Monday, March 16, 2015

What is Money?

Did you read the Wall Street Journal this morning?  Of course you did/didn’t.  Want to know something?  The people who write those front-page articles and the back page articles (and all the ones in between) for the world’s most important financial newspaper have a slight gap in their knowledge.  They don’t know what money is.

$1.00 Republic of Poyais ... a land that never existed.
That’s right.  Oh, they know the jargon, and can give the textbook response, e.g., 1) a medium of exchange, 2) a store of value, 3) a standard of value and 4) a common measure of value. (William Stanley Jevons, “The Functions of Money,” Money and the Mechanism of Exchange. New York: D. Appleton and Company, 1898, 13-18.)

Okay, that’s not a wrong answer.  It’s just not completely correct.  It describes what money does.  It doesn’t tell you what money is.  What is money?  Anything that can be accepted in settlement of a debt; it's the means by which we exchange what we produce, for what others produce.  That’s it.  That’s the whole thing in a nutshell.

Money is a symbol of wealth, not real wealth.
You want a little more, though.  Fortunately, we have it.  As a lawyer-economist concerned with the impact of contracts and property on the economic system, Louis Kelso delved even further into the nature of money.

Money is not a part of the visible sector of the economy; people do not consume money. Money is not a physical factor of production, but rather a yardstick for measuring economic input, economic outtake and the relative values of the real goods and services of the economic world. Money provides a method of measuring obligations, rights, powers and privileges. It provides a means whereby certain individuals can accumulate claims against others, or against the economy as a whole, or against many economies. It is a system of symbols that many economists substitute for the visible sector and its productive enterprises, goods and services, thereby losing sight of the fact that a monetary system is a part only of the invisible sector of the economy, and that its adequacy can only be measured by its effect upon the visible sector. (Louis O. Kelso and Patricia Hetter, Two-Factor Theory: The Economics of Reality. New York: Random House, 1967, 54.)

To reiterate, in legal and accounting terms, “money” is anything that can be accepted in settlement of a debt: “[E]verything that can be transferred in commerce.” (“Money,” Black’s Law Dictionary. St. Paul, Minnesota: West Publishing Company, 1951.) All money is therefore a contract, just as (in a sense) all contracts are money.

A Medieval contract, a.k.a., "money."
Money being a promise, that is, a contract, nothing is money until and unless it is “accepted,” that is, an agreement is reached as to the content of the promise. All contracts consist of offer, acceptance, and consideration. “Consideration” is the thing of value that induces someone to enter into a contract. (“Consideration,” Black’s Law Dictionary, op. cit.)

Strictly speaking, it is not necessary for anyone to cut consumption and accumulate money savings in order to finance new capital formation and become a capital owner. It is only necessary to have the capacity to enter into a contract.

Creating money by entering into contracts based on the present value of future marketable goods and services is called “pure credit.” This is because the credit does not rely on past savings for anything except traditional collateral — and money and credit are simply two aspects of the same thing:  “Money and Credit are essentially of the same nature; Money being only the highest and most general form of Credit.” (Henry Dunning Macleod, The Theory of Credit. Longmans, Green and Co., 1894, 82.)

They insure life, why not credit?
Traditional collateral, however, can be replaced with capital credit insurance and reinsurance, with the collateral consisting of the insurance premia collected in the future.  In this way, economic growth can be completely freed of reliance on past savings, and thus avoid both capitalism and socialism.

The process of money creation using a central bank (such as our Federal Reserve System) is neither mysterious nor occult. The system was designed to allow the creation or destruction of money as needed by the economy, so that there would never be too little (resulting in deflation) or too much (causing inflation): an elastic, uniform, stable, asset-backed reserve currency.

The House Banking and Currency Committee, in A Primer on Money (August 5, 1964), noted:

When the Federal Reserve Act was passed, Congress intended [the purchase of “eligible paper”] to be the main way that the Federal Reserve System would create bank reserves. . . .When this practice was followed, the banks in a particular area could obtain loanable funds in direct proportion to the community’s needs for money.

But in recent years, the Federal Reserve has purchased almost no eligible paper. . . .(p. 42).

When the Federal Reserve System was set up in 1914, . . . the money supply was expected to grow with the needs of the economy . . . . It was hoped that by monetizing “eligible” short-term commercial paper, by providing liquidity to sound banks in periods of stress, and by restraining excessive credit expansion, the banking system could be guided automatically toward the provision of an adequate and stable money supply to meet the needs of industry and commerce . . . . To safeguard their liquidity and provide a base for expansion, the member banks. . . could obtain credit from the nearest Federal Reserve bank, usually by rediscounting their “eligible paper” at the bank — i.e.,. . . selling to the Reserve Bank certain loan paper representing loans which the member bank had made to its own customers (the requirements for eligibility being defined by law). If necessary, the member banks might also obtain reserves by getting “advances” from the Federal Reserve bank. . . . (p. 69).

Chartering the Bank of England, 1694.
In other words, under a standard central banking system, businesses or other productive enterprises would obtain loans at their local commercial bank by offering for discount bills of exchange (bankers acceptances) representing the present value of future marketable goods and services that the customer reasonably expected to produce. The bank would purchase — “discount” — the bills by issuing promissory notes.

The commercial bank, in a process known as rediscounting, would then sell the qualified loan paper of the business enterprises to the central bank in exchange for the central bank’s promissory note if it needed additional reserves. In the case of the United States, the commercial bank would sell its paper to one of the twelve regional Federal Reserve Banks. To be able to purchase the qualified paper, the Federal Reserve would issue its own promissory note to back either new currency or new demand deposits.

As originally intended when the Federal Reserve System was established, this process would create a stable, uniform, elastic, and asset-backed reserve currency that increased as the need for money increased, preventing deflation. It is the cardinal rule of issue banking that the reserve currency, into which all other forms of money in the economy can be converted, must be asset-backed, that is, have real, tangible value. As the loans were repaid, the currency would be taken out of circulation, or the demand deposits “erased” from the books. This would remove money from the economy that was not linked directly to hard assets, and would thus prevent inflation.

That’s the theory, anyway.  So what happened?  We’ll look into that tomorrow, if nothing drastic happens in the interim.  Like the stock market crashes.  Again.


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