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.
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| $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.
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| 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.
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| 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.)
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| 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).
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| 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.
#30#