Appendix 3: The Textbook Story of Money

In order to fully appreciate how electronic value transfer systems are unfolding, it helps to revise what money is. We are forced to do this because token money has had a very stable form for the last century or so, and thus, its structure and attributes are not of significant interest to the wider population: we have generally internalised our learnings of what money is from our childhood experiences with pocket money.

Luckily, economists still study the nature of money, on the way to grappling with the wider questions of monetary policy. Standard economics definitions tend to ascribe the following characteristics to money [1]

Acceptance as a Medium of Exchange

This is what makes the dreaded barter economy unneccesary. Instead of having to accept cows as payment for my woven cloth, I can accept another item of value. This intermediate item is one that I know I can convert easily into the other valuables I desire. Hence, I avoid a double coincidence of wants.

This is often symbolised, with today's token money, in the phrase legal tender, although this is nothing more than a state's attempt to enforce the acceptance of its tokens as a medium of exchange -- it is still the citizens of the state who decide, or otherwise, to accept a monetary form as a medium of exchange.

Classically, most forms of physical money have derived their status from the desirability of the token for some unrelated purpose, e.g., gold as jewellry and salt as flavouring.

Unit of Account

By allowing money to be divided into convenient units, it can represent equally well things of great value and lesser value. Hence, if I can build one canoe in the same time as a hundred clogs, a unit of account will allow me to sell a clog for a monetary value of one hundredth of the value of a canoe (holding other things equal). Whilst not essential, trades are much easier if money can express a wide range of values.

Store of Value

I can use money to make purchases in the future - which implies that its value does not diminish significantly. This is not to say that it is the best store of value, but money must be good enough to be accepted in exchange, without me needing to cart it off in a wheelbarrow to the black money market.

Standard of Deferred Payment

Finally, if I am to borrow money now, there needs some way to recompense the lender in the future. This recompense is normally in terms of money, making it a unit of account over time.

Practical Aspects

So much for the theoretical aspects of money. Systems for exchange of value should also be measured against the following practical attributes:

value of token exceeds its cost of production,

restriction on availability or production, and

value as a means of payment exceeds its value for other purposes.

Notes and coins will normally be cheaper to make than their face value, with the resulting difference, siegnorage, being accrued by the issuer. They will also be more valuable as a means of exchange than for any other purpose - the cost of high-quality paper is much less than the face value of a greenback.

The issuer, these days, is normally a sovereign government which generally outlaws non-governmental production of it's token money as forgery. This gains several benefits, including economies of scale of production, security and consistency of supply, a stable promise, and the accrual of seignorage for the treasury.

Types of Money

Money generally separates out into two distinct forms:

Tokens. Physical objects are the ones traditionally used for small transactions, the sort that an individual is used to.

IOUs. The deposits held at a bank, or indeed any borrower, are IOUs. They may be noted down on a receipt, or by ledger entry. What makes them money is the fact that they can be accepted as payment, either by passing the receipt, or by instructing the borrower to adjust the ledger entries.

Unusual Forms of Money

All or most of the above attributes are recognisable in the money in widespread usage in each country. However, there are other forms of token money. Cigarettes were used in prisoner-of-war camps, and they conform to much of the above criteria [2]. There was no capability for production inside the camps, and consistent demand for them by smokers led to a belief that the value of cigarettes would be maintained over time, thus leading to their acceptance as a medium of exchange. They were low enough in individual value to form a useful unit of account.

In Japan, amongst the community of firms trusted by the banking system, yakusoku tegata, literally "promise hand form", circulate as money [3]. Firms are given pads of these notes to write as needed, and as they carry the name of a trusted bank as underwriter, they can be accepted as good payment.

1 Begg, Fischer and Dornbusch, Economics, 3rd ed, McGraw Hill, 1991

2 R.A. Radford, "The Economic Organisation of a P.O.W. Camp," vol xii Economica, 1945

3 Private conversation with David Lloyd-Jones.

Back to Index or Monetary Policy.