Home / Economics / The Errors of the Economists: What is Money?

 

In order to understand the nature of money, let us begin with a little economic fable. This fable is not meant to recount the actual historical process by which money developed, but is designed to bring out certain essential features of what money is. This is a logical, not historical, account of the origin and development of money.

The first sorts of exchanges would have been barter. One person had wheat, another shoes, another was a carpenter, another a miller. If the farmer needed shoes and the shoemaker wheat, then an exchange was easy. But it surely must happen that the shoemaker needed wheat at a time when the farmer did not need shoes. Perhaps then the shoemaker had something else to trade. But if not, he could give the farmer a slip, good for a certain amount of shoes, redeemable whenever the farmer needed shoes. A slip would be an IOU. Yet these slips or scrip could be exchanged with third parties too. Suppose the farmer mentioned above needed some carpentry work done, yet the carpenter did not need any wheat at that time. The farmer could give the carpenter the scrip from the shoemaker as payment, and similarly, this scrip could be traded by the carpenter with someone else, and so on. It is an item of value because it represents a claim on a product, namely the shoes.

It would soon be convenient for all the producers to issue this scrip to avoid the necessity of immediate product exchange (barter) when no product was needed by one of the parties to a transaction.

Concomitantly, a process of standardization of value would necessarily be going on. There would emerge a rough consensus as to how much wheat was worth so many shoes, so much carpentry work, etc. Even though individuals might differ in their estimate of the value of some items, at least for necessities and other things of general use the community would gradually form a rough common estimation of comparative value. (Of course this would be based on other factors as well, including scarcity and the cost of production. The important thing to note is that this common estimation is not based on one factor alone.) So as the use of these slips became general, many of them would circulate around the community, each one good for a certain product or service, yet standing in some quantitative relation one to another. For example, if someone bought a pair of shoes he would expect to pay for it with scrip of equivalent worth, say, a scrip worth one bushel of wheat. Or if he had a house built, he would pay for it with scrip for shoes, clothes, wheat or what have you, yet standing in some more or less fixed quantitative relationship with the worth of the building work.

The next step would be for each producer no longer to indicate a particular product on his scrip, but simply some unit of value. If, for example, it had become the practice for a pair of shoes to equal one bushel of wheat, then the shoemaker might begin marking his scrip simply with the notation One Unit, and the farmer likewise. Other producers who made more costly items could indicate larger values on their scrip, and so on. So the shoemaker would produce scrip which in a sense represented a claim on a future pair of shoes, but since they named no particular product or service, could be spent on any product or service. With this you now have a complete system of money.

Some points need to be noted. What “backs” this pure paper money? In one sense it is backed by the faith of the particular community that their scrip money will be accepted for the goods they need. In another sense of “back,” the money is backed by the economic power of the community, the ability of the community to produce the goods and services its people need to live. The money in fact is a claim on some economically valuable good or service, a kind of IOU. Does the money itself represent an addition to the wealth of the community? No. If it did, each producer could leave his trade and begin writing money-slips all day long instead. The only things of economic value are products, services or land. The scrip just enables these items to change hands more easily, aids in standardizing their relative worth and in allowing economic values to be stored for future use, since it is easier to keep an amount of scrip than of some actual product.

The money system is now set up. Previously, before the slips of paper had become divorced from a particular product or service, they were made by each economic producer, whenever he needed to buy something for which he could not barter; and they stood in some relation to his stock of goods, for if the shoemaker, for example, instead of making shoes, made slips of paper supposedly redeemable for shoes, soon people would find this out, and not accept his slips. So he could not make more slips than he had shoes in stock, or could produce within a reasonable time. But when the slips no longer represent a particular product and simply state an economic unit of value, redeemable for anything costing that much, who is to issue the money, and how much are they to issue?

First, how much? The answer is implied in what I said above. If the money is in units of economic value, and this economic value is in reference to certain products or services, then the amount of money must keep pace with the amount of goods and services available, unless the value of the money is to change. Money is simply a surrogate for real economic goods and services. As the amount of economic activity increases or decreases, the money supply should roughly keep pace with that increase or decrease.

Who is to issue the money? There is more than one possible answer to that. One obvious choice is the guardian of the temporal common good, that is, the government. Another possible candidate would be the federation of all guilds (occupational groups). But whoever undertakes this function must adjust the money supply as the total of goods and services produced grows or decreases. How is he to do this? When more money is needed, it can be paid out in salaries, wages, and as payment for purchases by whatever entity is charged with supplying money. If the money supply needed to be reduced, money in possession of the issuing authority could simply be destroyed. But in any case, the creation of money must be strictly limited by statute and other means so as not to cause inflation by issuing too much money. The money supply must roughly keep pace with the economic activity of the society.

Note that commercial banks play no role in money creation in this hypothetical society, for there is no reason for them to do so. The money-creating role of banks is economically unnecessary, and in fact a kind of tax and blight on the community, since all the money created by the banking system comes into being as debt and must be repaid with interest.

Note also that there is no logical role for gold or any other commodity as money. The desire for commodity money often represents a confusion about the nature of money, as if money itself were to have value, and not simply be a claim on real economic goods and services.

Ths purpose of this little fable is to illustrate that money is logically neither some object of value itself (as gold or silver) or the creation of the private banking system, but is simply an expression of the sum total of the society’s economic activity. Money is the tool and servant of the community, to accomplish the community’s goals of facilitating exchange and supplying the public’s needs.

 

About the author: Thomas Storck

 

Thomas Storck is the author of Foundations of a Catholic Political Order, The Catholic Milieu, and Christendom and the West. His work has appeared in various publications including Homiletic and Pastoral Review and the book, Beyond Capitalism and Socialism. Mr. Storck is a former contributing editor of New Oxford Review and Caelum et Terra and serves on the editorial board of The Chesterton Review.An archive of Mr. Storck's writings can be found at www.thomasstorck.org.

 

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23 Comments

  1. Thomas-

    What do you think about the “Money is Debt” videos, which I am assuming you are familiar with? The premise of the video is that private creating of money by banks ensures that we will always be in debt, since the banks, in issuing loans, only create the principal but not the interest. Therefore what is owed (P + I) will always be greater than what is put into circulation (P) and we will always need more debt to pay off existing debt. Just interested in your opinion…

  2. There is an advantage to having a commodity backing a currency that has an intrinsic value. First, it helps to not depend on the good faith people have that the government wont abuse its ability to create money if it is limited by the availability to obtain and produce that commodity as a currency unit. It also retains value if that government no longer exists as was the case with the Confederacy, the Soviet union and Nazi Germany whose scrip became worthless afterwards.
    Trusting a government to restrain themselves and not print money as they desire it (to pay off supporters, mostly) is as foolish as trusting a drug addict with your life savings and amounts to the same thing.

  3. Phillip,

    I am not acquainted with the videos you mention, but I am familiar with the idea. Although I haven’t read a thorough debate on the point, the idea seems to me correct.

    And, Mr. Cheek. Though the first danger you mention is real, there can be danger with commodity money too, as when Spain imported huge amounts of silver and caused inflation after the discovery of silver mines in the Americas.

    As to your second point, I don’t think this is correct. Nearly all countries that were on the gold standard found it more convenient to use paper currency with gold backing. Therefore it would be easy for a conquering nation to declare the currency of the defeated nation worthless and simply confiscate the gold in the treasury. On the other hand, if people actually carried gold pieces around in their pockets, those gold pieces actually have little value, despite what people think. I suppose people could take gold coins from no longer existing nations to be melted down as jewelry, but this seems like an unlikely occurrence to base a system of money on.

  4. Maybe there’s something to bring out a little more fully.

    > money in fact is a claim on some economically
    > valuable good or service, a kind of IOU.

    Here’s the way I put the money question and I probably got it from somewhere else but I couldn’t tell you where anymore.

    Roughly: cash is a claim on “stuff” that’s already been made. Debt is a claim on “stuff” that hasn’t been made yet. Some people say debt is money.

    When the cobbler hands over a slip of paper good for ten pairs of boots to be (reasonably) delivered at a later date — this essentially is debt. It is in the form of a futures contract, but it is debt. Only the fear of God or bankruptcy or a lack of buyers keeps the cobbler from (unreasonably) printing more and more Cobbler Boot Notes.

    It is hard to understand why these Cobbler Boot Notes are not money: they can theoretically at least be traded for (say) tires. The cobbler’s need for cash has gone down because somebody accepted a Cobbler Boot Note which in turn makes cash worth a little less. Aren’t cash and Cobbler Boot Notes both money? The difference I can see: eventually that Cobbler Boot Note would have to be settled somehow. It could be settled in boots, maybe it could be settled in money. A narrower view of money says that money is not a kind of IOU — if you have money you command anything that already exists: it requires no settlement.

    @Phillip: “I” has to be put into circulation as well. One problem I think the anti-Fed people have is they never consider loans they don’t have: the only thing they’re looking at is their home mortgage and consumer debt. They don’t think about the financing their employers engage in on their behalf in order to secure their wages. Under our central banking scheme money is created as debt and is destroyed when the debt is paid off. One way to think about “interest” is that it is a reflection of how much more stuff is available for trade in the economy. One claim made is that the ability of banks to create money gives them an unfair claim on real assets, that they don’t really do any work in the creation of money per se. (They may do lots of work originating & servicing loans, doing risk assessments, and the rest, but the actual creation of the money itself is said to be entirely risk & work-free for them but they profit anyway strictly from that). Here is a very simplified view of how it works: http://bit.ly/gRG5EE This doesn’t illustrate profits, but it isn’t hard to interpolate them in the example.

    The Chicago Plan called/s for 100% reserve requirement on banks, eliminating their ability to create money. Milton Friedman modified this by advocating a “legislated formulaic” growth of the currency supply rather than letting the Congress or whomever change it according to whim. Since banks can’t create money at all anymore and the formula is supposedly tied to (reasonably expected) growth in the real world economy, this should eliminate nearly all inflationary effect of creating more money.

    Louis Kelso added something further: ownership of this new money should be distributed to everyone in something like a social security account. Thinking of the example, what would it look like to eliminate the Federal Reserve, and have the Treasury print up the $10,000 and distribute it to you and nine of your friends?

    Since the bank doesn’t create the money in the first place and has to borrow it from you in order to operate, any unfair advantage bankers might have had simply because they can create money with no work – in DR terms, their opportunities for usury, goes way down. The investment bankers get paid for the work they actually do for you but you not they profit strictly from the creation of money.

    The only thing Kelso would let you do with your new money is buy corporate bonds (i.e. you only can buy a promise to produce something in the future). Why? Because increased future production is the only reason to increase the supply of money. In practical terms, the only bank you could deposit your new money in would be a commercial bank that loans to businesses.

    This scheme harmonizes well with The Chicago Plan. What I don’t think we ought to do is what the “original” Chicago Plan had in mind: Congress creates money debt free, and then spends the money itself into the economy. If Congress wants to spend money, it should be required to raise taxes or borrow from people with cash savings versus Kelsonian capital accounts. Full Stop. If you want to go to war you gotta raise taxes or sell war bonds and those can’t be bought out of a capital account. This will make it very clear that wars destroy value.

    What you do with the dividends off this account is up to you – you could spend or re-invest. The idea is that over time, people have enough in their capital accounts to afford (say) half a frugal existence simply by virtue of being a member of the society and the income is tied to societal production not fantasy. They’d have to do actual work for the other half of their existence, but it frees them from total wage slavery at the same time taking nothing from anybody else. Imagine who might choose to become a teacher if some big chunk of wage differential were handled this way. Imagine the impact of a marriage bonus versus a marriage penalty when couples have two capital accounts. Imagine how the impact of a layoff would be reduced if you had income off your capital account. In this modern society, your fief is your capital account and you got it from “the king” – the personification of the whole society. This was the vision. I have talked about it with a couple of central bankers (one from Canada, one from the USA) and they both say it isn’t crazy.

    But! Nobody really knows. All we can do is ask whether we like these underlying assumptions better than we like the assumptions underlying our current system and then go from there. It does give me comfort that the Kelsonian Plan harmonizes with traditional understandings of money and ownership, and reforms (rather than destroys) institutions we have in place. There seems to be a kernel of non-contradiction here which just might point at a truth or two. It hasn’t really been tried, but this is no excuse for not trying it. It is the only way we’ll learn.

  5. I enjoyed your article but have an issue with your definition of money.

    Money represents real things. One slip of paper represents shoes. As a result, this money is on a “shoe standard.” It’s value is backed by shoe makers and too many shoes will devalue the currency.

    This and the rest of your examples are commodity monies backed by the particular commodities the producers make. These monies would not be very stable in value. The supply of all of these products would need to regulated.

    Money needs to be stable in value. Therefore a stable commodity would need to be selected that was stable in value. Historically, societies have chosen precious metals and gold in particular as the best commodities for money.

    Thank you for a thought provoking article.

  6. Hmmmm. What is value? What does it mean that 2,500 tons of gold are mined each year, and it is estimated that the commercially-viable un-mined gold in the world is only about 50,000 tons? What does it mean that half of this is in South Africa?

    http://www.galmarley.com/framesets/fs_commodity_essentials_faqs.htm

    Should people be allowed to command more and more resources by simply waiting, doing nothing, producing nothing, risking nothing? That’s the consequence of deflation. It would be sinful if there were a loan involved. The big question: how much deflation is too much?

  7. There are over 400 billionaires in the US today. I estimate an average of 3 billion each. At an average wage of 50,000 per year those 400 people own IOU’s for 24 million years of labor. The only way to understand the economy is to simplify it. We work and in exchange for work we get IOU’s then the IOU’s determine what work gets done. Unfortunately in todays society money is not being managed very well. 400 people should not be able to own 24 million years of labor.
    Mr. Storck the idea of the article is perfect keep trying to make it clear and simple. All schools should teach “What is Money”.

  8. See, Dorschner, this is my problem with some forms of Distributism. I completely disagree with the assertion that rich people “owe” anybody anything based on some arbitrarily set “average wage” of $50,000 or whatever. Different people’s labor is worth different amounts based on what they do, the talent involved, what they could be doing (opportunity cost), etc. I would not want to live in a system that limited my income to $50,000 per year. I want a system where I am MORE free to earn, not less constrained. And what kind of monstrous government bureaucracy would you need to set up to deprive these billionaires of their money and redistribute it?

  9. @Phillip — So you completely disagree with a bunch of assertions that Dorschner didn’t make?? I don’t see where he said anything about being owed anything, arbitrarily setting a wage, or redistributing existing wealth. He says a system that permits 400 people to amass 24MM “median household incomes” needs reform. He’s right, not least because this system requires a monstrous government bureaucracy to prevent outright revolt — namely the whole welfare apparatus including the public schools.

  10. First, 50,000 is close to the average wage in America. Second, the point is “What is Money”. The economy and the “free market” is Labor not money. Labor heats your home, picks up your garbage, feeds you, builds your car, maintains your roads, teaches your children, takes care of you when your sick, ect. ect. Money is just the guide that tells Labor what to do. So what should Labor do?

  11. There is a reason why precious metals where used as money i.e. a surrogate for barter. Practical experience showed that the surrogate needed to be durable, portable, and easily divisible. The precious metals meet this criteria — paper doesn’t.

  12. Above, Tom Leith wrote, “cash is a claim on `stuff’ that’s already been made. Debt is a claim on `stuff’ that hasn’t been made yet. Some people say debt is money. When the cobbler hands over a slip of paper good for ten pairs of boots to be (reasonably) delivered at a later date — this essentially is debt. It is in the form of a futures contract, but it is debt.”

    In a generalized money system, it is true that no cobbler would have to make shoes any more if he decided to leave his work and become a hobo. The fact that money was available to pay him to produce shoes would have no moral or legal claim on him – he could up and leave if he chose to. Whereas if, as in my hypothetical example, he himself had issued the scrip good for a certain number of shoes,then it would seem that he would be at least morally, if not legally, bound to redeem all the outstanding shoe scrip before he left his business. But for someone whose business is a service – of course there is never any finished product and everything is a claim on future work. Although the cobbler’s scrip represents debt in a sense – every IOU is debt – the generalized scrips – “cash” – functions in exactly the same way and as a whole fulfills the function of debt redemption and claims on existing goods.

  13. @Dorschner — Labor should recognize that less and less of what we think of as “wealth” depends on labor, and more and more depends on capital: natural, intellectual, and physical. Laborers therefore should obtain ownership of the capital they wield in order to have the just return of both. This can be facilitated by institutional reforms and by a shift in attitude. DR is right to emphasize guilds — guilds do not (in theory anyway) separate “management” from “labor” or from “capital” for that matter. The trick will be not to privilege guilds so much in law that they gain too much market power. This is a great challenge, and I’d love to see some model legislation and bylaws. We have disintegrated our society — it is time to re-integrate it and the guild is one institution that can help.

    @Clay — Coins made of gold and silver are not particularly durable when used for trade; they wear easily. The reason these coins tend to have rims and reeding is to prevent wear and detect fraud (“clipping”). Silver coins from the 1870s through about 1960 were not all that precious: the melt value of a silver coin was almost always less than the face value.

    As for divisibility: in the 1930s gold was fixed at $35/ounce. The smallest practical gold coin would’ve been worth $3.50 when a 6 oz Coke cost 5 cents or 1/700th of an ounce of gold. Today I’d need a gold coin 1/1,400th of an ounce to stick in a vending machine to buy a 12 oz Coke. This is why token currencies are developed even if they’re supposed to represent actual gold or other precious metals.

    Gold is portable if you mean “doesn’t take up much space”. If you mean “easy to carry around” it isn’t: it is heavy and should be protected from wear. Which is why we had not-so-precious silver, nickel, copper, zinc, and even steel coins, as well as cotton-paper bills. A $1 bill lasts about 3 years in circulation and is cheap enough to replace although the mint keep trying to get us to use dollar coins again.

    Our current monetary policy implements Mr. Storck’s description of money: “Money is the tool and servant of the community, to accomplish the community’s goals of facilitating exchange”. If the money is to be the tool for facilitating exchange, we should de-emphasize the ancient role of money as a store of value, and we do. The main trouble (as I see it anyway) is that this tool is given debt-free to only a few.

  14. Tom Leith, GNP or GDP figures still show a large majority of the product going to labor, at least in the US. There IS a big difference in living standards between, say, the 99th percentile in income and the 50th, but that is attributable in great part to salary-and-wage differences. I’m not sure therefore that more equal capital ownership among families and households would be as efficacious as it would have formerly in reducing inequality. Btw, what is the difference between “natural” and “physical” capital? Is the former inclusive perhaps of such as unrefined foodstuffs and fossil fuels, while the latter machinery and buildings? In any event, “land” must also be included with “labor” and “capital” in the calculations of wealth.
    Viking

  15. Tom, what do you mean given debt-free to only a few?

  16. @Viking — as best I can tell, about half of GDP goes to wages and about half to dividends and capital gains. See here:

    http://www.irs.gov/pub/irs-soi/06intop400.pdf

    I think this says wages are $5.5T out of a $12T economy. Am I reading it wrong?

    You’re right though: I’ve overstated the likely effect of Kelso’s Capital Homesteading idea. It busts the money-creation trust so to speak, but that’s all. This may be worth $1K per person per year in present value. Kelso had some other ideas about democratizing ownership as well but these were about a modest increase in family income, and he hoped for a substantial increase of income stability.

    By “physical capital” I mean buildings and machines and roads and so-forth; by “natural capital” I mean everything from air to rocks. I am not sure it is useful to think about foodstuffs in this framework. What did you have in mind?

    @Dorschner — money is “given” to bankers debt free but not to the rest of us.

    In the banking system we have right now, bankers are allowed to “create money” (the terminology is imprecise from my POV but it’ll do). The banker doesn’t have to borrow this money from anyone — he get it debt-free because he simply declares its existence. This isn’t as bad as it sounds when you consider that money itself is agreement among people to trade: the banker (ideally) looks at the people and the agreements among them and makes a determination “yes, there is reasonable agreement here — there is indeed new money because there are productive new agreements. I judge it so. Here is a pile of tokens to trade among yourselves and the interest represents the expectable results of the agreements. If I’m wrong too often, my capital reserves will fall below the regulatory minimum and the government will shut me down (unless I am too big to fail).”

    The banker pays himself out of the interest and also pays interest on his capital reserve (i.e. money he got from depositors, about 10% of his loans outstanding). If there’s anything left over, he pays that out to his stockholders. There is room here for mischief and there is surplus value to be had simply by being in the position of a monopolist with respect to the creation of those tokens of money.

    Gotta go, duty calls.

  17. I believe Thomas Storck’s claim regarding “commodity money” is not new, nor should it be surprising at this stage in our advanced money economy (whereas, in the past, such a statement might not stand so much scrutiny).

    Indeed, Georg Simmel, in his masterwork, “The Philosophy of Money” clearly lays out “the declining significance of money as substance”:

    “Perfect stability of the value of money could be attained only if it were nothing in itself, but only the pure expression of the value relationship between concrete goods. Money would then reach a neutral position which would be as little affected by the fluctuations in commodities as is the yardstick by the different lengths that it measures. The value of money established by the performance of this service would then also reach its maximum stability, because the relationship of supply and demand could be regulated more easily than when it depends upon a substance the quantity of which we can never fully control. This is not to deny that, under particular historical and psychological conditions, the value of money may be more stable if it is tied to a metal than if it is detached from it…”

    Simmel’s work is actually more a sociology of money than anything else; it identifies a number striking consequences of the money economy, some of which would be of interest to Distributists and to others who believe that there exists a moral dimension to economics.

  18. Tom, the site you gave, as i read it, only applies to the top 400 incomes for each year, not American society as a whole. It couldn’t be all wages and profits anyway, as there are rent, interest, and entrepreneurial incomes as well. A better site for this determination, IMO, is http://www.g24.org/pbno4.pdf which gives labor’s share for 17 OECD countries. I was surprised that said percentage has gone down significantly, from a high of about 75% in the mid-seventies to about 65% in 2005, the last year given. (Hope all those are correct, i’m quoting from memory and my own perhaps inexact measurements.) Even there though, i wonder if the aging of our societies, and increased generosity to the elderly, might be at least a partial explanation.

    Viking

  19. @Viking — it is true that the special topic of that report is the top 400 incomes but the column “Total for all returns” is for all tax returns, not just the top 400. The telling report is “Net capital gains less loss in AGI” — the top 400 get 63% of their adjusted gross income from capital gains, 37% from everything else.

    With respect to income distribution — you think returns to labor in the OECD are declining because of increased generosity to the poor??

  20. Tom: No, not to the poor, to the elderly, who are a potent political force. (Unlike the impoverished.) This includes the wealthy old as well as middle-income ones. I’m not claiming this is the whole answer, but i’d be surprised if it weren’t part of it.

    Viking

  21. @Viking — if you mean wages are being taxed at ever-higher rates compared to other income (as in the USofA) that could indeed be a partial explanation.

  22. @Tom Leith: Yes, FICA taxes in the US have indeed increased, and no doubt their equivalents elsewhere in the OECD. But i’m also thinking of increased pension payments because of the increasing numbers of elderly, and the individual and familial holdings of wealth which this group has in disproportionate amounts to their numbers.

    Two other factors come to mind besides decreasing unionization: One, the increasing numbers of women in the work force, who often take part-time jobs or low-paying ones. Two, the large numbers of immigrants from low-wage countries into more prosperous lands. Indeed, these two may explain the lesser number of unionized workers in great part.

    Viking

  23. Doesn’t anyone want to say something?
    Viking