser” coins are produced in limited quantity and do not exceed “trade needs” (Sparavigna, 2014, P.9) [10].

 

The misapplication of Gresham’s Law due to careless interpretation has lead to many faulty claims. Attempts to invalidate the law or restructure its conditions have been predicated on such flimsy grounds (Selgin, 2003) [11]. American economist Frank Fetter reinforces Gresham’s stipulation in his 1922 book Modern Economic Problems:

 

The law applies only under certain conditions and within certain limitations. The “ good” will be driven out only if the total amount of money in circulation is in excess of what would be needed if all were of full weight and of the best quality. Paradoxically speaking, if there is not too much money altogether, the bad money is just as good as the good money. But, even if good money is driven out, it may not leave the Country. It may behoarded, or be picked out by banks and savings institutions to retain as their reserves or be melted for use in the arts. (Fetter, 1922, P.42-43) [12].

Making it crucial to properly interpret the conditions under which Gresham’s Law holds. Good money drives out bad money is a far too rudimentary presentation of this economic law.

 

One novel interpretation of Gresham’s Law came from the grandfather of Anarcho-capitalism himself, Murray Rothbard. He stated that Gresham’s Law could not happen in a purely free market. That govenment intervention would be necessary to artificially overvalue one currency and then undervalue another other. That retaining full redemption value of even worn coins versus intentionally debased coins only takes place due to government decree. Valuing a new coin and worn coin at the same nominal value operated as a form of “imposed price control” (Rothnard, 1980, P.19) [13]. Due to the fact that the government is setting a firm pricing floor and ceiling for the value of the worn coins. When by the pure monetary weight they have lost value.

 

Gresham’s Law certainly is an underappreciated economic law.  Generally only acknowledged by monetary economists, gold enthusiasts, cryptocurrency enthusiasts, and proponents of the Austrian School of Economics. To really put it into context please consider the following example. An American Silver Dollar or Silver Eagle has a face value of $1.00. A 2020 edition of the U.S. Silver Dollar retails between $20.00-$25.00 [14]. Which is substantially larger than its nominal value. This is why Silver Dollars are held and sold by collectors rather than used to buy a Big Gulp at the local 7-11 convenience store. Current Silver Dollars are approximately 99.9 % pure silver, 1 ounce by weight. The price of silver today (3/31/20) is $14.29 per ounce [15].

 

 

 

 

 

 

Credential Inflation: Is College Worth It?

 

accomplishment ceremony education graduation
Photo by Pixabay on Pexels.com

 

 

As a society, we invest in many things. We invested in promising startups. We invest time in our community through charity. We even invest in ourselves. Which explains the plethora of fad diets and gym members we have to choose from in America. Americans also invest in human capital. Mainly through acquiring college degrees. Does a bachelor’s degree look impressive when nearly half of all Millennials have one? [1].

 

Investing in a college degree is certainly a costly endeavor. The typical college student who graduated in 2017 owed on average $28,650 in loans [2]. The assumption being that the student is going into debt to purchase a degree that will be the golden ticket to a good salary. Unfortunately, this is a somewhat faulty assumption. The significant numbers of college graduates are underemployed [3]. In 2008, it was estimated that 17 million college graduates employed in jobs that did not require a college degree (Vedder, 2012, P. 8) [4]. Notably, examples of underemployment being 29 % of flight attendants, 17 % of hotel clerks, and 23.5 % of amusement park attendants hold 4-year degrees (Vedder, 2012, P. 8) [5]. There is nothing wrong with any of the listed occupations. Is it wise to go into debt to take a job that requires no more than a high school diploma?

 

Underemployment is a key fixture of what has been credential inflation. Similar to monetary inflation is the depreciation of requisite education for a specific job. In a fiat system of currency when we print more money the purchasing power of our currency decreases. Likewise, flooding the job market with applicants possessing  4-year degrees diminishes the “purchasing power” of this previously advantageous form of human capital. The law of diminishing returns applies to education and the underemployment of college graduates being symptomatic of over-investment (Vedder, 2016, P.3) [6]. That’s why expanding college education universally will only compound the issue. The prevalence of college degrees has deduced this level of educational attainment to a bare-bones requirement. Putting into question the value of investing in a bachelor’s degree.

 

To really illustrate the dramatic increase in college obtainment it is important note when World War II started less than 5 % of adults had a degree (Bankston, 2011, P.3) [7]. Truly making a college degree a prestigious achievement. Part of what has driven the dramatic influx in college attendance has been government subsidies. For example, the Pell Grant established in 1972 to provide funding for low income students to attend college. Which ended up providing assistance to 5,428,000 students in the 2007-2008 academic year (Bankston, 2011, P.11) [8]. Outside of grants loans and other forms of financial aide have also contributed to the sizable increase in college attendance. It should also be noted that societal pressure also come into play. Your parents, teachers, society, and even politicians urging you to go to college.

 

Some would argue that there is  a two-sided debasement of the college degree. Not only is there any increased quantity, but a decrease in the quality. Some experts believe that the college curriculum has been “dumbed down” (Bankston, 2011, P.20) [9]. Which I personally find to be difficult to empirically determine. We are making a qualitative statement that can be swayed by perception. Standardize testing results perhaps? SAT scores for math have improved since 1966-67 school year, however, reading scores have been on the decline (Bankston, 2011, P.20) [10]. Is college admissions testing specific enough of a criterion to assess curriculum quality? I believe that is an open question. It is fair to question the conviction of current college students. The typical college student spends 900-400 hours a year on school related activities (studying, class attendance, etc.). In contrast the average full-time employee spends 1,800 to 2,000 hours annually (Vedder, 2012, P. 5)[11]. This may not necessarily measure the same variable. However, it does put into question strongly encouraging young people to attend college. If their priorities are video games, beer-pong, and dating then maybe it might not be the strongest option.

 

It is it really wise to be pushing recent High School graduates towards college? Considering odds are even with a college degree they will be underemployed. While away at college will spend more time hitting the beer-pong table than the library. Not too mention the cost. There was a 32.4% increase in the cost of college from 2001-2011 (Lemke & Shughart II, 2016, P.1) [12].The costs are only going to continue to rise. I would suggest that perspective students judicially choose their majors for what will have the biggest return in the job market.  Otherwise your decision will be a prime example of malinvestment. You will end up with massive student loans making 13.00/hr at a call center. However, computer science, applied mathematics, healthcare, and engineering  (P. 12) are “safer” bets than a philosophy degree.

 

Fortunately companies such as Google are not weight college degrees as heavily in the process of job candidate selection. Which is a shrewd move considering the number of programming certificates that exist. In all honest maybe more beneficial than a degree.  Even some grants now are predicated on the contingency that the recipient does not attend college. Example being the Thiel Fellowship. Shifting away from the college degree signaling model discussed by economists such as Bryan Caplan [13].

 

I have been personally impacted by credential inflation and have been lucky enough to rebound from underemployment. I was urged by my mother to attend college. I wasn’t too keen on it , so I decided to get my core requirements satisfied at a Community College. Due to my academic achievement at Community College I received a break on my tuition when I transferred to a 4-year institution. Luckily, I got my partying days out of the way in High School. Graduated Summa Cum Laude from University and was then in the massive expanse known as the job market. Armed with a mere Bachelor’s of Science in Psychology, needless to say I didn’t fare too well. Ended up working as a janitor at a casino. Thankfully, due to my strategic planning I graduated with virtually no debt. Then ended up working several office jobs. Typically, corporate offices prefer candidates with college degrees. Which is gratuitous because there is nothing about the job that makes inherently necessary to hold a college degree.