I have in front of me a 50 euro note.  When you draw money out of a French hole in the wall, you are almost invariably given one of these.  Using it to buy anything is slightly embarrassing, as the amount of change you will normally receive will be significant.  I wouldnít usually expect to buy anything at a price even close to that amount with cash. Indeed, if you draw any money from an English ATM, the biggest note you will receive is £20.  Iím not sure that Iíve ever handled a £50 note and if I tried to use one in a shop, I would be looked at with suspicion; they have a reputation for being fakes and used only by drug dealers.

But what I was trying to do was to see what the 50 euro note actually says.  The information recorded on it is rather sparse. It says Ď50í and Ďeuroí and has its serial number. It also has the initials of the European Bank on it in 10 languages and the signature of Mario Draghi beneath the European flag.  But nothing else. The £20 note has similar information on it, and also pictures of the Queen and the artist Joseph Turner.  But it also famously goes on to say: ďI promise to pay the bearer on demand the sum of twenty poundsĒ

Reaching back into my distant past, I recognise the wording as being that of a promissory note. A bare promissory note; one not subject to any conditions, so that the payment due can be demanded at any time. All you have to do, as the bearer, is produce the note and ask. Which is comforting. Or perhaps not. Isnít the note already £20?  So what, other than yet another £20 note am I going to be paid with? Small change? Well itís possible, but I can go into a corner shop and get the value of the note paid to me in change Ė if I smile nicely at the shop-keeper. How about Gold? I rather doubt it. Maybe then twenty pounds of Sterling silver? After all, thatís where the pound Sterling comes from Ė a pound coin was a pound in weight of sterling silver. Not good for the pockets. But I doubt that there is enough silver in the world to redeem even a small percentage of all the notes in circulation. So best get in quickly, before everyone else realises the problem we have.

So then, what does it all mean? In terms of monetary theory, our currency and virtually all the others in the world are not backed by anything tangible of value. The gold standard was abandoned in 1971 by President Nixon when he decided that the dollar would no longer have an automatic conversion rate to gold at the rate of $35 dollars per ounce.  It meant that the he could sell off some of the gold in Fort Knox, rather than having it available in case someone turned up wanting to redeem their dollars. So then, the dollar and the rest of the unbacked currencies are free-floating. In the jargon, they are Ďfiatí currencies rather than Ďconvertibleí currencies and so their relative values depend upon the whims of the financial markets.  And, of course, if the markets really donít like a currency then it can go into free-fall and effectively end up as worthless. The post-war Weimar republic was an early example, with the Zimbabwean dollar coming a close second, used in a country so corrupt and badly governed that no-one had any confidence in the currency, and of course now we have Venezuela.

So why do we maintain the fiction of a promissory note? Because fiction it is - just try knocking on the door of the Bank of England.  Iím not at all sure that itís more than a piece of marketing designed to persuade us that the currency is strong, stronger than it is.  After all, itís a currency which has gone down in value against the Euro and Dollar very significantly over just the last few years following the Brexit debacle.  The question for now, however, is whether it will go down even further, granted the stalled trade talks between Number 10 and Brussels and the continuing effects on our economy of the Covid virus.  I would like to plead that, not being an investment banker, I cannot be expected to know. In fact, though, they are in no better position that the rest of us to see how things are likely to unfold. There is a statistical truth behind the pronouncements of experts when they pontificate without being able to know all the relevant facts. It is regression to the mean Ė in other words although an expert may by chance get it right once or twice, his performance will regress to the normal 50/50 chance result very quickly thereafter.

Brexiteers tell us that we can rely on the power of free trade to give us a blossoming economy at the end of this year.  Free trade is undoubtedly good, although often at its best when tempered with a little protectionism. Trading under WTO rules, however will inevitably bring with it tariffs, a lot of tariffs Ė high tariffs. The President of the World Trade Organisation has said this week that economically we will suffer significantly if thatís where we end up.  And it is this for which we are headed at the moment, with Boris showing no sign of being able to negotiate a trade agreement of any substance with the EU or with the USA in the time available. So not encouraging.  Maybe, though, he is a wonderful negotiator and has Monsieur Barnier over a barrel. 

But then we have the interrelationship of this with the economic effects of our friendly neighbourhood virus.  Of course, itís not just in our neighbourhood; the economic downturn itís bringing is worldwide. Certainly the volume of worldwide trade has diminished substantially and so we shall all be poorer as a consequence.  Itís just that as weíve been more badly affected by it than many other 1st world countries, we shall take longer to recover from the difficulties. Where we have done well is in the economic response to the situation, maintaining jobs as far as possible, with the state becoming the major provider of employment Ė in the sense of employing so many to sit at home for an extended period.

Itís here that Modern Monetary Theory comes into question.  As a country with its own non-convertible currency, we could follow MMT and print all the money we like. Or we could if we prefer borrow on the money markets what we need to keep things going.  Of course borrowing implies an obligation to repay and to pay interest on the outstanding balance in the meantime.  As noted before, the amount borrowed to compensate the middle and upper classes for their loss upon the abolition of the slave trade was only finally paid off in 2015. Most borrowing these days is by way of relatively short term bonds which have to be repaid either out of tax revenues or by other borrowings.  The danger with this is that the interest rates demanded for the replacement bonds may well rise above the current historically low levels. So then, why not just print the money?  And here we come back to the risk of high inflation. The proponents of MMT say that this can be damped down by increasing tax rates, so taking money out of the economy and thus preventing too much money chasing too few goods. Quite how popular that would prove to be at a time when, by definition, prices were going up is another question.

So we would risk punitive future interest rates if we took out huge loans to boost our economy and risk inflation if we printed money.  Having examined MMT a bit, I have to say it's like all the other economic theories. It's a theology, with experts discussing how many angels can dance on a pinhead. They leave the rest of us in an impossible situation because none of them can actually prove that their arguments are true. They can only assert that they're right. Human behaviour is too unpredictable and the matrix of facts is too complex for one theory to be obviously right and the other wrong. And the possibility of doing a double-blind experiment to find out which one is actually right is a bit surreal. So, it's a matter of faith, or perhaps political fashion. We'll have to see what our political masters decide to do, all led by that great journalist and master tactician, BoJ.

Paul Buckingham

16 June 2020

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