Thursday, 29 December 2016

What is money?

Money is such a multi-faceted and all-pervasive element of our system, that our capability to obsess about one aspect of it prevents us developing a proper appreciation of what it actually is.

Our monetary system is based on fraud. Can you and I write checks “drawn on ourselves”? Of course not. We have to back them up with value. The Fed does not. So, the mighty US dollar is not backed by gold or silver or anything at all; it’s simply an accounting trick ... Paul Rosenberg

How does a monetary economy differ from one in which trade occurs by barter? This ruled out gold being money, since gold is a commodity that anyone can produce for themselves with a bit of mining (and a lot of luck). So even though gold is really special and incredibly rare, it is in the end, a commodity: an economy using gold for trade is really a barter economy, not a monetary one.

A true monetary economy is inconsistent with the presence of a commodity money. A commodity money is by definition a kind of money that any producer can produce for himself. But an economy using as money a commodity coming out of a regular process of production, cannot be distinguished from a barter economy. A true monetary economy must therefore be using a token money, which is nowadays a paper currency ...  Augusto Graziani

In a credit economy at the end of the period some agents still owe money to other ones, a final payment is needed, which means that no money has been used. So to be money, the token given in exchange for a good must be accepted as a final payment, but this carried the danger that whoever produced the token might be able to “get something for nothing”.

Graziani's three basic conditions that had to be met for something to be called “money”:
  1. money has to be a token currency (otherwise it would give rise to barter and not to monetary exchanges);
  2. money has to be accepted as a means of final settlement of the transaction (otherwise it would be credit and not money);
  3. money must not grant privileges of seignorage to any agent making a payment.
The only way to satisfy those three conditions is to have payments made by means of promises of a third agent, the typical third agent being nowadays a bank.

So money is fundamentally the promise of a bank to its customer, and a monetary payment is the transfer of that promise from one customer to another. 

Monetary payment must therefore be a triangular transaction, involving at least three agents, the payer, the payee, and the bank.

Firms are present in the market as sellers or buyers of commodities and make recourse to banks in order to perform their payments; banks on the other hand produce means of payment, and act as clearing houses among firms. In any model of a monetary economy, banks and firms cannot be aggregated into one single sector.

In reality it is simply the nature of a monetary economy: money is simply a third party’s promise to pay which we accept as full payment in exchange for goods. The two main third parties whose promises we accept are the government and the banks.

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