Monthly Archives: June 2014

If we had to pick one ‘truth’ that economics and finance insiders and innocent bystanders alike agree on, it’s perhaps that money is central to a modern economy. I think it’s a deeply flawed idea. Money is a convenience, and one not without drawbacks, but certainly not, as such, essential to a modern economy. Moreover, I believe that understanding how inessential money is greatly enhances one’s ability to understand how it works.

Money is seen as fulfilling two primary functions:

  • A store of value
  • A mean of payment

Any persistent asset or belief with a mechanism for recording exclusive usage is a store of value

That one is perhaps easier understood. To store value you need an exclusive claim (property) on something you can exchange in the future against things or services you may then want. The property can be of a functional object (e.g. an anvil) or a right (e.g. the right to keep out uninvited guests from a piece of land) or even a scarce but popular abstraction (e.g. fiat currencies, vanity plates). In all cases you need a central record keeper of property claims (though there may be as many as there are assets) which is likely enough to persist (remain recognised by possible future claimants).

Money is one such, but it is in no way essential to the ability to store value. Being at the more abstract end (it’s belief based, worth something as long as people desire to hold it) it may be seen as one of the weaker ones due to the risk of debasement (however low in practice in stable societies) or loss of interest from other users. However weak or strong, it cannot be argued to be indispensable.

A central bank (or all of them) could remove this function by simply establishing punitive negative real interest rate on reserves (after removing paper currency, a distraction, from circulation). People would then move their saving to other assets, exchanging their claims on central bank balances against claims on things, services or other scarce beliefs, of which there is a very great variety in the world (and if classic currencies fell out of use, an incentive to create more).

Any liquid asset with an easy to use property transfer system is a mean of payment

The mean of payment function of money is perhaps more essential, and the one that may seem harder to replace. Before we can replace it, we should think what problems does money as a mean of payment solve?

The first is that, by being used as a pivot asset in transactions, it enables generalised barter at society (market) level. That is considerably more efficient than everyone having to negotiate balanced pair transactions of the goods or services they directly use and produce.

The second one is a common unit of account, basically that enables a single price label that anyone can read.

In other words money is a payment app. The problem central money solves though are largely predating electronic devices and finance systems. It’s a payment app for the paper era.

The pivot function of money can be done with any asset whose ownership title is easy to transfer, either physically (metal tokens, diamonds, cigarettes) or electronically (any electronic register with a trading system, e.g. shares and bonds).

In the presence of electronic devices and real time data communications, it’s perfectly possibly to buy a loaf of bread by transferring a claim on any asset to a claim to any other asset that’s liquid. If the client likes to store value in Apple shares and the baker in Palladium futures, it is now perfectly possible to make a quasi instant transaction that will decrease the ownership claim of the buyer in Apple shares and increases the baker’s claim in Palladium futures by the value of the loaf of bread. This is made possible by electronic devices connected with the central property registries. Incidentally the electronic devices also solve the “common unit” issue, as the customer can display the loaf of bread’s price in terms of Apple shares on their screen, converted from what the baker entered in metal futures terms in their own terminal. No paper price label is needed any more.

Essentially everything liquid can be used as money, and indeed functionally is money. Dollars and Apple shares are not functionally distinguishable: both are based on a register of a finite number of units, whose issuance and record keeping is managed by a central entity. Members of the public can swap their claims with each other on electronic system (bank accounts and brokerage accounts are functionally the same thing).

What about credit then?

Credit is probably the weakest way in which money could be considered as essential. Credit is always a swap of resources in exchange of future recompense: “I give or lend you today an anvil that I have, and in exchange you give me a share of the metal widgets you’ll make with it”.

It’s just a trade with a temporal element that as such, very obviously, does not require money to exist.

Money is only, at best, a convenience. As the favourite payment app of the pre-electronic era, you may wonder if it’s not past its prime.

Why not close down all central banks and convert their HQ to flats then?

Why keep currencies then? Old habits die hard, mainly. It is convenient to still be able to use paper price labels, and have a relatively stable unit that one can talk about without using an electronic device. That does not make it essential though.

Beyond a better understanding, the world could benefit in financial robustness if the role of central money was reducedĀ  by making it less of a store of value (real rates should be kept negative) and encouraging diversity in disintermediated payment and credit systems (so as to make the bakery example less clunky than it is today).