back to article What is money? A rabid free marketeer puts his foot in lots of notes

Several of you have asked for the skinny on what money actually is. So, here's the full fat Worstall take on cold, hard cash. Answer: It's a way of keeping score. Who has the right to call upon the resources of others in that same society? And that, other than a couple of footnotes which we'll deal with overleaf, is pretty …

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  1. Mike Bell

    Moral dimension

    There's a big moral dimension to this. Why is it seen as a good thing to help out a handful of rich – and let's face it – reckless bankers by gifting them tens of billions of freshly minted pounds, with the hope that they'll pass it on in the form of loans to stimulate the economy? They clearly haven't done that. Instead they've said 'thanks very much'.

    And worse, that 97% of money you mention is more or less made on trees, conjured into existence by banks lending money that doesn't exist, even in their own coffers. The only way it can be sustained is for the money supply – and debt – to increase forever and a day.

    I never want to hear a politician talk about 'prudence' ever again.

    1. Tim Worstal

      Re: Moral dimension

      Umm, what was this gifting of tens of billions to bankers then?

      There's been three things done:

      1) Liqudity provision. During the crisis, banks were running short of readies (those lines at Northern Rock etc). So, the central bank issues as much money as anyone wants in return for a security. This is what a central bank is supposed to do. It's all been paid back plus interest. Yes, saved the banks and that's the purpose of it: but didn't make the banks money.

      2) Funding for Lending or some such scheme. Not been very successful as not that many people want to borrow money (rather our basic problem at present). BoE creates money, banks bid on it to be able to provide cheap lending to companies.

      3) What I think you're talking about, quantitative easing. This didn't go to the banks.

      Before QE the BoE had a few gilts. The banks had less than none (they were short). The pension and insurance companies had lots.

      Now, after QE, the banks have lots of gilts, the BoE has lots of gilts and the pension and insurance companies have many fewer. Thus the BoE didn't purchase the gilts from the banks. They bought them from the pension and insurance companies.

      Which was the aim all along. Buy enough gilts to drive up the price/down the yield, so those investors (note, not banks!) will move out along the risk curve in order to get yield. This lowers long term interest rates. And it has worked as designed.

      But QE was never about the banks and except for the actual dealing in them (done at margins of a basis point or two, 0.01% being one basis point) never did have anything to do with the banks.

      1. Dan 55 Silver badge
        Flame

        Re: Moral dimension

        What would have happened if NR were allowed to fold like any other business?

        1. Some other bank or other banks would have bought up the mortgages.

        2. The other banks would have been legally obliged to cough up and pay according to Savings Guarantee rules.

        3. Other banks would have realised they're not going to get bailed out* at any cost so they'd better start being responsible.

        4. Society wouldn't have ended.

        5. The country would have been a better place. Instead of disabled people with one extra bedroom in their house than deemed necessary (the bedroom where the carer sleeps) and people at a similar level in society paying for austerity, the ball would have been in the banks' court, where it belongs.

        * Or however you describe the debt-generating money merry-go-round which transfers bank debt to state debt and requires more bonds to be paid out at some future time than would otherwise have been.

        1. Tim Worstal

          Re: Moral dimension

          NR was allowed to go bust as banks go bust. And it's the government (FSCS) which pays the savings compo. Which they charge the banks an insurance fee for.

          And 5) doesn't follow from NR at all.

          1. Dan 55 Silver badge

            Re: Moral dimension

            I thought NR was nationalised and then privatised at a loss to the taxpayer.

            Sorry, was thinking of another country's scheme, but the end result is same.

            After a state takes on bank debt, the state needs to make cutbacks or raise taxes or both. The government decides where to do that based on their economic policy/dogma.

            Whilst I agree that benefits system needs trimming back a bit in many areas there are many areas where it doesn't. If the government didn't have austerity as an excuse they would have to use another one, so instead of "we're cutting back and taxing those areas which target the weakest in society because austerity" maybe it'd have to be "because we're a gang of sociopaths".

            They could instead, for example, forget about HS2 and just invest on improving track signalling and mobile connectivity on Britain's railways which would be much more cheaper and effective. Now that everyone's got mobiles, a few trains arriving 15 minutes earlier per day barely adds any measurable improvement to the economy. Many more trains arriving on time and people having better mobile connectivity while they arrive would be much better.

          2. tiggity Silver badge

            Re: Moral dimension

            Ah NR, hey Tim, how about a few comments on the joys of building society demutualisation in the UK, a good while ago but the starting point (in the view of many) of the massive rise of reckless financial services in this country .

            I recallthe "old" traditional building societies back in the day, with their quaint practices of careful "housekeeping" so boring for free marketeers, primarily just running savings accounts & providing mortgages, ensuring they were prudent about reserves, with respect to income and outgoings, a mysterious lack of CEOs paid obscene multipliers of what the cashier earned.

            But hey, thank your deity (or none) of choice for the free market saving us from such dull institutions and giving us too big to fail, massively under regulated & over confident mega banks instead with financial services that are aimed at shareholder smiles (unlike the old mutuals) customers are no longer members, just cash cows.

            1. Tim Worstal

              Re: Moral dimension

              Sure, let's talk about building societies. Two of which went bust at about the same time as Northern Rock. Dunfermline and, umm, Chelsea was it?

        2. DavCrav

          Re: Moral dimension

          You start with a question:

          "What would have happened if NR were allowed to fold like any other business?"

          And then write some stuff that doesn't normally happen. You forgot stage 0:

          0. Any slightly vulnerable-looking banks immediately fold from a bank run.

          The entire reason all these bank bailouts, the FSCS, etc., were set up is because bank runs are horrible things, and entirely impossible to avoid for a bank as the only thing that can be 100% backed up by cash is a safety deposit box.

          Let's continue:

          "1. Some other bank or other banks would have bought up the mortgages."

          Isn't that what the Government did? You might argue about the price paid, or whatever, but what you suggest was exactly what happened. Most people who go all swivel-eyed about banks also like the idea of government ownership of companies, so surely you would be happy about this outcome?

          "2. The other banks would have been legally obliged to cough up and pay according to Savings Guarantee rules."

          They do, every year, pay the government for this protection. It's an insurance scheme, and so it's the government that coughs up. Of course it is, because you cannot expects the banks to have enough money put aside to bail out a bank.

          Let's skip down to 5:

          "5. The country would have been a better place. Instead of disabled people with one extra bedroom in their house than deemed necessary (the bedroom where the carer sleeps) and people at a similar level in society paying for austerity, the ball would have been in the banks' court, where it belongs."

          So the collapse of a few banks and the others vastly reducing and tightening their lending, causing a 5-10% recession, would have meant the Government would have had more money to spend and wouldn't have to choose between austerity and a sovereign debt crisis? Have you seen Greece?

          1. Anonymous Coward
            Anonymous Coward

            Re: Moral dimension

            Yes, it would have been a good thing. There is going to be a crash, and thanks to the unnecessary bailout it's going to be far worse and far bigger than it would have been, and we have no money left to fix it because it was all spent the first time. And we have the addition of the moral hazard, because everyone now knows it doesn't matter how much you fuck up, the taxpayer will bail you out.

            1. Anonymous Coward
              Anonymous Coward

              Moral hazard

              Flatpackhamster,

              > And we have the addition of the moral hazard, because everyone now knows it doesn't matter how much you fuck up, the taxpayer will bail you out.

              This was my main criticism of the bailouts at the ttime. But Ive spent the last few years in RBS working on risk restructuring, and can asssure you that this is not the case at all. The baliouts, quite rightly, came with strings. The banks absolutely do not want another bailout, or to be in the sort of position where they might need one.

              Part of the problem with the bailout was that there was no effective division betweenn any bank's retail and investment arms, so the government simpyl couldn't bail out the former (which is what they needed to do) without also bailing out the latter. Banks are now legaly obliged to ringfence retail from investment, precisely so that, in the future, it will be possible to prevetn the collapse of the money supply and the loss of the public's savings by baiilng out the retail banks while letting their investment arms collapse.

              1. DavCrav

                Re: Moral hazard

                "Part of the problem with the bailout was that there was no effective division betweenn any bank's retail and investment arms, so the government simpyl couldn't bail out the former (which is what they needed to do) without also bailing out the latter. Banks are now legaly obliged to ringfence retail from investment, precisely so that, in the future, it will be possible to prevetn the collapse of the money supply and the loss of the public's savings by baiilng out the retail banks while letting their investment arms collapse."

                Except, as has been explained often, here and elsewhere, the three big banking collapses in the UK -- Northern Rock, RBS and HBoS -- either had no, or only very small investment banking arms, and these weren't the source of their collapse, but rather massive exposure on mortgages to poor people who couldn't pay them back.

                1. Tim Worstal

                  Re: Moral hazard

                  NR wasn't that at all.

                  NR was a bank run pure and simple.

                  Their business model was: issue those mortgages, funding them with a bit from deposits and lots from the wholesale money markets in short term (overnight even) money. Then every now and a bit issue bonds with about the same maturity as the mortgage book and pay down the wholesale money borrowed from the market.

                  Continue to rinse and repeat. Those bonds didn't go bust at all (called, umm, Granite I think?).

                  However, NR got caught when it had less than a "now and a bit" number of mortgages agreed, paid out to, and funded by overnight money, but before they had enough to issue another tranche of those granite bonds. They couldn't then fund that loan book as no one would lend them money in the interbank market: a wholesale bank run.

                  As far as I've seen the mortgages are just fine.

                  1. Anonymous Coward
                    Anonymous Coward

                    Re: Moral hazard

                    Yep Granite was the NR securitisation program. They're still steadily paying away and although the call date is long passed the expectation is that they'll pay down in full, at least for anything other than the Z tranche.

                  2. DavCrav

                    Re: Moral hazard

                    "As far as I've seen the mortgages are just fine."

                    Really? I remember them giving out 125% mortgages as late as 2007. I know prices are back on the up and up, unfortunately, but the plateau period, together with recession, must have screwed them over a fair bit. Or did they tighten their lending criteria in the run up to the crash?

                    Northern Rock also got bank runned on both ends though, with people also cashing out as fast as they could as things looked serious. I wonder if the long turnaround time on the FSCS (some people were saying six weeks in the media), together with the fact that until that time very few people were familiar with the FSCS and that they would get their money back at all, contributed to the retail run, rather than the wholesale run, which might be at least survivable if they stopped issuing new mortgages and dropped the bonds on the market as quickly as they could.

                    But yes, I agree, Northern Rock was not floored by defaults on mortgages, and I take back what I said above about them.

                2. Anonymous Coward
                  Anonymous Coward

                  Re: Moral hazard

                  @ DavCrav

                  > Except, as has been explained often, here and elsewhere, the three big banking collapses in the UK -- Northern Rock, RBS and HBoS -- either had no, or only very small investment banking arms ...

                  NR and HBoS, OK, but RBS? Are you kidding? Their investment bankign arm was huge. Theyve made it a lot smaller over hte last few years, but it's still big.

                  > ... and these weren't the source of their collapse, but rather massive exposure on mortgages to poor people who couldn't pay them back.

                  What I actally said was that banks are now legally obliged to ring-fence their retail and investement arms, which they are, and that the reason for this is so that future governments will have the option of bailign out just the retail banks while letting investment banks fail. I DIDN'T say that politicians enacted that legislation in response to an accurate understandnig of thwe situation. I mean, come on, that's crazy talk.

                  To be fair, the parliametnary inquiry's conclusion that the problem was mortgages came long afterr the bailout. Also to be fair, it's still the right thign to do, even if it was noticed by politciians for the wrong reason.

                  Personally, I find it quite amusing that banks are being forced to rignfence their two arms in orderr to protect the poor wee innocent fluffy retail baqnkers from evil rapacious investment bankers, when in fact the effect will be to protect the responsible intelligent incvestment bankers from feckless retail bankers. If there evr is another baiolout, the cognitive dissonance will be hilarious.

          2. Dan 55 Silver badge

            Re: Moral dimension

            The entire reason all these bank bailouts, the FSCS, etc., were set up is because bank runs are horrible things, and entirely impossible to avoid for a bank as the only thing that can be 100% backed up by cash is a safety deposit box.

            Presumably, in a transparent market economy where the consumer is able to find out enough information about the products they purchase, money would naturally flow to the least-exposed banks?

            Isn't that what the Government did? You might argue about the price paid, or whatever, but what you suggest was exactly what happened. Most people who go all swivel-eyed about banks also like the idea of government ownership of companies, so surely you would be happy about this outcome?

            Not if that means that the state has taken on more debt. There is always profit to be had in a mortgage, so someone, somewhere in the private sector would buy them up anyway.

            So the collapse of a few banks and the others vastly reducing and tightening their lending, causing a 5-10% recession, would have meant the Government would have had more money to spend and wouldn't have to choose between austerity and a sovereign debt crisis? Have you seen Greece?

            Isn't a sovereign debt crisis what happens when a state cannot pay out what it has to pay out when the bonds it has sold mature? If a state doesn't gratuitously take on debt, it won't have that problem.

            1. Anonymous Coward
              Anonymous Coward

              Re: Moral dimension

              "Presumably, in a transparent market economy where the consumer is able to find out enough information about the products they purchase, money would naturally flow to the least-exposed banks?"

              You didn't specify what 'they' should be the least exposed TO, but lets imagine its high interest yielding (potentially) bad debt. Such banks with high exposure would be the ones offering the highest interest rates for deposits (simplification on the verge of inaccuracy).

              "People" don't seem keen on seeking out the banks with the lowest savings rates and highest lending rates, just because that makes them more stable and 'less-exposed'.

              "Not if that means that the state has taken on more debt. There is always profit to be had in a mortgage, so someone, somewhere in the private sector would buy them up anyway."

              Indeed, have you been to Detroit recently?

            2. auburnman
              FAIL

              Re: Moral dimension

              "There is always profit to be had in a mortgage"

              This is the kind of wishful thinking that caused the economic crash in the first place.

            3. Squander Two

              Re: Moral dimension

              Dan55,

              > the debt-generating money merry-go-round which transfers bank debt to state debt and requires more bonds to be paid out at some future time than would otherwise have been.

              ...

              > After a state takes on bank debt, the state needs to make cutbacks or raise taxes or both.

              ...

              > Isn't a sovereign debt crisis what happens when a state cannot pay out what it has to pay out when the bonds it has sold mature? If a state doesn't gratuitously take on debt, it won't have that problem.

              Perhaps I've missed something in your reasoning here, but you appear to be treating borrowing and lending as the same. You've used the phrase "take on debt" to describe both issuing bonds (debt) and nationalising mortgages and other bank loans (credit). You then describe the consequences of too much debt and assume that they are also the consequences of too much credit -- easy to do when you're using the same words to describe each. But no. If a government "takes on debt" by nationalising a bank, it has purchased an asset, which it can sell and which will probably provide an income before the government sells it -- because it is not in fact taking on debt; it is taking on credit. If a government "takes on debt" by issuing bonds, it is simply borrowing money that it will eventually have to pay back. So you're right when you say "If a state doesn't gratuitously take on debt, it won't have that problem." But you're wrong when you imply that the phrase "take on debt" in that sentence can refer to buying a bank. They're opposites.

        3. Jason Hindle

          Re: Moral dimension

          "What would have happened if NR were allowed to fold like any other business?"

          NR was, relatively speaking, small potatoes. The bigger question is why, around the world, a great many more banks were bailed out. To answer that question, you need to start by consider what happens when the finance system collapses.

          The problem with banks is, I think, that we can't afford to treat them like any other business.

  2. graeme leggett Silver badge

    short and largely to the point

    Well, I followed it anyway.

  3. WibbleMe

    Its a very old argument; what if you Hitler and have 1 Billion thanks to your parents and what if you Jesus and have nothing

    1. DavCrav

      "Its a very old argument; what if you Hitler and have 1 Billion thanks to your parents and what if you Jesus and have nothing"

      I think I speak for everyone here when I say, "what?"

      Also, *It's, *are, *billion, *are (I think).

      1. dotdavid

        "Also, *It's, *are, *billion, *are (I think)."

        Maybe it's some kind of slang; "you Hitler" when you're being mean and "you Jesus" when you're being nice.

  4. Bruce Hoult

    cash is not the only money

    I fear that Tim has got a bit confused about things such as gold and bitcoin.

    They are not the only kind of money, they are only the cash. Both still allow the creation of money via entries in ledgers.

    Tim is correct that as we get richer we need more cash -- or at least a greater *value* of cash. Both gold and bitcoin can increase in value arbitrarily so that even though there is a fixed amount of each, the value of that amount can increase.

    For this to work, the cash has to be infinitely divisible, so that the smallest unit of cash can still buy one cheeseburger, not 1000 cheeseburgers as a minimum.

    Gold is in theory infinitely divisible, but it could get a bit impractical when you need an electron microscope to count your cash to buy a cheeseburger.

    Bitcoin is in actual fact infinitely and conveniently divisible.

    Note: the Satoshi is 1/100,000,000th of a bitcoin, and is currently the smallest unit. That in itself will last us a very very long time of expansion of the value of bitcoins before it become a problem. But if it ever does become a problem, all that is needed to fix it is a simple software update of the bitcoin protocol.

    1. Tim Worstal

      Re: cash is not the only money

      Well, yes:

      "Both gold and bitcoin can increase in value arbitrarily so that even though there is a fixed amount of each, the value of that amount can increase."

      We have a name for that. Deflation. Which is what we're doing all this QE to try and avoid because we don't think deflation is a good idea.

      1. Bruce Hoult

        Re: cash is not the only money

        WHY is very slow deflation -- at a rate matching the general increase in wealth and productivity -- a bad thing?

        STUFF gets slowly cheaper. What's wrong with that?

        1. Tim Worstal

          Re: cash is not the only money

          We're absolutely delighted when things get cheaper: it really is just fabulous that enough wheat calories to keep us alive now costs 10 or 20 minutes of labour a day rather than 12 hours of it as was.

          However, we're not entirely happy with the general price level declining. Not in a debt based economy we're not. Because the nominal value of the debt remains constant (in the absence of negative interest rates that is) while the value of what is being produced from having contracted that debt is falling. Everyone eventually goes bust in that world.

          We could, perhaps, get away with 1-2% deflation, around and about the level of total factor productivity each year. But more than that would be a problem.

          Another way of putting this is that we're just delighted that things get ever cheaper in real terms: we are 100 x or whatever it is richer than our forefathers because everything has got cheaper in terms of the labour we must perform to get it. But having things get cheaper in nominal terms, fewer tokens that represent that control of labour, has some problems.

      2. Yet Another Anonymous coward Silver badge

        Re: cash is not the only money

        Having a fixed maximum number of bitcoins isn't deflationary precisely because they are divisible.

        It's like regarding the unit of the US$ as simply a fraction of the US GDP.

        The GDP goes up and US minimum wage is now now 1.2x10-12 GDP units rather than 1.1x10-12 units

        1. DavCrav

          Re: cash is not the only money

          "Having a fixed maximum number of bitcoins isn't deflationary precisely because they are divisible."

          What? If there is 1 tonne of gold in circulation, and the value of all gold goes up, then just because you can chop your bars in half doesn't mean you don't have deflation. For example, suppose that the prices of all goods in the UK halved overnight. That's deflation, whether or not you re-introduce the halfpenny.

          1. Sorry that handle is already taken. Silver badge

            Re: cash is not the only money

            As a thought experiment, run a hypothetical economy on bitcoins. If you need to increase the money supply above the fixed (and decreasing) rate at which new ones are created, your only recourse is to (somehow) increase the value of a bitcoin.

            Any good or service that you could buy with one bitcoin now costs less than one bitcoin, and it had nothing at all to do with improvements in the production of that good or rendering of that service. Hence deflation.

            Goldbugs and bitcoin pumpers want this to happen because they hold gold or bitcoins, and they think it will make them rich.

    2. Mage Silver badge

      Re: cash is not the only money

      Bitcoin isn't money or cash. It's tulips. It's used too for transactions, but IBAN does that better with a chance of getting it back if there is fraud. Unlike cash, IBAN (or plastic debit card) isn't anonymous, but I suspect some flaw will be found in Bitcoin to allow tracing of buyer and seller. But really Bitcoin is a ponzi scheme / speculation system. It also unlike IBAN or plastic card doesn't scale. Even with hardly anyone using it it barely works (in terms of latency).

      Gold is only an exchange token ultimately, just like bank notes, if it's working, when it doesn't work it's a tulip and gets hoarded. Hoarding money is bad.

    3. Charles Manning

      Re: cash is not the only money

      The problem with bitcoin is that it is not tied to any value.

      A nation's currency is linked to the value and size of the nation's economy. Essentially you have the goods and services of the nation on one side and the cash on the other. Or as Tim put it, you have an IOU for part of the pig.

      A fiscally responsible government will only be printing money at about the rate that the goods and services are increasing in value, thus preserving the currency value.

      Even M4 money is somewhat linked to value: M4 is linked to the borrower's future labours, so it is still an IOU for something.

      With bitcoin there is no pig - not in the present or the future. There are no services There is no IOU.

      1. Yet Another Anonymous coward Silver badge

        Re: cash is not the only money

        A nation's currency is linked to the demand for the nation's exports, The Canadian $ is down 25% in the last 2years because China doesn't want coal, copper, iron ore or oil.

        If Google charge 1/millionth of a bitcoin for viewing pages and people start using bitcoin for micro-payments then bitcoin will rise. If they make their own currency or find a way of charging 0.01c without any fees then bitcoin will drop

  5. Anonymous Coward
    Anonymous Coward

    "If there are hundreds of billions in profit to be had from credit creation, then where the hell is it? The banks certainly don't make that sort of sum and they are doing 97 per cent of that credit creation."

    According to a (Corbyn-supporting friend) bankers are making precisely those billions and spending it on themselves. They are also taking it directly from the pockets of the "deserving poor" for no motive other than all bankers are evil. On the other hand,same person wonders from time to time why he should work simply to lose so much in tax on a low salary (sub £15k) when others around him don't work at all yet get (London) housing provided and always seem to have more cash to spend at the end of the week. The scary thing is that this combination of views seems to be increasingly common.

    “When the people find that they can vote themselves money that will herald the end of the republic.”

    1. DavCrav

      Did you ever point out to your friend (is that friend as in "my friend has a question", meaning you?) that if HSBC's global turnover was only around £40bn/year, even if they had no costs whatsoever, it still wouldn't come to hundreds of billions. If bankers, and there aren't too many of them, spent hundreds of billions each year on themselves, what did they actually buy with that money? Of course, we know it isn't the cashiers in branches these lunatics are talking about, it's senior bankers, of which there are about 10000 or so (order of magnitude). In which case, if there is £100bn of poor-people's money stolen by bankers, they are spending, every year, ten million pounds on themselves without anything really to show for it. That's tough.

      1. J.G.Harston Silver badge

        He's probably one of those people who thinks that the banks' customers' money in the banks' "coffers" are the banks' money. £40bn of turnover? Yes, but they've got £950bn of deposits! That means they've really got £1trillion! slobber foam drool.

      2. Doctor Syntax Silver badge

        "what did they actually buy with that money?"

        And when they spent it all where it the money go?

        1. Anonymous Coward
          Anonymous Coward

          I suspect they added up those hundreds of billions

          By looking at the amount of credit and average interest rate, and ignored pesky stuff like expenses, salaries, reserves for bad debt, etc.

          Obviously banking is profitable, this is just arguing about how profitable. The idea is "if the government is the bank then the government gets that profit". Well, that's nice but as Tim says you have the little problem of the government deciding who gets loans - do you really want a situation where someone gets a $100 million loan to build a skyscraper based on being the friend of a politician in charge, rather than because he's got credit / business plan / whatever that a bank thinks will be profitable for them?

          Maybe a school chum gets to be a high government official, so even though I have no experience with such things, I've got a big loan and am paying myself $1 million a year to be CEO of a corporation building a skyscraper. I don't care if the corporation fails and the building is never finished, or is finished but never gets any tenants because it was built in the wrong place, because I'm still making $1 million/yr for a few years before that failure becomes apparent! This sort of thing has been happening all over China, because that's how a lot of loans get done over there.

          You can capture some of that profit via taxes. If you want a bigger share, you can have higher taxes on banks, but you will cause there to be fewer banks and less credit being issued because the bar for profitability goes up when taxes get higher. Most people don't think that's a good idea (or at least they don't think its a good idea if it means their access to credit becomes more difficult)

    2. DaveDaveDave

      "According to a (Corbyn-supporting friend) bankers are making precisely those billions and spending it on themselves. They are also taking it directly from the pockets of the "deserving poor" for no motive other than all bankers are evil. On the other hand,same person wonders from time to time why he should work simply to lose so much in tax on a low salary (sub £15k) when others around him don't work at all yet get (London) housing provided and always seem to have more cash to spend at the end of the week. "

      And that's where camp guards came from...

  6. dcluley

    Smoke and Mirrors

    Economics is one of those fairyland concepts that is so flexible you can make it whatever you want. It can't even measure anything sensibly. Take this example affecting GNP.

    A company importing meat from Argentina and packaging it and selling it as pet food. Assume for the sake of this example that its turnover was £100 000pa. Entrepreneur buys the company (call it A); forms a new company (B). Now A does the import and sells the raw import to B for £90 000pa and B packages the goods and sells for £100 000pa as before. Result: the same physical activity now split between two companies had raised the share of GNP from £100 000 to £190 000. I.e. it has almost doubled it using smoke and mirrors.

    1. Anonymous Coward
      Unhappy

      Re: Smoke and Mirrors

      Conversely, this is why Jeep is a registered trademark of FCA (or whatever). It means that Chrysler (who make Jeep) must pay Chrysler (who own the Jeep trademark) for licensing when they make a Jeep.

    2. Tim Worstal

      Re: Smoke and Mirrors

      Err, no.

      GDP is a measure of value added, not of turnover.

      In both cases the addition to GDP is £10k.

      Imports are a negative number in GDP. Final sales to consumers we do count in one of the methods of working it out. So, in scenario 1) GDP is final sales minus imports, £10k, in scenario 2) GDP is final sales minus imports: £10k.

      This becomes very important indeed when we start talking about the difference between a VAT (or sales tax) and a transactions tax.

      1. DavCrav

        Re: Smoke and Mirrors

        "Err, no."

        How long do you put aside each day for correcting people who say wrong things on the Internet?

        1. Tim Worstal

          Re: Smoke and Mirrors

          A little bit for the comments to pieces which an editor has paid me to write. Part of the job description these days really.

          1. Chris Miller

            Re: Smoke and Mirrors

            And thanks for doing that, Tim - not all columnists are so punctilious. You're (obviously) right about the GDP issue, but would you agree that GDP is a pretty lousy way of judging the output of an economy? It works (reasonably) well with the car factory, but less well with a primary school or hospital.

            I half-remember a quote that the person making the greatest contribution to GDP is someone lying in a hospital bed dying from cancer, while simultaneously divorcing his wife (or something along those lines). GDP is chosen as a measure because it's relatively easy to calculate, not because it's an ideal indicator of economic success.

            1. Tim Worstal

              Re: Smoke and Mirrors

              Hmm, I think a proper "what the hell is GDP?" might be a future subject.

              You're generally right. It doesn't measure distribution, doesn't measure unpaid work, Just assumes that government output is worth what we spend upon government and has all sorts of other problems with it.

              But we do know how to measure it.

              1. Squander Two

                Re: Smoke and Mirrors

                GDP may contain all sorts of crappy assumptions, but it at least contains the same crappy assumptions wherever we measure it. So, whilst it may not be a great absolute measure of an economy, it is quite a good way of comparing economies to each other. Ish.

              2. Any mouse Cow turd

                Re: Smoke and Mirrors

                I read somewhere that the cleanup and re-build following Hurricane Katrina added a few points to the US GDP number but I can't honestly believe that it was considered "Value-added".

                Is this an urban myth or would something of this sort increase a nation's GDP?

                1. DaveDaveDave

                  Re: Smoke and Mirrors

                  "Is this an urban myth or would something of this sort increase a nation's GDP?"

                  https://en.wikipedia.org/wiki/Parable_of_the_broken_window

                  It's not quite one or the other. One of the widely acknowledged problems with GDP is as you say: cleaning up some disaster can technically add to GDP in the short term. In the longer term, though, the economy is going to suffer the effects of having put that effort into clean-up where otherwise the effort could have been invested in something new/useful, so GDP will be lower.

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