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Trade money

19–21 March 2015

Real currency?

Some people seem to believe that only coins and banknotes are real money, and bank balances are not.

OK, coins are special in that they have some intrinsic value, a value of their own, because they are made of more or less precious metals like copper and nickel, and in the past also silver and gold. But the metal value of coins is usually lower than their nominal value.

Banknotes and bank balances share the fact that their physical manifestation is virtually worthless: banknotes are made of paper (albeit with costly security features) and the memory bits that encode bank balances on modern computer disks are also very cheap.

What makes banknotes and bank balances valuable, is that they both are liabilities of some sort of bank, liabilities to the holder of the banknote or bank account. In other words, the holder holds a claim on the issuing bank.

The only difference between them is, that a banknote is a liability of a central bank (technically more correct: of a note-issuing bank) and that a credit balance in a bank account is a liability of a non-central bank.

So it is in no way correct to say that only banknotes, only currency is real money. Money in bank accounts (‘giral money’ as it is called in some languages, but English does not seem to have this word) is just as real as banknotes.

Fungibility

Banknotes, and bank balances in a transaction account, are fungible, are interchangeable, meaning you can receive banknotes after which your transaction account is debited, and when handing in banknotes at your bank, your account is credited.

Money as debt?

It is often claimed that money is debt.

Two things are true:

  1. Money in a bank account is administered at the right side (credit side) of the bank’s balance sheet. It is balanced by assets at the left side. A large part of that left side (debit side) of a bank’s balance sheet consists of somebody’s debts. The holder of the bank account need not be among those somebodies, by the way.

  2. Any time a bank supplies somebody in the public with a loan, new money is automatically and inevitably created. As a result, much (but not all) of the money in bank accounts was once created when a debt was granted and as a consequence of that.

Many people think it is undesirable that money in bank accounts is tied to debt in this way. I used to think that too: maybe not undesirable, but certainly strange and unpleasant to say the least.

Some take their visions a step further and it is their opinion that we should look for ways of creating a different kind of money, money which has no relation to debt. Debt-free money.

Recently it occurred to me why (in my opinion) that isn’t necessary at all, why money linked to debt isn’t a problem at all. That’s because I then realised how debt is part of the nature of money, how it is intimately connected to what money is, how money was invented, what money is for. I’ll explain.

(Text continued from here on 20 March.)

The nature of money

Community survival

Humans once lived in small communities in Garden of Eden-like environments, probably in Africa or not too far from it. For picking fruit and eating it, no trade or money is needed. Neither does hunting prey and eating it together with all members of the community.

The economy was based on everybody contributing to their ability, and benefiting to their needs.

Barter

That changed with increasing contacts with the outside world, and the advent of travelling traders. These traders had to move on soon, so there was no time for retributing what they had delivered or received in the natural pace of the community’s economy.

Transactions had to be settled in full right away. That was the birth of barter trade.

(Text continued from here on 21 March.)

With society becoming more complicated, contacts becoming more frequent and over greater distances, trade became ever more important. This is true of trade in the narrow sense of buying and selling goods, but also in a wider sense which involves services and employment as well.

Coincidence of wants

Barter can work but it has a serious problem: the often occurring lack of a double coincidence of wants (William Stanley Jevons). I referred to it before.

Money, first in the form of coins, is a smart way to overcome the difficulties of barter. Money is divisible and combinable to create any amount. Money can be exchanged for goods and services, and goods and services can be exchanged for money.

That makes money highly suitable to bridge the mismatches that make barter impractical, mismatches between potential sellers’ and buyers’ needs in terms of product size, product quantity, product quality.

This is money in its function as a medium of exchange. An additional function of money, that of being a unit account, naturally spring from its being a medium of exchange: for money to facilitate trade, pricing is necessary: people need to agree about how much money corresponds to a product of a given kind, quality and quantity.

Time mismatches

The problem with barter trade is mismatches: what a seller has on offer is often not what potential buyers want, and vice versa. This problem can be overcome by splitting every trade transaction into two, with money taking the place of the mismatching exchange product, in both of the partial transactions.

But the mismatches are not only in the nature of the products to be sold and bought. Time mismatches also often occur.

Examples: you reap what you sow, but not right now. You plant before you harvest. Necesse est facere sumptum, qui quærit lucrum. He who seeks for gain, must be at some expense. Outlay must precede returns. Nothing ventured, nothing gained.

A shop must be furnished and have sufficient stock, before clients will be willing to buy anything. First you work, then you get a salary at the end of the month. As a company: once a month you pay wages, you have to earn them back sometime, not necessarily right then.

Etc. etc. etc.

All those mismatches can also be solved by money, but then in its function of ‘store of value’, and its natural counterpart: credit (which could also be called deferred payment).

Getting things backwards

So if you look at money as a smart invention to overcome the natural problems of barter trade (with trade in a wide sense of the word, that of any economic transaction), it is not at all alarming or worrying that money is intimately tied to credit, in other words: to debt.

Money is the natural solution for both temporary surpluses of value (savings) and for temporary shortages of value (credit).

It is getting things backwards to say: if society needs more money, somebody has to go into debt for that, and that can’t be right.

The right approach is: credit is a function of money, so if more credit is needed in the economy, of course that involves that there will be more money too.

Conclusion: the quest for debt-free money could only result from failing to understand what money is really for. Money is a remedy for mismatches in trade, including time mismatches. Therefore money is a medium of exchange, but also serves to facilitate savings and debt.

Riches and inequality

It seems the money supply, the quantity of money in the economy, has been rapidly increasing in recent years. Some people think that’s a problem and is the result of a plot by vile banks to put us all in more and more debt until they own everything and we are left in eternal poverty.

However I prefer to look at it much more rationally. Credit being one of the natural functions of money, more money and more debt can be explained by such factors as:


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