What is Money?
December 1, 2011
(This item appeared in Forbes.com on December 1, 2011.)
What is money?
You would think this would be an easy question to answer – and it
is, actually – but very few people seem to be able to, including
most economists. This leads to all sorts of confusion, and the sort
of disasters of incompetence that are now happening in Europe and
Ideally, today’s troubles will lead to a new monetary system,
preferably a gold standard system. However, that would be difficult
if nobody knows what money actually is.
As I argue in my book Gold: the
Once and Future Money, money and credit are very different.
Yes, I know there are many, many people who claim that “money is
credit” and “credit is money.”
These people are confused. That is why, when you read what they
write, you become confused also. Don’t you feel confused after you
read this stuff?
The primary characteristic of money is that it is the item mutually
acceptable as a means of payment.
Credit (a loan or a bond) is not generally acceptable as a means of
payment. In effect, it would be a sort of barter.
Credit is a contract denominated in money. It is a legal agreement
to deliver certain payments at certain times. For example, a 13-week
U.S. Treasury Bill is not money. If I buy a bicycle, or some
groceries, I can’t pay with a 13-week U.S. Treasury Bill. I can
either wait for the bill to mature, or sell it, and receive money in
return, which I can then use to make payments.
The same goes for a money market fund. A money market fund is an
equity shareholding in a fund that owns things like 13-week Treasury
Bills. I can redeem my holdings with the money market fund manager,
and receive money in return. But, I can’t pay for groceries by
saying: “Here is my holding of 174.334 shares in the RMT Bank
Universal MMF.” The payee does not become the owner of a 174.334
share holding in the RMT Bank Universal MMF. I have to request RMT
Bank to redeem my holdings in money, which I can then use for
The same also applies to a basic bank deposit account, like a
checking account. You can’t pay for groceries by saying: “Here is a
deposit of $121.74 in RMT Bank.” The payee does not become the owner
of a bank deposit in RMT Bank. They receive money.
There are two ways the payee can receive the money. One is that they
can take the check to a branch of RMT Bank, and receive banknotes in
return. More commonly, however, they receive the payment at their
Let’s say the payee is a customer of ABC Bank, and the payer is a
customer of XYZ Bank. The payer uses their debit card to transfer
$121.74 to the payee’s bank account at ABC Bank. What actually
happens here? XYZ Bank has to make a payment to ABC Bank. XYZ Bank
makes this payment in money — either banknotes, as was the case in
the past, or deposits held at the Reserve Bank (a central bank such
as the Federal Reserve).
This is why bank reserves held at the central bank, although they
are electronic book entries, are considered money — because they are
acceptable as a means of payment. In the past, before there were
centralized bank clearing houses in the form of central banks,
commercial banks would actually make these transactions with paper
money. ABC Bank receives the payment and credits the account of the
payee accordingly. (In effect, ABC Bank automatically borrows the
money from the payee, increasing their deposit account, which is a
loan to ABC Bank callable on demand.)
Thus we see that even a debit card, wire transfer or check is
actually a payment made by one bank to another, using base money,
the acceptable means of payment.
Following from the above, money has certain characteristics. One is
that there is no counterparty. There is no legal agreement. This is
easy to see in the case of a commodity money like silver coins.
However, the same is largely the case for U.S. dollar banknotes,
managed by the Federal Reserve. It is more in the nature of a
manufactured good, just as gold coins must be manufactured.
A banknote redeemable in bullion is a sort of legal agreement.
However, since it serves as an acceptable means of payment, a
redeemable banknote is, I would say, a form of money, not credit.
Money generally does not pay interest (although Fed reserve deposits
do for the time being), and credit generally does pay interest
(although many forms of credit do not for the time being).
Gold bullion today generally does not serve as a means of payment.
However, gold has the desirable characteristics that we all want the
means of payment to have. Primarily, it is stable in monetary value.
It has other desirable characteristics as well, such as being easy
to store, infinitely divisable, a chemical element, compact and of
high value, and so forth. This is why we say that “gold is money,”
and it is why gold has so often been the foundation for successful
monetary systems for the last five hundred years.
Perhaps this sort of theoretical discussion seems disconnected from
today’s daily events. However, one of the reasons for the monetary
chaos we endure today is that few people even know what they are
talking about. How can you have a discussion about the best kind of
money … if you don’t even know what money is? It turns out that
money is actually very simple. When you can see how simple it is,
then the process of making rational monetary systems also seems
simple and achievable.