Sunday, August 29, 2010

What Is the Difference Between Commodity and Fiat Money

What Is the Difference Between Commodity and Fiat Money
Thomas Allen

Monetary systems can be divided into two major categories. One category is fiat money, which is sometimes called managed money, debt money, forced paper money, or irredeemable paper money. The other is commodity money, which is sometimes called full-bodied money, metallic money, specie, hard money, or precious metal money.

Commodity money is “that sort of money that is at the same time a commercial commodity.”[1] Gold and silver are the premier commodities used as money.

Fiat money “is a legal claim, since it derives all its properties from the law.”[2] It is simply a purchase voucher, whose purchasing power varies, that can be exchanged for goods and services. The settlement of debts is its only fixed right.

Webster’s New International Dictionary (second edition, unabridged) defines fiat money as “paper currency of government issue which is made legal tender by fiat or law, does not represent, or is not based upon, specie, and contains no promise of redemption.” The government or its central bank issues fiat money, and the government declares it to be legal tender. Currently, in the United States fiat money occurs as federal reserve notes.

Commodity money differs from fiat money in two important ways. First, under a commodity monetary system, the money supply adjusts automatically to monetary needs. “[T]he demand for, and supply of, money react simultaneously, through market prices for all goods and services and the monetary metal, to determine a given quantity of money.”[3] The markets decide how much money to create and issue. Under a fiat monetary system, the money supply is regulated artificially. The government or its central bank regulates the money supply. The government decides how much money to create and issue. Second, the value of commodity money is directly related to the material of which it is made. For fiat money, value is independent of its material and depends solely on the demand for and supply of money. Of these two differences, the most important lies in the method used to regulate the supply of money.

Johnson makes the following comparison between commodity money and fiat money: “(1) commodity money, or money made out of material of which the free use is permitted as money, so that its value is the product of two sets of utilities, namely its utility as money and its utilities as an ordinary commodity; (2) fiat money, or money the value of which has no relation to the value of the material out of which it is made, being the product solely of its utility as money.”[4]

Many people often confuse commodity money with fiat money when the fiat monetary system incorporates gold or silver. A money backed by gold is not necessarily commodity money. (Under the true gold standard, gold does not back the money. Gold is the money.) For example, legal tender federal reserve notes between 1933 and 1968 were legally required to be backed by gold. Yet it was not commodity money. No American citizen could redeem federal reserve notes for gold. The Federal Reserve decided how many federal reserve notes to issue instead of the markets. The value of gold backing them was much less than the monetary value of the notes. Hoppe makes this error.

Hoppe compares fiat money with commodity money as follows: “Fiat money is the term for a medium of exchange which is neither a commercial commodity, a consumer, or a producer good, nor title to any such commodity: i.e., irredeemable paper money. In contrast, commodity money refers to a medium of exchange which is either a commercial commodity or a title thereto.”[5] Hoppe’s description overlooks an important feature of fiat money, and, that is, the issuance of fiat money is arbitrary. Under Hoppe’s description, silver dollars issued in the 1880s and 1890s were commodity money as they contained a commercial commodity. They were money in their own right and were not directly redeemable in gold on demand. However, as Congress and the Secretary of the Treasury arbitrarily fixed the amount issued, they were fiat money. Moreover, the coin’s face or monetary value was greater than the value of its metal content.

Rist explains the difference between commodity money and fiat money as follows:
[I]t must be recognised that the belief in gold arises not from age old superstitions of a more or less magical character, but from age old experience. A claim on gold—a cheque or a banknote—is something clear and precise that everybody understands, just as everybody understands a mortgage on a piece of land or a house that he knows. Paper [fiat] money is a claim on something unknown, on a country or a government, whose political, social or financial escapades and arbitrary decisions nobody can be sure of beforehand.[6]
Vieira compares commodity money with fiat money as follows:
With commodity money, the actual commodity, the silver or the gold, is both the medium of exchange and the standard of value. The supply of commodity money is self-limited because of the costs of minting, refining, and coining the silver and gold. New supplies of commodity money will be coined only to the extent that coinage is economically profitable. The market will simply not produce more gold and silver coin than is necessary compared to all the other uses of that capital. . . . [F]iat money is composed of some intrinsically valueless substance which the issuer does not promise to redeem in a commodity or in a fiduciary money. Because fiat money has no legal connection to a commodity money, and, therefore, has no real economic cost in terms of production, the supply of fiat money is never self-limiting and is always largely a matter of public confidence in the economic or political stability of the issuer.[7]
Vieira description of commodity money and fiat money fails to account for silvers dollars of the 1880s and 1890s. They contained a valuable substance, silver, which seems to make them commodity money. However, the government decided the quantity to issue instead of the markets, which makes them fiat money.

It also fails to account for U.S. notes between 1879 and 1933. U.S. notes were redeemable in gold on demand during in those years. However, Congress decided the quantity to issue. Also, the gold backing them varied between about one-third and one-half. Thus, they were not genuine warehouse receipts as were gold certificates, which were required to be fully backed by gold.

Mises describes the difference between commodity money and fiat money as follows:
. . . it is the commodity in question that constitutes the money, and that the money is merely this commodity. The case of fiat money is quite different. Here the deciding factor is the stamp, and it is not the material bearing the stamp that constitutes the money, but the stamp itself. The nature of the material that bears the stamp is a matter of quite minor importance.[8]
Mises’ description accounts for silver dollars of the 1880s and 1890s The stamp instead of the metal content gave these silver dollars their value. His description also accounts for U.S. notes between 1879 and 1933. The stamp and not the metal backing gave them their value as they were not fully backed by gold.

With commodity money, the commodity makes the money. “The value of a coin has always been determined, not by the image and superscription it bears nor by the proclamation of the mint and market authorities, but by its metal content.”[9] With fiat money, the stamp and force of government make the money. Fiat money derives its power to make purchases and to pay debt solely from words printed on the currency, i.e., it derives its power from governmental fiat.

Fekete notes that commodity money is “tied to a positive value: the value of a well-defined quantity of a good of well-defined quality.”[10] Fiat money is “tied not to positive but to negative value—the value of debt instruments.”[11]

Commodity money is the only form of money that is a present good. All paper money, including certificates and fiat money, is a promise to pay; it is a future obligation. With fiat money the payment is never made; it is only discharged. Payment with commodity money completes the transactions; payment with fiat money is an extension of credit. (In this respect a gold certificate is like fiat currency. The gold certificate is credit, a promise to pay in gold and the transaction is not completed and the debt retired until the certificate is redeemed in gold.) With irredeemable fiat currency, the transaction can never be completed because the currency is irredeemable. The transaction is discharged by a transfer of credit.

Under a fiat monetary system, debt, promise, or obligation is used as money and as final payment. Fiat money is basically paper money and its electronic equivalent representing nothing but a promise or an obligation. Under a fiat monetary system, a final payment can never really occur as one is always paid with debt, promise, or obligation, a representation that something else is owed. Thus, fiat money can only discharge debt; it can never retire debt.

Under a pure commodity monetary system, final payment is always in the commodity being used as money in the transaction. The commodity can function as final payment because it is no one’s obligation. Receipt of the commodity in payment ends all further obligations. Thus, it retires debt.

In fiat monetary systems, the monetary unit is a nebulous abstraction, a legal fiction. Fiat money is not tangible, lacks definition, and has no defined unit of measure. It is an illusion with no connection to reality.

In commodity money systems, the monetary unit is tangible and measurable. It is a specific and definable weight of a particular commodity, usually gold or silver. Unlike fiat money, commodity money has value in and of itself independent of its monetary use.

Under a commodity monetary system like the gold or silver standard, the quantity of money is not subject to governmental manipulation. With fiat money, the government maintains control of the money and can change the money supply to suit political considerations.

With a commodity monetary system like the gold standard, market forces determine the quantity of gold coined. The people decide how many gold coins that they need by the quantity of gold brought to the mint for coinage and by the quantity of gold coins melted for other usages. Thus, a commodity monetary system uses the knowledge and wisdom of all the people in regulating the money supply.

With a fiat monetary system, a definite governmental monetary policy is needed to regulate the quantity of the fiat money. Development of this policy requires the opinions of “experts” on the desirable goals. Thus, this policy is nothing more than the personal value judgment of these experts. Once they have selected a policy, the force of government is needed to carry it out. Neither the experts who develop the policy nor the governmental agents who impose it can accurately foresee the long-term effects of the policy. Adolph Miller, a member of the Federal Reserve Board, in his testimony before Congress, summed up this major problem with fiat money: “Up to this day it has never yet been demonstrated that any agency can be invented to which power to govern the currency could be entrusted without ultimately disastrous consequences.”[12]

Commodity money is an economic currency. Needs of the economy determine its quantity. It is directly connected with the production of real goods and services.

Fiat money is a political currency. Needs of politics determine its quantity. It is directly connected with government debt even if the government issues the currency directly and interest free. (When the government issues a currency like U.S. notes, it is issuing interest free government debt that is used as money. Often such debt is never paid.)

With fiat money, the government gains a monopoly over money. Using its monopolistic control of money, it can inflate until the money becomes completely worthless. With legal tender laws, it can force people to accept ever depreciating money.

Under a commodity monetary system, the value of the monetary commodity comes from its production. Under a fiat monetary system, the value of money comes from its legal obligation.

With fiat money, people trust politicians, bureaucrats, and bankers. They trust paper and promises. With commodity money, people trust gold and silver. They trust that which is no one’s obligation or promise.

Fiat money is totally dependent on commodity money, at least initially, for its value. Greaves describes this dependency as follows:
The original value of any money was the use value that commodity had in its other uses before it was first used as a medium of exchange. It then had an objective exchange value based on some other use or uses. This historical link is absolutely necessary, not only for commodity money, but also for every legally sanctioned credit or fiat money. No fiat money ever came into use without first satisfying this requirement. It is absolutely impossible to start a new money without an historical use value, or without its being related to some previous money or commodity with a prior use value. Before an economic good or a “paper money” begins to function as money, it must possess, or be given, an exchange value based on some use or good other than its own monetary value.[13]
“Money cannot originate as a new fiat name, either by government edict or by some form of social compact.”[14] Fiat money grows out of commodity money. “Money must emerge as a commodity money because something can be demanded as a medium of exchange only if it has a pre-existing barter demand. . . .”[15]

Unlike commodity money, fiat money does not come into use spontaneously. Conversion from commodity money to fiat money requires coercion. People do not naturally and freely abandon commodity money for fiat money.

Fiat money rests upon the premise that the power of government is enough to give value to a piece of paper that has no intrinsic value. Fiat money adherents firmly believe that a government can create value by simply proclaiming that a piece of paper has value. Evidence of this is seen in the federal reserve note. Originally, the note promised to pay in gold. Now it just declares itself to be so many dollars. It went from being a legitimate substitute for real money, gold, to being fiat money.

Gold and silver protect the people. Fiat money enslaves them. Frederick von Hayek remarks:
With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people. What is dangerous and ought to be eliminated is not the government's right to issue money, but its exclusive right to do so and its power to force people to accept that money at a particular rate.[16]
Commodity money limits the power of government.

Gold and sliver money limits the size of government by restraining its growth. Fiat money allows government to expand almost without limits.

Endnotes
1. Ludwig von Mises,. The Theory of Money and Credit (New edition. Translator H.E. Batson. Irvington-on-Hudson, New York: The Foundation for Economic Education, Inc., 1971), p. 61.

2. Charles Rist, History of Monetary and Credit Theory from John Law to the Present Day (1940; reprint. Translator Jane Degras. New York, New York: Augustus M. Kelly, 1966), p. 337.

3. Richard H. Timberlake, “Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy,”Econ Journal Watch, II (August 2005), 199.

4. Joseph French Johnson, Money and Currency: In Relation to Industry, Prices, and the Rate of Interest (Revised edition. Boston, Massachusetts: Ginn and Company, 1905), p. 32.

5. Hans-Hermann Hoppe, “How is Fiat Money Possible?—or, The Devolution of Money and Credit,” The Review of Austrian Economics, VII (1994), 49.

6. Rist, p. 434.

7. Edwin Vieira, Jr., “Restoring the Dollar,” http://www.citizensforaconstitutionalrepublic.com? Vieira_Restoring_the_Dollar.html, Apr. 23, 2008.

8. Mises, p. 62.

9. Mises, p. 62.

10. Antal E. Fekete, “Whither Gold?”, Oct. 29, 1996, http://www.sagold.com/whithergold.html, Sept. 13, 2007.

11. Ibid.

12. Percy L. Greaves, Jr., Understanding the Dollar Crisis (Belmont, Massachusetts: Western Islands, 1973), p. 231.

13. Ibid., p. 157.

14. Murray N. Rothbard, The Case for a 100 Percent Gold Dollar (Washington, D.C.: Libertarian Press, 1974), p. 10.

15. Hoppe, p. 51.

16. Antony C. Sutton, War on Gold (Seal Beach, California: ‘76 Press, 1977), p. 65.

Copyright © 2010 by Thomas Coley Allen.

More articles on money.

Wednesday, August 18, 2010

What Are the Functions of Money

What Are the Functions of Money
Thomas Allen

Money has four basic functions. They are a medium of exchange, standard of exchange value, store of value, and payment of debt.

As a medium of exchange or purchasing medium, money is used to buy goods and services. It is immediately available in its existing form to the buyer and immediately acceptable by the seller. Not only is money a means of payment; it is also the thing used as final payment for purchases. After a purchase has been made, money involves no continuing or further obligation. As a medium of exchange, money can transport value through space.

Fiat money is a failure as a medium of exchange. When a person buys something with fiat money, he pays with credit (the fiat notes). Buying goods and services with fiat money is more like nothing-for-something than something-for-something that occurs when commodity money is used. Fiat money is a poor semblance as a medium of exchange.

When a person buys with commodity money, he exchanges a real asset whose material value equals its monetary value for assets. Even if he buys with a form of credit money, such as a bank note or check, instead of commodity money itself, he still buys with a real asset. The credit money that he uses quickly converts into the underlying commodity. Fiat money can only convert into another obligation.

Besides being a medium of exchange, money also serves as the standard unit of exchange value, i.e., as a standard of prices and of account and debt. Money is the standard by which the value of various things is measured and compared. Thus, money is a measure value. As a standard of value, money can transport value through time. It enables people to estimate the present value of future acts.

With commodity money, the standard of value is objective. It is the value of the commodity in its nonmonetary use. With fiat money, it is an arbitrary arithmetical abstraction.

Being the standard of value, money is the common denominator by which value of things are compared. It is the measure. As a measure of value, money simplifies the comparison of contemporaneous values of goods and services. By comparing prices of various goods and services, a buyer can determine their relative value to each other. For example, if a haircut costs $15 and a hamburger costs $3, then a haircut has the value of five hamburgers. Money becomes the common denominator by which the values of things are reduced to their prices. Price is simply “the exchange value of an article in terms of the monetary unit.”[1] Price makes possibly the keeping of general accounts. Thus, as the standard of value, money becomes the unit of accounts.

However, for money to function properly as the common denominator by which values are compared, the monetary unit itself must have value. The monetary unit must have a specific definition and made of something that has value.[2] To measure value, it must be a unit of concrete value. For example, a silver dollar, the dollar mentioned in the U.S. Constitution, is 371.25 grains of fine silver or 412.5 grains of standard silver (nine-tenths fine). Money should contain material that is in itself valuable. It ought not be an abstraction. It must be able to move value from one place to another and from one time to another.

The value of paper fiat money becomes an abstraction. Initially, its value is based on the commodity money that it replaces. No paper fiat money spontaneously comes into existence without a relationship to a preexisting commodity or tangible asset.

As a standard of value, fiat money also fails. It is useless as a long-term accounting unit without adjustments. These adjustments are poor substitutes for sound money. Furthermore, “business profits are widely overstated because historically determined depreciation charges are inadequate in terms of current replacement costs. Likewise for inventory accounting and charges for goods sold.”[3]

Money is also a store of value, i.e., wealth can be held in the form of money. As a store of value, money must be able to retain its value when moved from one place to another and from one time to another. It transports value over time and space. Money serves “as a standard of deferred payments.”[4] It “stores up the value of future goods and services sold”[5] and bridges the present with the future. People expect today’s money to serve as payment ten to thirty years from now. Such expectations make long-term contracts practical. The expectation is that today’s money will retain its purchasing power over the long term. Also, as a store of value, money serves as insurance against the uncertainties of the future.

To serve as a store of value, money must be stable in value for an indefinite time. As a store of value, fiat money is a miserable failure. In the United States since 1933, the dollar had lost 93 percent of its purchasing power by 2005. Since its complete divorce from gold in 1971, it had lost 79 percent of its purchasing power by 2005.

On the other hand, gold has retained its value through the millennia. The ancient Babylonian and Hebrew gold shekel contained about 252 grains of gold or about as much gold as an American eagle (a $10 gold coin).[6] Those 252 grains of gold are still worth 252 grains today.

If a time traveler carried a $10 gold coin back two thousand years, he would have the buying power equivalent to about 58 days of wages of a common laborer. A common laborer’s wage at that time was about 17¢ per day.[7] Moreover, because a double eagle (a $20 gold coin) contains twice the gold of an eagle, it would have twice the buying power. If he carried a $100 and a $1 federal reserve note with him, he would get only what he could trade his bills for as a curiosity. He would find the $1 bill worth more than the $100 bill if the person with whom he is trading finds that the occult symbols on the back of a $1 bill have great value whereas a picture of Independence Hall on the back a $100 bill has none. Unlike commodity money, fiat money fails to maintain its value through time.

Nevertheless, the purchasing power of gold and silver does fluctuate. At times their purchasing power rises; at other times it declines. Gold and silver’s value tends to rise for about 10 to 20 years and fall for about 10 to 20 years. However, compared to fiat money, whose purchasing power usually trends downward, gold and silver are stable.

Money is not the only store of value. Commodities, financial assets, land, and collectibles can serve as a store of value. However, there is a cost to converting money into other assets and these assets into money. Money is merely the most liquid asset for a store of value as no conversion is needed.

Finally, money must be able to pay debt. It provides a means to pay debt.

When a person pays a debt, he either retires it or discharges it. If he pays with commodity money, such as a full-weight gold coin, he retires the debt. He has paid the debt with something that is no one else’s obligation.

If a person pays with paper money (gold certificates, bank notes, or government notes), check, or any other kind of money substitute (credit money or representative money), he merely discharges the debt. He has paid the debt with another obligation or debt. The debt is not retired until the paper money is converted into commodity money or the check transfer the commodity money to the creditor’s account.

Although the same substance can perform all four functions of money, it does not have to do so. Much convenience is often found in one substance performing all four functions. For example, a 10-pennyweight gold coin can be a medium of exchange, the standard by which value is measured, a store of value, and a payment for debt.

Under bimetallism, gold and silver were used as money with a legally fixed exchange rate or ratio between the two. In the United States, silver was the standard of value until 1862. In 1834 Congress changed the exchange rate or ratio between gold and silver. The new ratio reduced the value of gold in terms of silver. Thus, full-weight silver coins soon ceased circulating, and gold coins became the medium of exchange. Silver was the standard of value. Gold was the medium of exchange. Both were a store of value.

Endnotes
1. E.C. Harwood, Cause and Control of the Business Cycle (Great Barrington, Massachusetts: American Institute for Economic Research, 1974), p. 58.

2. J. Laurence Laughlin, The Elements of Political Economy (New York, New York: American Book Co., 1887), pp. 61, 68.

3. Ernest P. Welker, editor, Why Gold? (Great Barrington, Massachusetts: American Institute for Economic Research, 1978), p. 11.

4. Joseph French Johnson, Money and Currency: In Relation to Industry, Prices, and the Rate of Interest (Revised edition. Boston, Massachusetts: Ginn and Company, 1905), p. 15.

5. Charles Rist, History of Monetary and Credit Theory from John Law to the Present Day (1940; reprint. Translator Jane Degras. New York, New York: Augustus M. Kelly, 1966), p. 84.

6. Madeleine Miller and J. Lane Miller, Harper’s Bible Dictionary (New York, New York: Harper & Brothers Publishers, 1959), pp. 454-455.

7. John D. Davis, The Westminister Dictionary of the Bible (Revised by Henry Snyder Gehman. Philadelphia, Pennsylvania: The Westminster Press, 1944), p. 630.

Copyright © 2010 by Thomas Coley Allen.

More articles on money. 

Sunday, August 8, 2010

What Is Money?

What Is Money?
Thomas Allen

In Money and the Mechanism of Exchange, Jevons discusses the difficulty in defining “money.”[1] Jevons was an Englishman, and his comments are directed at England in the late nineteenth century. He states that a full-weight legal-tender gold coin was undoubtably money. Today such a coin is not money in the legal sense although one can buy more with a gold British sovereign from an Indian peasant than he can with an equivalent quantity of today’s British paper money. He is inclined to include legal-tender bank notes converted on demand into gold coins. Should U.S. bank notes, which were never legal tender before 1933 but could be redeemed in gold on demand, except between 1862 and 1879, be considered money? (Between 1862 and 1879, most banks redeemed bank notes into legal-tender inconvertible government notes, U.S. notes, commonly called greenbacks.) Should inconvertible legal-tender government notes like U.S. notes between 1862 and 1879 be considered money? They were a common medium of exchange and used to discharge debt during this era. Should everything used to pay a debt that a debtor is willing to use and the creditor is willing to accept be considered money? For example, if a debtor pays a debt with a stock certificate and the creditor accepts it as payment, does that make stock certificates money?

Gold as a full-weighted coin seems as it should obviously be money although not in the legal sense. Some economists, such as Gary North,[2] argue that today gold coins are not money because one cannot walk into a department store and buy stuff with it. As more stores begin to accept silver coins at bullion value for payment, North’s argument loses its weight. At least one store in Texas refuses payment in federal reserve notes and only accepts silver in payment.

Is gold bullion money? What about Asian gold bullion jewelry, is it money? George, who wrote under the gold standard, claims that they are not. For example, in the United States, a person could not go to the ticket counter and buy a train ticket with a small bullion bar or Asian bullion jewelry. He probably could not even do it with a British sovereign. He would have to use a U.S. gold coin. Yet under the gold-coin standard and to some extent under the gold exchange standard, gold bullion was used to settle foreign accounts. It can easily be coined with minimal cost. As Rothbard notes, the material makes the money and not its shape.[3]

As can be seen from the above brief introduction, economists disagree about what is money. They have been debating money and what it is for more than 200 years. They have not yet come to a consensus.

Most people call what they use to buy everyday goods and services and to pay their debts money. This is what money means in the popular sense and, as we shall see, how some economists define it.

In the legal sense, money is whatever the law declares it to be legal tender. Usually whatever the law declares to be legal tender, a creditor must accept as payment of debt.

Let’s see how some economists define money.

Webster’s New International Dictionary (second edition, unabridged) defines money as “1. Metal, as gold, silver, or copper, coined, or stamped, and issued by recognized authority as medium of exchange; coinage in general. . . . 4. Any particular form or denomination coin or paper which is lawfully current as money;—now chiefly pl. 5. Anything customarily used as a medium of exchanged and measure of value, as sheep, wampum, copper rings, quills of salt or of gold dust, shovel blades, etc.; hence, Econ., anything having a conventional use either (1) as a medium of exchange or a measure of value, or (2) as a measure of value alone. In the latter case it is often called a money of accounts, and may be any arbitrary amount of property or wealth of any kind, as a flock of sheep of determined size or a lac (100,000) of rupees. 6. Any written or stamped promise or certificate, such as government note or bank notes (often called paper money), which passes currently as a means of payment.”

F.A. Walker defines money as “that which passes freely from hand to hand throughout the community in final discharge of debts and full payment for commodities, being accepted equally without reference to the character or credit of the person who offers it and without the intention of the person who receives it to consume it or enjoy it or apply it to any other use than in turn to tender it to others in discharge of debt or payment for commodities.” [4]

Johnson defines money as “that valuable thing or economic good which possesses in any country or community universal acceptability as a medium of exchange or means of payment.”[5]

Ely defines money as “whatever passes freely from hand to hand as a medium of exchange and is generally received in final discharge of debt.”[6] Ely considers this definition to be the popular definition. He defines money in the economic sense as:
Money, according to the economic conception, must first serve directly and immediately as a measure of value; secondly, it must serve as a medium of exchange; in the third place, it must be capable of serving as a means of making payments; and fourthly, it must be a store or receptacle of value.[7]
Mises defines money as “the thing which serves as the generally accepted and commonly used medium of exchange.”[8]

George defines money as “whatever in any time and place is used as the common medium of exchange. . . .”[9]

Hawtrey defines money as “the means established by law (or custom) for the payment of debts.”[10]

Duesenberry defines money as “something that people are willing to accept in exchanges, even if they have no use for the thing themselves. . . . [M]oney is something people accept in exchange for goods, in the expectation of passing it on to someone else in a further exchange.”[11]

Klien defines money as “anything generally acceptable as a means of paying off debt.”[12]

Robertson defines money as “anything which is widely accepted in payment for goods, or in discharge of other kinds of business obligation.”[13]

Gnazzo defines money as “the commodity that has the most stable value, and which can be exchanged in value or kind, for any other commodity, or service in the market place.”[14]

As can be seen from these definitions, money is defined primarily by its functions, especially its function as a medium of exchange. These basic functions of money are a medium of exchange, a standard or measure of value, a store of value, and a payment of debt. These functions are discussed later. Hawtrey remarks, “Money is one of those concepts which, like a teaspoon or an umbrella, but unlike an earthquake or a buttercup, are definable primarily by the use or purpose which they serve.”[15]

Money is that thing that people accept as final payment for their labor and products. It is whatever a community uses to exchange for goods and services and to discharge debts and other monetary obligations. It can be fiat money or commodity money. These two types of money are discussed later.

People use a thing as money for one of two reasons. One is that the markets prescribe its use. (The markets are the people acting spontaneously in their economic activity according to their economic contribution.) The other is that the government forces its use. Market activity leads to commodity money whereas governmental coercion leads to fiat money.

The thing that the markets choose to be money is (or becomes) the most marketable or saleable thing in that economy. The more marketable or saleable that a thing is the less it changes value when it changes hands. For example, when one buys a car and immediately tries to sell it even without moving it from the dealership, he cannot sell it for the price that he paid just moments earlier. An immediate sell results in a noticeable, and possibly significant, drop in price (value or purchasing power). Likewise, with stock, when one buys a stock, he pays the higher ask price. When he sells it, he sells it at the lower bid price. However, when a person sells (exchanges) a product for money, he can immediately use that money with no noticeable loss in value or purchasing power. Thus, one can buy money by selling his labor or goods and immediately sell it by buying another’s labor or goods with no risk of a noticeable lost in value. That is because of the marketability or saleability of money. It is so marketable that it can change hands without a loss of value. With all other items, a person risks a noticeable lost if he immediately sells that which he has just bought.

Money has only one real utility and that is its exchangeability. People want it because of this utility. Like a hammer, money performs a specific service, and people want it because it performs that service. They can easily exchange it for goods and services that they want to consume. People want money not to consume it, but to exchange it for things that they want to consume.

Money has no inherent value in and of itself. Its value lies within the goods and services for which it can be exchanged. It represents purchasing power and is a receipt for value. It represents the value of the thing for which it is exchanged. Because money is only useful for buying and selling goods and services, the more that a given amount of money can buy, the greater is its purchasing power.[16]

According to Alchian and Allen, “Money is a device that lowers costs of exchange and enlarges productivity via specialization.”[17] Rothbard states, “[Money enables] goods and services to travel more expeditiously from one person to another.”[18] George writes, “. . . [money] may be passed from hand to hand in canceling obligations or transferring ownership. . . .”[19] George adds, “. . . the use of money, no matter of what it be composed, is not directly to satisfy desire, but indirectly to satisfy desire through exchange for other things.”[20] Duesenberry remarks, “Unlike most things, money isn’t used up when it is used.”[21] People acquire money not to consume it or to employ it in their own productive activity, but to exchange it in the future for goods and services.

In conclusion, money is whatever a community accepts as payment for goods and services and as payment of debt. It is also the standard by which the values of goods and services are measured and compared. It can vary with time and place. What a community uses for money at one time may differ from that used at another time. What one community uses for money may differ from that which another community uses.

Some commodities possess characteristics that other commodities lack that give them an advantage as the use of money. Such commodities become money when the markets are left free to choose their money.

Money should not be confused with wealth. It is not wealth; it is a tool to acquire wealth. Things like food, cars, houses, and factories are wealth. Money can reduce wealth to a single number, price.

Nevertheless, because gold and silver are desirable in themselves, they are part of wealth even when in the form of coins. Gold and silver coins can be thought of as wealth in circulation. Being merely legal claims, paper money, whether redeemable or irredeemable, is not a part of wealth.

Fiat money adherents mistakenly believe that money creates wealth. They believe that inflating the money supply increases wealth. The opposite is true. Inflation destroys wealth. Inflation drives down the purchasing power (value) of money.

Wealth causes an increase in the value of money. If productivity increases faster than the money supply, the purchasing power of money increases. With commodity money, as wealth increases, general prices decline, and the value of money rises. This increase in money’s value gives the incentive to search for more of the monetary commodity.

Endnotes
1. W. Stanlely Jevons, Money and the Mechanism of Exchange (New York, N.Y.: D. Appleton and Co., 1896), pp. 248-250.

2. Gary North “What Is Money? Part 2: Precious Metal Coinage,” Oct. 1, 2009, http://www.goldseek.com/tools/print.php, Nov. 26, 2009.

3. Murray N. Rothbard, The Case for a 100 Percent Gold Dollar (Washington, D.C.: Libertarian Review Press, 1974), p. 12.

4. C.F. Bastable,“Money,” Encyclopedia Britannica, R.S. Peale Reprint (1890), XVI, 720.

5. Joseph French Johnson. Money and Currency: In Relation to Industry, Prices, and the Rate of Interest (Revised edition. Boston, Massachusetts: Ginn and Company, 1905), p. 7.

6. Richard T. Ely, An Introduction to Political Economy (Revised edition. New York, New York: Eaton & Mains, 1901), p 177.

7. Ibid., p. 178.

8. Ludwig von Mises, Human Action: A Treatise on Economics (3rd revised edition. Chicago, Illinois: Henry Regnery Company, 1963), p. 401.

9. Henry George, The Science of Political Economy (1897; reprint. New York, New York: Robert Schalkenbach Foundation, 1962), p. 494.

10. Ralph George Hawtrey, Currency and Credit (London, England: Longsmans, Green and Co., 1919), p. 17.

11. James S. Duesenberry, Money and Credit: Impact and Control (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1964.), p. 6.

12. John J. Klein, Money and the Economy (4th ed. New York, New York: Harcourt Brace Jovanovich, Inc., 1978), p. 3.

13. D.H. Robertson, Money (Chicago, Illinois: University of Chicago Press, 1957), p. 2.

14. Douglass V. Gnazzo, “Honest Money: What It Is and What It Isn’t,” part 1, 2006, http://www.honestmoneyreport.com/archives/2006/0312.php, Jan. 1, 2007.

15. Hawtrey, p. 1.

16. Douglass V. Gnazzo, “Honest Money: What It Is and What It Isn’t,” part 2, 2006, http://www.honestmoneyreport.com/archives/2006/0319.php, Jan. 1, 2007.

17. Armen A. Alchian and William R. Allen, University Economics: Elements of Inquiry (3rd edition. Belmont, California: Wadsworth Publishing Co., Inc., 1972.), p. 572.

18. Murray N. Rothbard, What Has Government Done to Our Money? (Santa Ana, California: Rampart College, 1963), p. 11.

19. George, p. 483.

20. Ibid., p. 484.

21. Duesenberry, p. 3.

Copyright © 2010 by Thomas Coley Allen.


More articles on money.