What a Free Lunch Looks Like in a Barter System

This is the third part of a collection of pieces on money and debt.  Be sure to read the first part, The Meaning of Money, and the second part, Money: Power, Security, and Status.

The best way to understand the costs–or risks–of continually financing large portions of public expenditures with newly-created, i.e., “printed” money, is by removing “money” from the equation altogether, and tracking the concept instead.  In this piece, we will analyze a fictional economy that conducts the same print-and-spend activity without there being an actual printing press, or any referential money of any kind.  We will explore what such an economy looks like, and how it functions.

Suppose, then, that we live in an economy in which there is no money, just people with time and labor to trade among each other.  Though each person in this economy has unique, specialized abilities, we will assume that, with a few exceptions, these abilities add the same value, and that the time and labor of every healthy adult in the economy is therefore worth a similar amount, in real terms.  This assumption is not true in a real economy, but we are positing it in our hypothetical economy to simplify.

You are sick.  I am a doctor, so I give you treatment–it takes an hour of my time.  In exchange, you provide me with a steak that you grilled up–it took an hour of your time.  Alternatively, if Jim is sick, I provide him with the treatment, and he gives me the steak that you provided him in exchange for his having cleaned your house–which took an hour of his time.  An incredibly inefficient system, no doubt, but one that effectively conveys the tangibles that are traded through money in a real economy.

Because there is no money, individuals in our barter system have to use promises to coordinate reciprocation across different time periods.  During the time that I am treating your sickness, you will not be able to grill a steak for me.  All that you will be able to do is promise to grill one for me later, when I tell you that I’m hungry.  So you make that promise to me, and I treat your sickness.  Later, I tell you that I’m ready for the steak, and you prepare it.

There is an interesting analogy between promises used in this barter system, and money and debt used in a monetary system.  Money would be analogous to the promise: “I will grill a steak for you, at any time, on your request.”  You can “spend” that promise, i.e., demand redemption on it, any time you want.  You don’t have to wait for anything.  Debt, in contrast, is analogous to the promise: “I will grill a steak for you, on your request… but not until some period of time has passed.”  You cannot “spend” the promise, i.e., demand redemption on it, until the term expires.

Obviously, when a person promises a good or service later in exchange for a good or service now, the provider of the good or service needs to make sure that the promise can be fulfilled.  Otherwise, a “default” will turn his contribution into charity–time and labor given away for free–which he is obviously not interested in.

Now, suppose that we have a bum who is ill.  He needs help, but he is too weak and mentally deranged to reciprocate help.  Granted, if he is left on the street as a spectacle, he will get public sympathy–those that see him suffering won’t like what they see, and will want to help him, even if for free.  But they aren’t necessarily capable of helping him, and even if they were, the help would represent too much charity, too much uncompensated sacrifice, to ask of a small group of people simply because nature happened to thrust them into his world.     

Because we feel a natural empathy for the bum, we band together as a society, as a collective, and make a deal with the doctor.  If he provides services for the bum, out of his time and labor, we will collectively reciprocate.  We will each give him a small piece of our time and labor, to do something that he needs done.  Right now, he is working on building a house and wants help–so we will increase the total number of hours we work each day, with the balance going to help him on that project.

We can think of this action as a kind of crude, bartered version of redistribution through taxation–a charitable obligation that is collectively fulfilled and enforced.  We part with a portion of what we have–our time and labor–and give it to those that need it, through the doctor, who we collectively compensate.

Now, we might ask, in this barter system, what would public borrowing, as opposed to taxation, look like?  It would look like this: instead of offering our time and labor to the doctor now, we would promise, as a group, to provide him with some amount of our time and labor on a date he specifies in the future–to build the house, or to do whatever else he happens to want.

The promise we make, and its mirror image, the claim that the doctor receives on us, could be executable on demand, in which case it would be analogous to newly “printed” money in a monetary system.  Alternatively, it could be executable only after some period of time, in which case it would be analogous to debt in a monetary system.

Now, suppose that we decide that we want to live in a society where doctors perform a lot of compensated public charity–charity for the poor, the sick, the disabled, the elderly, everyone in need.  But, as a collective, we don’t want to have to part with our time and labor, to compensate the doctors for their efforts.  Can we escape the burden?

The answer is yes, with an important caveat.  If the doctors want to have claims on our time and labor not for the purpose of actually exercising them, but for the intangible value–the power, security and status–that having those claims bringsthen we can make promises endlessly.  The doctors will be performing uncompensated charity, free labor, without even knowing it.  They will be doing work for others that will never be reciprocated.  Or rather, the reciprocation will take the form of the comfortable thoughts, feelings, and states of mind that come with knowing that one has power, security, and status.  Because no actual redemptions need to be made, there is an infinite supply of the promises that can be given.

Unfortunately, we cannot be sure that the doctors won’t ever want to exercise the claims or demand redemptions on the promises.  Maybe they won’t want to exericse them now, but that doesn’t mean that they will never want to exercise them, or that the promises won’t slowly leak out of their hands, into the hands of those who will want to exercise them.

Suppose, then, that in the future, the doctors decide that they want to exercise them.  They identify a need, and tell us to do work to satisfy it.  We will either have the free time and labor to do that work, and, equally importantly, be willing to provide it, or we won’t.  If we will have the free time and labor, then we will provide it, and this will be our act of reciprocation, of “paying” for the services that were never intended to be provided for free.  If we won’t, for example, because we’ve made the same commitments to other people, who also want to exercise claims on our time and labor, or because we’ve made commitments to our own leisure–and aren’t willing to do the work right now–then we will need to utilize interest.

We have these claims on our time and labor that we’ve created and given away.  More of them are being executed than we have room to support, and so we need to find someone with a claim who is willing to refrain from exercising it.  The way that we do that is the same way that an airline finds people to get off of an overbooked flight,

“Unfortunately, this flight is overbooked, and we are actively looking for people to take the next flight.  Please, if you are willing to give up your seat, we will give you a free future flight to any city in the country.”

This is the same thing that happens with interest: we offer to give claimants more future claims if they agree, for some period of time, to not execute the claims they currently have, claims that we don’t have the present ability to make good on.

Notice that in a monetary system, this problem can be resolved through inflation.  We stand back and let all of the people to whom we’ve made promises exercise their claims, spend their money, or deploy it into non-money investments.  The economy doesn’t have the capacity to fulfill all of these claims, receive all of this spending, support all of this investment, so prices rise.  Whoever holds money during the rise–and someone must, because not everyone can win the bid–becomes the sucker who loses out, whose claims are automatically reduced by an adjustment of the monetary index itself.

But notice that this can’t happen in a barter system, because there is no money!  The collective is trapped, there is no self-created currency that it can inflate to escape from its prior commitments.  Thus, if the claimants want to exercise their claims, even though the spare capacity to meet those claims does not exist, the collective must either explicitly default on the claims, or offer to pay sufficient interest to motivate claimants to postpone their exercise.  The collective has to become American Airlines, and promise future flights to whoever agrees to get off of the currently overloaded plane.

Now, when we, the collective, use interest to postpone the exercise of claims that want to be exercised, we don’t really escape from the burden they entail.  We still have to give our time and labor to those to whom it is owed.  The interest simply allows us to push the obligations off.  Unfortunately, the interest also grows the obligations.

If our productive capacity is growing faster than the interest payments that we will have to offer–now and in the future–to keep the overflowing commitments that we have made from being exercised, or even better, if the services that we wish to fund through those promises will directly increase our productive capacity, our ability to redeem promises, it makes sense to use interest to delay the reciprocation.  But if we are funding unproductive charity, then using promises and interest to postpone the reciprocation would not be the right choice, especially in a barter system where we cannot use inflation as a way of extracting work from people (i.e., the holders of money who lose parts of their wealth to it).

Let’s conclude with some monetary insights from this barter example.  The problem is this.  When we fund government expenditures–such as healthcare–with newly created money, the person that we pay with the money–the doctor–is doing for work for someone else–the patient.  But no one–not the patient, and not the collective, i.e., the taxpayer–is doing any work for the doctor in reciprocation.  It seems, then, that the doctor is doing work for free.  But, if you ask the doctor, he will insist that he is not doing work for free.  He is running a business, not a charity.  So what gives?

Trivially, over a given segment of time, an economy will only have the capacity–the labor base, the real resources–to absorb some finite quantity of claims placed upon it, some  specific amount of money spent.  When new money is created and paid to people for the work they do, there are three possibilities.

(1) The economy’s capacity might grow commensurately with the creation of the new money, allowing the new money to be spent without inflation (assuming all else is held constant).

(2) A sufficient number of people might want the money not to spend or invest it, but to have it, to hold it–for its psychological value.  In that case, their saving of the money will cause it disappear from the economy.  There will be no inflation.

(3) The money might be spent in a situation where the economy does not have the capacity to absorb the spending, in which case there will be inflation.

Now, many fiscal expansionists appeal to (2) as a reason why US policymakers should undertake a large money-financed spending effort right now.  They point out that the economy is in a slump.  People want to have money just to have it–they don’t want to spend it, and they don’t want to invest it.  Therefore, new money can be created in excess of the economy’s capacity to absorb the spending of it.  No inflation will occur because it won’t be spent.  A genuine free lunch is available, and policymakers are stupidly declining it.

The problem of course is that the economy is cyclic.  It’s not enough to say that the newly created money will not be spent or invested now.  To be a free lunch, the money needs to never be spent or invested.  In fairness, it may never be.  According to many, the US and the western world face significant future stagnation as populations age.  Presumably, this will create significant demand for idle monetary savings.  But such a gloomy outlook is hardly guaranteed–it is certainly possible that the cycle of animal spirits, which leads people to prefer to spend and invest their money, rather than hold it cautiously and idly, will return again some day.  If the economy has not grown enough to absorb the plethora of new claims that will come out of the woodwork and be placed upon it at that time, then either interest will have to be paid to keep those claims on the sidelines, or there will be an inflation problem.

What if the cycle is not dead, and does return?  Again, interest will have to be paid to the holders of money to keep them holding it–because there is not enough room for everyone to be spending or investing it, given the amount that has been created.  Put differently, the central bank will have to raise interest rates to discourage people from spending or investing their money (and also from borrowing the idle money of others).  Given the huge stock of money and debt that will have been built up by then, the cost of those interest payments will be quite expensive.  Unless it is financed with even more money printing (which will obviously be inflationary), it will require a large tax increase.  Note that this tax increase is just the “pushing out”–in one big move–of the tax increases that did not occur now to fund the needed stimulatory expenditures.  So unless we can be sure that circumstances will arise that will cause the excess of printed money to never ever be put to use, the free lunch is not really free.

The problem with a big tax increase later, forced by ballooning interest obligations, is that it shocks the economy.  It’s always better for growth, and for prosperity, to change things in an economy gradually, rather than all at once, in an emergency.  This is why, even though the level of expected future savings demand makes room for deficit spending right now without a risk of inflation in the future, the Democratic platform of reducing some of the deficit via tax increases on the wealthy–those who, for various reasons, are amassing large amounts of excess money that they are not spending or investing in labor, the taxation of which will not hurt the economy–makes economic sense, and is better for the economy’s long-term health.  If or when the cycle does turn, the money collected now will represent money that will not need to be paid interest to, and that will not need to be taxed to pay for.

Note that the reduction in wealth inequality that would come from a progressive tax increase of this sort is just an added benefit.  If my having a lot of money brings me security and status in my social universe, that shouldn’t be a problem for you.  Why should you care?  But things are different when we talk about the other intangible that money offers–power.  There are very good reasons why you might not want me to accumulate extreme amounts of power.  Therefore, there are very good reasons why you might not want me to accumulate extreme amounts of money.  That money is power over the economy, over it’s resources, over it’s people, and ultimately, over you, because you, like everyone else, are a slave to it.

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