The path to becoming a Portfolio Manager

Throughout my career, I have helped train and mentor a number of aspiring portfolio managers. Many find themselves prepared for various technical aspects of the job i.e. how to trade certain products, how trades settle, how to calculate risk, how to build a portfolio, how to manage stop-losses etc. In my opinion, these technical skills will not be the biggest problem faced on the journey, but rather the emotional issues that accompany it and sadly most people do not enjoy that aspect of the job.

For most becoming a portfolio manager is not a good career choice, but for a small number it is perfect. Therefore, one of the things I try and help aspiring managers to understand is the different stages they will pass through.

 

Stage 1 – Observer

This is the stage where people have shown real interest in financial markets. They follow the news, read analysis, develop their technical knowledge and skills, and enjoy forming market views and expressing them to others.

A common error for an aspiring PM is to think this stage is a long way along the road. A key element is the lack of clear feedback mechanism; or rather feedback is likely to be qualitative (perhaps social i.e. do people like what they say and write) but unlikely to be quantitative or objective.

 

Stage 2 – Paper trading

This is a helpful stage that I push aspiring PMs towards – I explain that this is what I did myself. My observation is that those who will become successful PMs will have already done this sort of activity on their own. After all who could stop them?

Paper trading is the stage where people can realise if they care enough about forming views and narrative about financial markets, or care about playing a game in which you keep score by how many dollars you gain or lose. Paper trading becomes engrossing because it is an active feedback mechanism on your decisions and thus the only way you could ever improve. All I do at this stage is help them think about trading and how to evaluate their decisions for themselves. The key is that only those that enjoy it and like keep to score in an honest way, can actively progress from here.

Most aspiring PM’s actually stop at this stage and soon revert to stage 1. Some get bored, some use their paper portfolio as a means to signal their “view” e.g. bullish the Australian dollar, much like a research strategist does. The preference to talk about trades where they were “right” often becomes dominant, rather than all the other lessons they learnt. If I point out that their overall paper portfolio has lost money they will often blame “money management” or “risk management” as though this is some technical add-on that is of secondary importance to their view formation.

 

Stage 3 – trading real money (small)

At this stage, aspiring PMs are often shocked to find out how much worse they perform than when they ran a paper portfolio. To the outside observer, it may appear identical, but for the participant I would highlight these key differences:

It is public
Actual P+L in a firm will be reported. In a paper portfolio you are free to make any decision you want and the only person who will ever know about them is yourself. Once real money is at stake, all your decisions are visible, and can be can be looked at much later by other people who will judge them. In this respect it is similar to my very first blog post “How to Write“, your thought process will change in the same way that writing in a private diary is different from an essay submitted to a teacher.

It is real money
I remember being really stressed at this stage in my career, partly because I was so bad at it! I kept losing money. It felt real to me. I would lose perhaps $500 on an FX trade and this felt like a lot of money. I could buy a TV for that. I struggled to understand why my bosses were so relaxed and tolerant of me throwing the firm’s money away. Later once I was the manager I understood that this is a cost of training and most people really struggle at this stage.

It matters for your career

This is especially tough as you are starting to take risks with your future. You need to persevere, building up evidence to convince people to give you more money to trade. It is hard to predict who will make this transition and who will fall back into the far more numerous careers in stage 1.

 

Stage 4 – trading real money (large)

By the time you get to Stage 4, the vast majority of aspiring PMs will have already fallen away. This does not mean that you are now the finished article and that it will be easy from here. Once you start managing larger amounts of money you will face different stresses.

Now your trading decisions will have a material impact on your life and career. If you do really well you will get a large bonus, buy a flat and a nice car. If you do not, you may get fired.

It is starting to be too late to simply go back to Stage 1 and find another path in finance (unlike at stage 3). Here you will be highly vulnerable to Desirability Bias (Desire – The Fatal Flaw). You will want to make good decisions really, really badly. You will really, really want the decisions you have made to be good ones. This can damage the delicate cognitive processes that are required for nuanced decision-making.

Some people struggle here and effectively behave as though they are still in Stage 3. They will take small risks and although they enjoy trading and are good at it, they cannot commit to risking their job and livelihood based upon it. For some reason, I loved this stage. I felt freed up from the restrictions of Stage 3 and had huge (over)confidence in my ability. In hindsight, I still had an awful lot to learn but my confidence and ambition kept me moving forward.

 

Stage 5 – full-time portfolio manager

Here there is nowhere to hide. Managing money is not just a part of your job – it is everything. The decisions you make will determine whether you can buy the nice house, pay for your kids to go to private schools, what lifestyle you can afford and more broadly your status in society.

My sense of this stage is that the people who really care about money, in the sense of what it can buy you, do not become portfolio managers. There are many safer and more reliable routes in finance to get those things.

The ones who do better are perhaps more like me. I did not care very much about leading a very affluent lifestyle, I had earned enough money in my career not to worry that I would end up in severe financial stress and so leaving the relative security of running a business in a bank did not feel very risky.

Conclusion

What I find striking is how hard is it to predict who will succeed at the various stages.

The people who were outstanding at Stage 1 might be complete failures at Stage 3. Those who were very good at Stage 3 would not come across anywhere near as well as the analysts and strategists in terms of their ability to talk about markets, economics and strategy.

Those who were successful at Stage 3 generally focused on the task at hand (i.e. find something, anything which they could turn into making a profit.) This might mean they became an expert in a tiny section of a market and thus needed to know nothing at all about unrelated areas of finance and broad market drivers. It is the focus on making money that is far more important than a broad interest in financial markets.

To become a portfolio manager, not only do you have to refine your technical ability, you will need add emotional strength to deal with the challenges. This can be even harder to predict.

Career Tips

I was asked recently to speak at an undergraduate event. Part of it was to give some career advice in the form of 3 tips. Here is what I came up with:

Many people after leaving university find adjusting to the world of work difficult and become very unhappy. Focusing on a lack of “meaning” in their job while searching for a “mentor” to guide them, they can quickly come to resent their firm and co-workers.

It does not have to be this way.

The most important thing to realise is that the workplace is not going to feel like an extension of education – it is completely and fundamentally different. For at least the first two decades of your life, focusing on your knowledge and your skills is the key and the whole environment around you is geared to helping you develop. However, the ability of a student to successfully transition into a happy and productive career has remarkably little to do with the knowledge and skills they start with.

What really matters is how well they can change their mindset.

Here are 3 things to focus on:

  1. It’s not about you any more

This is the piece of advice students generally find the most upsetting. A big change in mindset is required to succeed in a work environment compared to the one needed for education.

In education, the student is the product. The ultimate aim for a student, with the help of teachers, is to gain the skills and knowledge required to pass exams. This does not mean that students have complete free rein to do what they want. There will be various restrictions on behaviour, such as a requirement to go to lectures, prepare for tutorials, do reading, problem sets and essays – however these are all designed with the success of the student in mind. The best attitude for the student is to be focused on themselves and their own needs.

In the workplace, the business is the product. The ultimate aim for a new employee is to become useful. Many graduates find this transition to the workplace a shock. Senior members of staff may not think that a key part of their role is to educate you and make you more productive or happy. In a few years’ time, you will also be more senior too and it will be obvious to you that this is not a priority either. You will want to be productive at work, impress your boss, get promoted, get a bonus etc.

Adjusting to this new reality, the best attitude is to be focused, not on yourself, but on the needs of the people around you and of the firm – Be useful! You will then find good things will start to happen to you. Given reciprocity (see “Influence: The Psychology of Persuasion” by Robert Cialdini), people you help will also help you. Senior people will start to spend time helping you learn and improve. You will have signalled to the firm that you have the right mentality to succeed and so will be promoted more quickly, paid more and given more training.

Having a real job is extremely helpful in preparing you for work and choosing a career path. I spent my Gap year working full time as an economist, but working at McDonalds may have perhaps been even better. You need to understand what it is like to be the other side of the counter.

  1. Be flexible.

In education, a targeted focus and narrow determination are extremely helpful for excelling with high results. The world of academia is fragmented and siloed, with status derived from expertise in ever more specialised areas.

The world of work is very different. A modern and successful career will come with many parallel and some orthogonal leaps into new areas, combined with an ability to master a broad range of cross-disciplinary problems.

I could easily have become a consultant or economist and I think I would have really enjoyed it and been successful. In banking and hedge funds, my career could have gone in lots of different directions. The only way to take opportunities is by being open minded.

  1. Work with people you would like to become.

This piece of advice was given to me as an undergraduate, and it has repeatedly proven itself true as my career developed.

Don’t think that you can join an Investment bank for the money and not become like them. Either you will change to fit in, or you will not and you will hate it and leave.

You must judge it from meeting real employees, not from impressions from TV shows. Being a lawyer is not the way it is on Suits just as being a Hedge Fund manager is not like Billions (well mostly anyway). That is why internships are so useful.

Conclusion

The world of work is can be a stimulating and fulfilling experience. For that to happen you need to be able to have the right mindset to take advantage of the opportunities on offer.

Money 4 – Why does it matter?

The elimination of money from economics theory and teaching leads to major practical problems.

  1. Why did we have the financial crisis and the prolonged recession?

The Queen famously asked why economists failed to see the crisis and ensuing recession coming. What is less talked about is how they subsequently also failed to understand a) what was happening as it was occurring and b) the nature of the recovery. Once you appreciate that money and credit are central to a modern economy, and academic macroeconomists were using models without money or credit, this failure is much easier to understand.

Some policy makers did a better job of learning and adapting to the crisis. Ben Bernanke, at the US Fed, with his study of the 1930s depression years, was well placed to support the economy once the crisis was underway. The Bank of England was not so well led. Mervyn King appeared to believe in a banking model in which the lender of last resort need not exist. When this model failed to have any correspondence to reality, he acted as though reality was at fault, not his personal model.

The financial crisis and its aftermath was predicted and understood by some people however.
But they were likely to be eclectic economists, on the fringes of the mainstream, who did not exclude the views of Keynes and Minsky for their lack of “microfoundations”.

  1. Why did the enormous monetary stimulus not lead to a stronger recovery?

The answer is that the monetary stimulus was not so enormous. The numbers were large, but the transmission mechanism was very weak, and therefore the recovery has been slower than most predicted.

Another misunderstanding follows, since the recovery has been slower than expected, new ideas have been sought to explain it away, such as secular stagnation. But once you accept the idea that QE is eye-catching, but not very powerful for the economy (it may be more powerful for asset prices but that is a different matter) then the slow recovery is not so surprising.

  1. Why do we ever have unemployment at all?

The academic models we have been looking at, theoretically make the existence of unemployment impossible. Given that this is evidently not the case, the models must be augmented with ad-hoc frictions, to make them have some connection to observed reality.

If money is allowed in the model at the start then you do not run into such issues, and surely this is evidence that the theories with don’t include it, don’t make much sense.

Why do economists believe these myths?

If an economist is typical pressed on this, responses vary from claiming that the representation is broadly accurate (it is not!) or more likely that it does not matter (it does!). If the assumption does not matter, why choose such a strange one?

A more recent defence has been that the latest batch of sophisticated new Keynesian models incorporate money and credit and a banking sector. But if that is the case why not change all the teaching? Why is money tacked onto the end of a model rather than incorporated as a critical building block?

I think that they attempt to tack money onto the end of their model building because it is not possible to incorporate it at the start. The assumptions which exclude money are critically important to the complex mathematical models that the current breed of academic economists revel in building. The worry for me is that armed with them, they go on to lead to key policy and market implications. It would also be fair to say that pretty much everything I do in studying the macroeconomy would not be classed as macroeconomics by a current mainstream academic.

Modern academic economists believe that conversations about macroeconomics should be based upon General Equilibrium (GE) and rational expectations and have “microfoundations”. The most recent iteration is the Dynamic Stochastic General Equilibrium (DSGE) model. GE is a truly majestic piece of mathematics which describes an economic system based upon essentially perfect barter.

The concept of money is added as purely commodity money. Any asset can be arbitrarily chosen as the denominator in which to price all others, it is just the numeraire. This helps with the solution as it reduces the number of independent variables by one when solving a set of simultaneous equations.

The advantage of building models in this way is that you can translate many concepts used in micro economics and apply them to macroeconomic questions. This is known as “microfoundations” and many Noble Prizes have been won, tying the neat General Equilibrium theory up with clever mathematics.

After the financial crisis, it is obvious that money and credit had to be included, and so the most recent batch of Neo-Keynesian models attempt to do so. But this is an ad hoc tacking on of a couple of new variables that do not connect to the central mechanism of the model. I see these models as sophisticated in the same vein as the geocentric models used to argue against Galileo.

If we use Kuhn’s model of paradigms, then this looks like economists trying to bury “anomalies” during a period of “model drift” when their models are increasingly unable to answer the questions people think matter. The next stage is “model crisis”. Or perhaps we are already there.

Relationship to Politics and Free-market thinking

This model creates the illusion of a perfect economy in which everything works, with the practicalities of reality being termed “imperfections” such as imperfect competition or sticky wages. This links strongly to the ideology of free markets being the answer to all questions i.e. the idea is to make reality behave more like the model.

Economists of a more interventionist or left-wing persuasion can exist within this paradigm. But ad hoc elements such as asymmetric information have to be added, combined with some pretty inventive and tortuous modelling, eventually producing models which suggest intervention is the correct policy response.

Conclusion

Recent mathematical models cannot be held responsible for the birth of the myths of money and banking. In Classical economics the concept of value is separate from money and logically prior to it and so JS Mill told us that “There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money”.

We have recently seen stirrings from eminent economists that all is not well with the profession, https://piie.com/system/files/documents/pb16-11.pdf, but it is not yet filtering through to how the subject is being taught at grass roots.

Where we are left is a deeply divided set of disciplines. Practitioners, both in financial markets and many Central Bankers have a different approach to pure academics. But even academia is split between macroeconomists who study an economy without money and Finance professors who study a monetary system without an economy.

Both can be seen, to borrow a phrase from Keynes, as “an extraordinary example of how, starting with a mistake, a remorseless logician can end in bedlam”.

Money 3 Banking – a money creation myth

I will again use the bestselling undergraduate textbook “Macroeconomics” by Greg Mankiw as the source for this story.


How does money get created?

In the beginning, there were bank reserves……

 

  1. The Central Bank determine Bank Reserves – this is the money that the banks have on deposit with the Central Bank
  2. Banks, holding these reserves, then lend them out to customers, who then either put that money on deposit themselves or transfer the money to someone else who does. The mountain of customer deposits is generally many times larger than bank reserves. This is known as the “reserve-deposit ratio, rr”.
    It is an “exogenous variable” in other words “the model takes as given”.
  3. There is also the currency in circulation which the central bank also determines.
    This is known as the “currency-deposit ratio, cr”. It is also an “exogenous variable”.
  4. Combining these via “money multiplier”, gives you the Money Supply.

In this way, the Central Bank determines the level of reserves, and thus controls the money supply in a predictable way.


From bank reserves to money supply to inflation……

The next stage in this story is the “Quantity Theory of Money” which “remains the leading explanation for how money affects the economy in the long run.”
This starts with a key identity or equation:




Add a few assumptions….

P * Y is also nominal GDP, so if we assume that V (the income velocity of money) is constant (or “exogenous”), then a change in M leads to a change in nominal GDP.

Via a separate assumption, the level of output Y is determined by a production function which does not include money, therefore a change in M leads to a change in P i.e. changing the money supply causes inflation.

Economists are taught this key conclusion at university:
Thus, … the central bank, which controls the money supply, has ultimate control over the rate of inflation.”

Unfortunately, like many Creation Myths none of this is true.
As Mankiw says, this model “is simplified. That is not necessarily a problem.”
I agree, “all models are simplified”. But when causation is the wrong way around, this is a massive problem.

Banking – a personal perspective

When I left university, I became a trader at a bank, spending many years on a money markets desk. It is at the least glamorous end of trading, but I found it fascinating being at the centre of the banking system, funding the bank’s activities, and forming the link between the Central Bank and the markets. What was immediately striking was that bank operations were nothing like the models I had been taught at university.

In the story above, the driving force is the Central Bank adding reserves, causing banks to lend money. The mechanisms described are correct, just in the exact opposite order. The actual sequence goes something like this:

  1. Customer decides to buy something and uses credit card for the purchase.
  2. Transaction goes through. i.e. bank lends the customer money for the purchase.
  3. The money shows up as a credit entry on the shop’s bank account and a debit entry on the credit card.
  4. The banking system now has a debit and a credit. Banks move the money between them to square their accounts.
  5. It is important to note that the central bank wasn’t required to do anything in this process.

What if the customer takes out cash? Then the banking system is short of reserves.
This is not a problem as the central bank just adds or takes out reserves on a regular basis to make sure the banking system has exactly as much as it demands.

It is not the case that the Central Bank tells the bank funding desk it has more reserves, who then calls round the rest of the bank to tell them to do some more lending. In simple terms the central bank sets the rate of interest (Fed Funds in the US and the Base Rate in the UK) and then supplies money as demanded. The supply of money is determined completely by the demand for money.

Evidence

Correlation of money supply with inflation

Milton Friedman and Anna Schwartz “wrote two treatises on monetary history that documented the sources and effects of changes in the quantity of money over the past century.” What they did was document that money supply and inflation are positively correlated. This is a most obvious prediction from either story of money, and so I have never seen an argument that it supports one over the other. As inflation rises, then more money will be demanded in the economy to facilitate transactions. The central bank accommodates this so we see a direct relationship between money and inflation. This tells us nothing about causation. Friedman’s attempts to show causation by econometric tricks with “long and variable lags” are completely bogus.

Stability of velocity of money

An argument for why one can assume V is a constant, is that historically, over short periods, it has been. Unfortunately, this again is a direct prediction from both stories. If the central bank always supplies as much money as is demanded then there is no reason for velocity to change.

Why did QE not lead to hyperinflation?

According to this monetary theory in the textbooks, the vast increase in reserves caused by Quantitative Easing should have led to an explosion in bank lending and a rapid rise in inflation.

This clearly hasn’t been the case, and in fact, the taught theories really struggle with reality here. They are forced to rely on ad hoc and non-quantitative explanations such as “animal spirits” or a reduction in confidence. Since this “confidence” is not directly predictable or even observable, it requires a leap of faith, equivalent to “magic”.

It’s a wonderful coincidence that a model which predicts a MASSIVE stimulus finds, in reality, an unseen counterbalancing force which is of EXACTLY the same magnitude. But still, I read that MV=PY holds and the miraculous drop in V to exactly offset the rise in M, was a bizarre coincidence and that once the velocity of money rises back to “normal”, inflation will come.

There is a much simpler explanation. The amount of loans created by banks was never constrained by reserves and so increasing reserves has no effect on the behaviour of banks or their clients.

What do central bankers say they are doing?

Central bankers involved in monetary policy and the oversight of the banking system must understand how banking works. What do they say is going on?
They agree with my model and say that “the reality of how money is created today differs from the description found in some economics textbooks” and describe the model that is taught as “some popular misconceptions”. http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf

Conclusion

Money is simply not exogenous and does not cause inflation.

Amongst practitioners, including bankers and central bankers, this is obviously well understood. Bagehot famously described it perfectly in 1873. What is striking is the contrast to academic economists who persist with a very different mythical version of banking and continue to educate our bright, young minds with a story of pure fantasy. So why do they do it? I will speculate on that in the next post.

Money 2 – an alternative history

In the beginning, there were people….
People have social interactions which have very strong patterns. One of these patterns is the concept of Reciprocity. If someone gives you something you have a strong sense of obligation to give them something back. This forms the basis on many successful marketing strategies (see “Influence” by Robert Cialdini) but also sits at the heart of everyday social interactions.

For example, in the office someone makes coffee for you. This creates an implicit obligation which you will wish to later reciprocate, or perhaps “repay”. In fact, the word “pay” is said to come from Latin “pacare” meaning “to pacify” and later came to mean to settle a debt. You do not immediately barter, need to give something in return at that time. You have a social relationship and there is mutual trust that this obligation will be repaid. This obligation could be called a “debt” or a “liability”. The person who made the coffee now can be seen to be holding an “asset”.


Make it more useful by adding features….

This method of economic organisation works well for small items between tight-knit or homogenous groups. But it would be far more powerful if we could add some other features which allow us to expand it:

  1. Unit of measurement.
    It is handy to be able to quantify the economic value of the transaction so that more complex exchanges can be facilitated
  2. A method of recording ledger items.
    Just remembering that it is your turn to buy doughnuts for office is not sustainable for more complex economic transactions.
  3. Tradability to a 3rd party
    It would be great to be able to have the favour repaid by someone other than the recipient.

A voucher system….
So let’s start a voucher system. Every time you do me a favour such as babysit my kids I will give you a voucher. Every time I do a favour such as mow someone’s lawn I will be given a voucher. I can build up a stack of voucher from doing these jobs and then “spend” them by taking my family to a restaurant for dinner.

This system of money can be seen today in small areas. In the UK, there is the Lewes pound and the Brixton pound. Tight-knit communities can develop all sorts of formal and informal social conventions to regulate exchange. None of them require gold. These are the sorts of systems of money found in ancient, primitive societies. There is no strong archaeological evidence because this kind of money is not physical, however the earliest writing ever discovered was on tablets thought to represent ledger type records. Tokens in the form of Coins are in fact a later discovery and this has commonly been misunderstood as thinking that it was the tokens themselves that were the valuable item. In fact, it was and is the social obligation that matters, coins were simply a means of recording it.


Using a central authority to widen the usage….

But these local currencies or voucher systems have limitations. They rely on trust which is hard to foster with strangers. It would be much more powerful to have some authority or government to issue the money and guarantee its use across a broader area. This is when we see minted coins by a sovereign.

The unit of value can be solidified by collecting taxes in that unit. You will notice that you owe your taxes in US dollars in the US, and in pounds sterling in the UK. The benefit to society is huge, economic activity can be distributed and exchange facilitated on a grand scale. There is also a large benefit to the government, as issuer they get to earn seignorage.


Conclusion

The alternative story of money is still taught, but these days it is mainly in sociology, history or anthropology departments. This version has been eradicated from economics faculties and treated as “fake news”. Economics students are not taught arguments to support their story, it is simply assumed and most are even unaware there are other ideas.

Money 1 – A Creation Myth

In this piece, I take “Macroeconomics” by Greg Mankiw, the bestselling undergraduate textbook, as the source for this story.

A history of money

In the beginning, there was barter
and a rudimentary economy was based on it. This is extremely inefficient as you have to walk around all day carrying lots of goods, hoping you bump into someone who has something you need who at the same time wants something of yours and will trade you for it.

Efficiency demanded the use of commodities….
Given how poorly organised this world would have been, “it is not surprising that in any society, no matter how primitive, some form of commodity money arises to facilitate exchange”. “Most societies in the past have used a commodity with some intrinsic value for money”. We can see this because archaeologists have found lots of gold, silver and copper coins from previous civilisations.

A really nice example of recent commodity money is the use of cigarettes for currency in a POW camp in WW2. This is an excellent example of why commodity currencies existed and how they operate.

As society evolved thus did “fiat money”….
A modern development in the history of money is the development of “fiat money” which is “money that has no intrinsic value”. This occurs via a process of “evolution from commodity to fiat money”. The process by which this happens is rather mysterious but “in the end the use of money in exchange is a social convention: everyone values fiat money because they expect everyone else to value it.”

Modern money

Money is the stock of assets that can be readily used to make transactions” and it can be defined by its uses which are:

  1. Store of value
  2. Unit of account
  3. Medium of exchange

Between history and mythology

Unfortunately, as so often is the case with creation myths, none of this is actually true. Understanding what money is and why economists are taught its history in such a strange way is important. In fact, I would say it is central to understanding current economic policy and also how best to invest.

Myth #1 In the beginning there was barter

There is no evidence of any society has ever used barter as their primary means of exchange. This should be unsurprising as it would be horrifically inefficient.

Myth #2 Commodity money was the primary form of money for most of history

This myth is more serious and way more pervasive.
However the evidence from the existence of coins far from backs it up, I think it is good evidence of the opposite.

Imagine we are in ancient Rome and we have a Denarius coin in front of us
(Deni from Latin “containing ten” originally was the value of 10 asses)

It has a nice picture of Hadrian on it, “he” of the wall.
It was made of silver and so has an intrinsic value from its weight in silver
(there are examples of use of gold in coins too – the history is interchangeable)

Consider this, let:

A= intrinsic melt-down value of the coin

B= face value on the coin

Then scenarios are:

A > B the coin would not exist, it would be melted down.

A = B why mint it in first place? Why bother calling it a Denarius at all and put the Emperor’s face on it? It would be simpler just to weigh it. There is no benefit for the government to go to the trouble and expense of minting these things.

B > A Now there is a reason to mint it – a profit! The difference (B–A) is known as “seignorage”. We know this was a main source of income for monarchs for centuries from records. But if B>A then there is no strong link between the intrinsic value of the metal and the value of the money. It sets a lower limit but nothing more.
So what is the difference to fiat money? Not much. History indeed has little evidence for a prevalence of commodity money.

But what about the example of cigarettes in the POW camp?
I love this example because it is correct, and utterly misleading. There is an important reason why a commodity currency was used. It is because there was no way to enforce an obligation as the members of the economy were not in control of their society (see below for why this matters).

Myth #3 Money is an asset

Money is not a thing, or an asset like any other asset in the economy. It is much more special than that. It is a ledger item which always consists of an asset and a liability which come into existence at the same time. There is nothing else like it and it is central to the functioning of the economy. I will delve into this in the following posts.

A common error when struggling with such an abstract concept, it is often much easier and more natural to think in tangible terms. An analogy for this is units of measurement. It is now “obvious” that the concept of measurement is conceptually separate from any physical object. I can separate the concept of “1 metre” from the physical reality of a “piece of metal 1 metre long”. Although it is hard to imagine than this was not always obvious for humans, it was certainly not the case in ancient societies. In fact, it is striking how well these societies were able to operate, before the concept of number being separable from their physical objects, allowed formal arithmetic.

Myth #4 Money can be defined by its uses

This myth is again common but is a non-unique definition for money. There are many, many assets which could be used for the functions:

  1. Store of value
  2. Unit of account
  3. Medium of exchange

For example: dollars, gold, bitcoin, cigarettes, diamonds, canned food, oil etc.
In fact, anything non-perishable as bananas would not store well. The concept that in a mainstream economics they assume that anything can be used for money is important. Economic theories have developed from it, often containing the hidden assumption that money is not special and can largely be ignored. It is an asset like any other asset, is priced in the same way as any other asset. Therefore we should not be surprised that all the output from these models show no important role for money in the economy. I would have hoped the financial crisis would have exposed this as a myth.

Myth 5 Fiat money is a modern development

In fact, it is the oldest form of money.
I would prefer to say that “fiat money” means “money” and that “commodity money” is best defined simply as a “commodity”.


Conclusion

The story of money taught to economics students contains many a myth.
Next, I will tell an alternative story of money. The ideas I will present are not difficult.

But as Keynes said, “The difficulty lies not so much in developing new ideas as in escaping from old ones.”

What is our education system for?

Education plays a big part in every election campaign. But it seems that the only debate is over funding. It is implicitly assumed that the only way to improve our education system is by higher funding levels and that if only more young people could do A levels and get a degree then our economic productivity would rise and they would all be better off.

What I would like to see is some examination of what our education system actually does and reconsider if that really should be its goal.

Learn to write

Education can be seen as the way that students are taught to write and communicate “properly”. In particular, they are taught Standard Written English (SWE). David Foster Wallace’s essay “Authority and American Usage” examines how “rules” in English usage and grammar can be better understood as “norms” more similar to “ethics” than to “scientific laws”. Importantly “a dialect of English is learned and used either because it’s your native vernacular or because it’s the dialect of a Group by which you wish to be accepted”. Therefore, students from less privileged backgrounds have to learn SWE because it is the dialect of “power and prestige.”

You may find this form of education objectionable. My view is that given the structure of our society, it is useful for the individual. Highly paid professions require fluency in this dialect and if we want any social mobility this has to be taught.

If I look at what is taught at a UK university, I quickly conclude that they go much further than this in the enforcement of dialect. Peter Elbow in “Everyone Can Write” discusses the teaching of “academic discourse” which is the language academics use to write to each other. This is the form of writing that is taught and highly valued at university. But as he points out, there is not a single form of “academic discourse”. Historians do not write in the same style as Biologists. Even within subjects, there can be wildly different forms of acceptable dialects.

The purpose of these dialects is to provide a barrier to entry to the discipline. It is how academics can signal to each other that they are part of the same sub-group, and by enforcement of their dialect exclude outsiders. Much of academic writing appears to be deliberately obstructive to the lay reader. Within academia this is irritating, but when it forms a central part of the education of a population it is a lot worse than useless.

Learning to write in this dialect does not prepare the student for the tasks they will face after university. The language of business is very different from the language of English Professors. Hence the common complaint that not only do graduates have to be taught so much, they actually have to “unlearn” what they have been taught.

Learn a subject

In UK universities, it appears that the purpose is to train future academics. The subject matter is very narrow, the syllabus relates to one discipline and the student is encouraged to go deeply into a specific area within that subject. Ask a history student about anything and they will say “not my period”. Talk to an economist and they will refuse to have a conversation without a mathematical model. Lawyers learn the intricacies of Roman Law.

Unfortunately, it is not obvious that excelling at a narrow and specialised area has many transferrable benefits. It does not produce a well-rounded graduate with a range of interests and perspectives. It provides a very highly refined ability to do something they will never be asked to do again, unless they become an academic of course or maybe a macro manager.

 

It is a signal

This is a compelling driver for getting an education. It can be used to give very valuable signals which are important in your life. For example

  1. Getting into a selective university signals that I am intelligent and hard-working
  2. High grades signal that I am intelligent and hard-working
  3. Going to certain universities signals that I have been socialised into a specific culture and am motivated to belong to it. This is why investment banks interview Harvard students.

These signals have numerous costs, not just the financial and time cost of a university education.

Getting good grades at school to gain entry into a top university has become a growing driver of school education. We are obsessed with league tables, and education up to the age of 18 appears increasingly to be a competition. There are many other things that could be the focus of our children’s attention. Teaching to pass an exam necessarily leads to focus on a defined syllabus and the subordination of creativity and imagination to regurgitation of the approved answers.

The desire by students for high grades creates a strong demand for courses which can be graded and for the students to be ranked. To rank students effectively, a syllabus is required which leads to a test with a decent dispersion of results. This leads to a particular kind of subject matter being preferred. In subjects such as economics and finance, what I observe is a lot of time focused on the teaching of complex and rather arcane methods of mathematical and statistical modelling. This creates an exam which even some of the very smart students cannot do well and so it is possible to differentiate between them. But not on a basis which is necessarily meaningful.

If I taught a course, I have lots of things I would like to include. But I have no idea how I would examine it. What I would want to teach are concepts which are not very difficult. Everyone in the class could understand them and get an A. But just because there are not difficult does not mean that they are obvious or commonly understood. Perhaps the most important lesson would be that they should never use any of the sophisticated mathematical techniques they are learning in their other classes. Care and attention in assessing what the characteristics of the data are and what can reasonably be done with it are far more important.

For an individual, this signalling can produce compelling and powerful success stories. In many ways, my personal story can be expressed in this way. Teresa May wants to bring back Grammar schools because she went to one and ended up being Prime Minister. But this type of anecdotal reasoning leads to poor policy and worse outcomes for most children. http://blogs.ft.com/ftdata/2013/01/28/grammar-school-myths/

What should the purpose of education be?

We could add a focus on developing knowledge and skills which are useful for people to have

  1. In the workplace
  2. In their lives
  3. As a member of society

The opportunity is there. I meet many students who enjoy their time at university. I meet very few who enjoy their academic work and even fewer who think their academic work is useful.


My recent experience

I have to admit a tendency to get overexcited in the adoption of new things. I spent a week touring US colleges recently and was overwhelmingly surprised and impressed. I met students who described doing courses that were “not too hard, but really useful”. I never did courses like that.

I do not want to single out any one place as there were so many positive impressions. But this was the best video.

https://www.youtube.com/watch?v=tGn3-RW8Ajk