Pragmatic Capitalism

Practical Views on Money & Finance

Pragcap Glossary

The following is a glossary for commonly used words on Pragcap that my help new visitors better understand and navigate the website:

Acceptance Value: Acceptance value represents the public’s willingness to accept something as the nation’s unit of account and medium of exchange.  This is achieved mainly through the legal process and democratic vote.  That is, the government and the people deem a specific thing (such as the US Dollar) as the accepted unit of account and medium of exchange.  Acceptance value is only one facet of currency demand.  See quantity value for more.  

Active Investing:  The practice of picking assets in the expectation that a portfolio of selected assets can consistently outperform “the market” on a risk adjusted basis.  In the aggregate, “the market” is the Global Financial Asset Portfolio, the one true benchmark of all outstanding financial assets. Anyone who deviates from global cap weighting is technically engaged in a form of active investing.

Contingent Currency Issuer: A contingent currency issuer is a nation that operates with self imposed constraints where it borrows funds from its own banking system and private sector, but has the operational option to issue currency as the primary form of money if it wanted to.  These self imposed constraints are usually politically motivated and often designed to prohibit a centralized government from having total control over money issuance.

Equity: Equity represents an ownership interest.  When discussing equity we are generally referring to stocks.  

Fiat Money:  Fiat money is paper money organized under the rules and regulations of a government and sustained through the productive base of the private sector.  Fiat money, in and of itself has no value, but affords its users a convenient and simple manner for exchange.  When quantifying the value of fiat money it is best to study the living standards of the society as a whole rather than the more misleading and more commonly used rise in inflation over time.  A rising inflation can be perfectly consistent with both the existence of fiat money and rising living standards as evidenced by the experience of the USA in the 1900s.

Fiscal Policy: Fiscal policy is government policy geared at changing the size of federal spending and taxation.

FFR: This is a commonly used abbreviation for Federal Funds Rate, the overnight lending rate in the interbank Fed Funds Market.

Global Financial Asset Portfolio: The Global Financial Asset Portfolio is the aggregate portfolio of all the world’s outstanding financial assets. It is the benchmark of all financial assets.

Hyperinflation:  Hyperinflation is a very high level of inflation caused by unusual exogenous shocks to an economy.  Contrary to popular opinion, hyperinflation is not caused by money printing, but generally occurs after an exogenous shock to an economy which results in money printing or a collapse in the tax system.  The primary historical causes of hyperinflation are: lack of monetary sovereignty, war, regime change, production collapse and government corruption.

Inflation:  Inflation is a consistent rise in the general level of prices of goods and services in an economy.  A low inflation is usually consistent with healthy economic growth in a fiat monetary system.

IOR or IOER: A common abbreviation for Interest On Reserves or Excess Reserves.

Inside Money:  Inside money is bank issued money.  The term comes from the idea that it is money created “inside” the private sector by private competitive banks.*

Investment: Investment is spending, not consumed, for future production. The term is commonly associated with the stock and bond markets, however, most people who buy stocks and bonds are not actually investors. They are allocators of savings. Investment is performed primarily by firms who are spending for the purpose of future production.  The act of buying securities on an exchange can fund investment, but in and of itself, it is not technically “investment”.

MR:  A common abbreviation for Monetary Realism.  See below for more.

Monetary Policy: Monetary policy is policy conducted by the central bank of a country in an attempt to influence the money supply.  Specifically, monetary policy is conducted by interacting in various ways with the private banking system in an attempt to influence the cost and use of inside money.

Money:  Money is a social tool with which we primarily exchange goods and services.  Technically, anything can serve as “money”, but in modern societies money is most commonly organized under the rules and regulations of government.  Specific forms of “money” are generally viewed as having a high level of utility if they meet certain criteria:

  • A widely accepted medium of exchange
  • A store of value
  • A widely accepted unit of account

Monetary Realism: Monetary Realism is an economic approach that describes the operational realities of the monetary system through understanding the specific institutional design and relationships that exist in a particular monetary system.

Outside Money:  Outside money is government created money.  This includes notes, coins and bank reserves.  It is called outside money because it is created outside the private sector.  Outside money exists to facilitate the use of inside money.

Passive Investing: The practice of buying a portfolio that is a proxy for the market as a whole on the theory that it is so difficult to outperform the market that it is cheaper and less risky to just buy the market.  Quite technically, the truly passive portfolio is comprised of the GFAP (see above) and anyone who deviates from this portfolio is therefore active.

Quantity Value: Quantity value describes the medium of exchange’s value in terms of purchasing power, inflation, exchange rates, production value, etc.  This is the utility of the “money” as a store of value.    While acceptance value is generally stable and enforceable by law, quantity value can be quite unstable and result in currency collapse in a worst case scenario.

Quantitative Easing:  Quantitative easing is a form of monetary policy, implemented via open market operations, in which the central bank tries to influence the cost and use of inside money by altering bank reserves.  Specifically, this is achieved by swapping reserves for treasury bonds (in most cases).  It results in no change in private sector net financial assets and is often confused for “money printing” or “debt monetization”.  It’s really just an unusual form of standard Fed policy or open market operations and its effectiveness is highly debatable.

Reserves:  Bank reserves are a form of outside money used in the means of settling payments and meeting reserve requirements.  The existence of reserves (and the Federal Reserve System) is to help streamline the banking system into one cohesive unit while maintaining the private competitive banking system.

Risk: Risk, as it relates to portfolio management, is the potential that one will not meet their financial goals. The two primary causes of this are the risk of permanent loss and the risk of purchasing power loss.

Risk Profile Parity: Risk Profile Parity is a strategic approach to asset allocation which seeks to maintain an asset allocator’s risk profile in alignment with the dynamic risks of the underlying portfolio of assets.

S = I + (S-I): This is an important equation used by Monetary Realism to help emphasize the fact that an economy is based on private production.  The equation emphasizes the role of private Investment in the economy and the idea that living standards are best maximized when a nation is highly productive and creating goods and services that increase overall living standards.

Sectoral Balances Approach: The sectoral balances approach was created by Wynne Godley to show the flows through an economy.  It is a useful way of understanding the way that GDP is generated by the various economic agents.  (I-S) + (G-T) + (X-M) = ΔNGDP.

*  See here.