It’s time for another esoteric blog posting on the nature of money. Today we’ll be looking at the difference between what is called “the Currency School” that virtually all modern economics, whether or not mainstream, accept, and “the Banking School,” on which binary economics is based.
|Henry Thornton, "Father of Central Banking."|
The fact that binary economics is (as far as we know) the sole survivor of Banking School economics is a little perplexing. This is because those who articulated the principles of the Banking School are revered, even in some mistaken circumstances, venerated today, usually by individuals and groups vaguely defined as “conservative.” Banking School economists include such economic luminaries as Adam Smith, Henry Thornton, and Jean-Baptiste Say.
We’ve gone into this before in some depth, but we did it using a mathematical analysis of the Quantity Theory of Money equation. This went right by a lot of people. Evidently, when you put equations in front of people, even the simplest ones, people's brains tend to shut down.
So, what is the difference between the Currency School and the Banking School? It’s really very simple:
· Currency School: Money and credit are a commodity. The quantity is independent of the velocity of money, the price level, or the number of transactions.
· Banking School: Money and credit are the medium of exchange. The quantity is wholly dependent on the velocity of money, the price level, and the number of transactions.
Put even more simply, the Currency Principle is that money is a commodity, while the Banking Principle is that money is the medium of exchange.
The implications of the difference between the two are profound. Under the Currency Principle, the first question in carrying out productive activity or consuming something is, "Where is the money to come from?"
Under the Banking Principle, money doesn’t exactly become irrelevant, but it does become somewhat incidental to the real question. Which is? "How do we produce something to consume?" The Banking Principle recognizes that legitimate money derives from production. This is an essential corollary to Adam Smith’s first principle of economics as stated in The Wealth of Nations: “Consumption is the sole end and purpose of all production.”
This, of course, leads naturally into the question of where do you get something to consume?
The answer is that, absent charity, gift, theft, or something along those lines, there is only one way to be able to consume, and that is to produce. If you want to consume, you must either,
· Produce what you want to consume, or
· Produce something that someone who has what you want to consume, and trade what you have produced for what he has produced.
|Too many walnuts|
In other words, if you want to consume, you must produce. This leads directly to Say’s Law of Markets, which in part states that we do not actually buy and sell productions with money. Instead, what we are doing is buying and selling productions with other productions. “Money” is just the medium by means of which I exchange what I produce for what you produce.
For example, I have a bushel of walnuts and you have a bushel of apples. We each agree that a bushel of walnuts is worth the same as a bushel of apples to each of us . . . but you don’t want walnuts. You’re allergic to tree nuts. You do, however, want to get rid of your apples, and I want those apples.
I could go to you and find out what you want instead of walnuts. You say, “Peaches.” I either find someone who wants to trade peaches for walnuts, or find someone who has what the peach guy wants who also wants walnuts, or find out what he wants instead of walnuts, and go find someone else . . .
|We don't have to caption this, do we?|
As you can see, barter can get more than a little complicated. To make things easier, people very quickly invented money. I don’t need to find someone who wants walnuts and who has peaches. No, all I have to do is find someone who wants walnuts and who has money and sell him the walnuts. I then take the money to the guy with apples, buy his apples with the money, and he goes and buys his peaches with the money.
What has happened here? I ended up trading my walnuts for his apples, while he ended up trading his apples for peaches. Instead of several transactions taking up virtually all of our time, by using "money" there was a total of four transactions taking up very little time.
Nor did we have to wait around for someone to create money for us to carry out our transactions. That’s the Currency Principle, in which money is regarded as a commodity of its own that has to exist before you can use it in carrying out transactions.
No, under the Banking Principle we created the money ourselves by carrying out transactions. When I went to the guy who wanted walnuts, he gave me a negotiable contract, an I.O.U. to the value of one bushel of walnuts. I took this contract to the apple guy and he accepted it in payment for his apples. He took it to the peach guy, who accepted it, and so on down the line until somebody decided to go to the guy who issued it and demand something equal to the value of a bushel of walnuts.
|Louis O. Kelso|
This was how people carried out transactions for thousands of years before a standard measure of money was invented. Every transaction had to be valued during the bargaining process, because the standard of value was different for every transaction. When currency came along, matters became much easier because there was now a standard unit of measure for money and thus for productions. This is why Louis Kelso’s definition of money (actually currency) is so useful — it helps us understand that money is not a commodity, but a tool by means of which we value and exchange commodities:
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.
With this understanding of money, we can see that the question, Where is the money to come from? isn’t something that need concern us. The real question is whether we can produce something that we and others want, and that they will be willing to trade what they have produced for what we have produced.
Money, after all, isn’t everything, and it should not be anything to worry about.