Robin Hood In Glassland

In the middle ages when Robin Hood lived (according to legend), glass windows were incredibly valuable and only the elites could afford them.  The rareness of glass must have made stained-glass cathedral windows look miraculously heavenly.  Glass was still so rare in the early 1700s, that wealthy Americans could rarely afford much in the way of glass windows.  At the time, stained glass exemplified the state of the art of glass technology and ironically are partly explained by the technological limitations of the era.  Glass panes were impossible to make smooth, clear and large anyhow, so glaziers might as well dope their off-color glass with extra color and piece the little panes together into big stained glass windows.  Glass was still so valuable in the 1800s that it was still being used as money in some parts of the world.

If gold and silver had been as scarce as diamonds in Robin Hood’s England, it is conceivable that ordinary people would have used glass as money like they did elsewhere in the world.  If glass were used as money, the parable of Robin Hood Breaking Windows would explain Keynesian economics even more clearly.  Suppose the Sheriff was hoarding panes of glass rather than gold and silver, then even if Robin Hood could not directly steal the glass from the castle, he could indirectly ‘steal’ some of the Sheriff’s glass and give it to the poor by breaking the Sheriff’s windows.  The Sheriff would have to pay peasants some glass to put them to work replacing his windows.

In a commodity money economy like this, it is clearer how the Keynesian hoarding theory works than in a paper-money economy like today.  For example, imagine a society using weights of iron as its money.   A recession happens when people start hoarding money (and rich elites have the most to hoard).  Because they are hoarding a commodity money, it is clear that money hoarders are hurting the economy because they are hoarding iron.  Iron is useful and hoarded iron is unproductive.  Other people cannot work if they don’t have enough iron to make tools and work.  That is wasteful!  In an economic expansion, the invisible hand of finance would direct the iron hoarders to loan some of their unemployed iron to unemployed workers so that they can make more plows and pots and make everyone richer.   In capitalism, it is flows of money that facilitate productive exchanges and induce people to make more plows and pots and it does not matter if the money is iron, paper or electronic.  But in a recession, the invisible hand of finance has a spasm and clamps too much of the money in unproductive hoards.

Keynesian fiscal and monetary policies are all about loosening the cramped hand of finance to get the hoarded money–and the productive resources that the money commands–back out in the economy to can get people working again.  Economics needs to expand its vocabulary to be able to explain recessions better.  We need to be able to distinguish between savings and hoardings.  When economists talk about ‘savings’ they usually mean lendings.  A dollar saved is usually really a dollar lent to someone else because when you put it into the bank, or other financial institution, the bank has borrowed the money from you and promised to pay it back, often with interest.  Saving is great for the economy when it increases capital investment and productivity.  Hoarding is when money is taken out of the economy and hoarded for oneself.  That is unproductive because nobody can use it.  During the Great Depression, many Americans hoarded their money by hiding it in mattresses or in buried jars because they understandably did not trust the banks to pay back their savings.  Today is different, but the effect is the same.  The Great Recession of 2008 was caused in part by banks hoarding money as excess reserves that sit unproductively at the Fed, but it has the same effect as if people were hoarding their money in their mattresses.

Another place Americans have been hoarding their money during the Great Recession is in government bonds.  A government bond is normally a form of savings because it is a way to lend money to the government.  But It is impossible to call it ‘lending’ to the government when government bonds pay a negative real interest rate.  Real lending involves taking a risk and thereby earning a positive real interest rate.  Private sector loans almost always pay a positive real interest rate, even when the government borrows for a negative rate.  If a business in a competitive market could borrow money for a negative real interest rate, it would have to do anything it could to expand.  That is because loans are free and if you don’t use free money to expand, your competitor will expand at your expense.  The government doesn’t work that way.  It does not spend and invest more money simply because private individuals are willing to pay the government to keep their hoards.  Unfortunately, there are currently many private business like Apple that are run by executives with so little imagination and so little competition that they are hoarding billions of dollars at negative real interest rates rather than spending it on something productive.

Any money that is kept as a store of value rather than as a medium of exchange is being hoarded rather than saved.*  Money, as it is defined in economics, should be saved and not used as a store of value (hoarded) or else the economy goes into a recession.  Interest rates define the difference between savings and  hoardings.  Any financial asset that is being lent at a zero nominal interest rate is being hoarded because it is the same interest rate as money.  And money that is saved at a nominal interest that is less than the expected inflation rate is being hoarded because negative real interest rate signals that the savings are achieving zero productivity.**  Because risk is proportional to return, a negative expected return signals the low risk tolerance of a hoarder.  Similarly, any for-profit business that keeps persistent balances zero real interest or less (above the amount of cash needed to manage cash flow) is hoarding.  It is harder to use interest rates to determine when the median individual is hoarding because average people are often liquidity constrained, have higher transactions costs, and have little knowledge of how to invest at a positive real interest rate, but the same kind of logic would apply if we could actually measure the money stocks that individuals hold, but we cannot, so the true quantity of money that is being hoarded will always be unmeasurable.

Hoardings cease to be used as money for facilitating transactions.  Savings continue to facilitate exchange because savings are lent to a borrower, who has an incentive to spend the money because the borrower is paying a real interest rate for the use of the savings. That is why savings continue to circulate in the economy and hoardings don’t.  Savings = lendings are used to buy durable goods the yield a real stream of benefits and hoardings are where demand is simply sucked out of the economy altogether.

*Principles of economics teaches that money is useful for three purposes:  1) a medium of exchange,  2) a store of value, and 3) a unit of account.   This is true, but it should be emphasized that there is an inherent tension between the first two purposes because whenever money gets used as a store of value, it stops being used as a medium of exchange.   And that is what causes a recession.  Money used as a store of value is hoarding.  When money stops being used as a medium of exchange, that stops goods and services from being exchanged.  Savings are different than money because savings pay positive interest and money does not.  Savings should be used as a store of value, not money.  We also store value in durable consumption goods like housing and clothes that earn us value even if we never exchange (sell) them.  Money is different because it only produces value from exchange and is worthless if it isn’t exchanged for something that is directly useful to have.  Savings are a hybrid between money and durable consumption goods because savings are lent to people who use the money to buy things that earn them a value in use and then they pay the saver part of the use value in use in the form of an interest payment.  A positive real return on holding money is called deflation and deflation is particularly harmful because it encourages people to hoard more money.  The only way to keep deflation from creating hoarding is if the real return on investment for lending is high enough to keep the nominal interest rate from reaching zero.  Good monetary policy should strive to prevent deflation to reduce the tendency to use money as a store of value.  One of the reasons that recessions were so frequent under the gold standard was the fact that deflation was a regular recurrence whenever the price of gold (and therefore the value of money) increased.

**During deflationary periods (negative inflation), the interest-rate definition of hoarding is a bit different because hoarders get a positive real return by simply hoarding cash.  There is always a positive real return on hoardings during deflation which is why hoarding gets so bad during deflation.  During deflation, hoardings are balances that are expected to earn zero nominal interest.  If inflation is positive, hoardings are balances that expect to earn zero real return (or less) for at least six months.  Savings are balances that earn an income greater than hoardings without any turnover for at least six months.  Some balances that do not earn a real return are used for short-run transactions.  This is a transactional balance that turns over with cash flow.  That is neither part of savings nor hoardings because it is not intended to be used as a store of value, but as a medium of exchange.

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