So what is money…really?
There is an aphorism that “it is not getting the right answer but asking the right question” that is crucial. Readers of this site are surely familiar with advertisements such as ‘real money’, ‘honest money’, ‘fiat’ money, printed money, borrowed money… ad infinitum.
In fact, Aristotle named the desirable qualities of money;
The money must be sustainable.
Money must be portable
Money must be divisible
Money must have intrinsic value
What question did Aristotle’s qualities answer? The question ‘what makes good money vs. not so good’. This question is fundamentally different from ‘what is money’. If we ask what money is better/not so good, we assume that we already know what money is and what isn’t… a big assumption.
During recorded history, many things played the role of “money” (mainly store of value and medium of exchange); cattle (pecus… pecuniary of Roman origin) salt (origin of wages) cowrie shells, cocoa beans, even cigarettes in POW camps during WWII… and of course gold and silver through the centuries.
But before thinking about what money is better, we must decide what money is… bad or good… and what is not money. One way to understand this dichotomy is to study history; the history of money… and the history of real vs. fake money.
Please note that cattle, salt, cowrie shells, cocoa beans, cigarettes, monetary metals, etc. they are all some kind of ‘things’… that is, they are real items. Not a single ‘promise’ or ‘promissory note’ in the group. On the other hand, paper ‘money’ (banknotes) is nothing more than a promise… of something.
To make this clear, let’s simplify; consider a pound of sugar as the ‘thing’… and a ‘sugar pound note’ as the promise. I borrow a pound of sugar from you and give you a promissory note for ‘a pound of sugar’; then the difference becomes obvious; the ‘thing’ (pound of sugar)… and the promise… the paper promissory note.
And what do you say? Well, you can certainly use the sugar to sweeten your coffee… but not so much the (paper) promissory note. If you can put up with the pound of sugar, great; you have the property and can put it to use; but the promissory note, no way. Only if you redeem the promissory note will it have any real value.
Keep in mind that the pound of sugar is an asset… no matter who owns it. On the other hand, the note is an asset while it is in your hand; a claim on a pound of real sugar. Fundamentally, from my point of view, the promissory note itself is a liability; after all, it is a claim on me for a real item, a pound of sugar that I have to return to you on receipt of the promissory note.
The promissory note is an asset or a liability, depending on your point of view; the IOU writer vs. the Porter. On the other hand, sugar is a ‘pure’ or ‘real’ asset; valuable no matter in whose hands it resides.
This is what Aristotle considered ‘intrinsic value’…sugar has ‘intrinsic’ value, rather than the ‘derived’ value that the promissory note has. In simple words, the promissory note only has value to the extent that it is redeemed… and redeemable. This is often referred to as ‘credit risk’ or ‘counterparty’ risk… the note is not very resilient; it will lose its value if the issuer of the note defaults. Real things have no counterparty risk.
The very promissory note that is an asset in your hand is my responsibility… after all, if you present the promissory note to me, I am obligated to return a pound of real sugar to you… thus extinguishing the promissory note. In fact, once redeemed, the promissory note loses its value; paid in full…but a pound of sugar is still a pound of sugar…certainly not worthless.
Thus, money extinguishes debt; that’s the hallmark of ‘real’ money. When (yes!) I return the pound of sugar to you, the promissory note is redeemed; the debt disappears, is extinguished by real ‘things’. We could even negotiate that instead of a pound of sugar, I give you ½ pound of salt; if you agree, then the promissory note is also extinguished, again for real things. Substitute silver and gold for sugar and salt…
Suppose you decide to exchange your note to Jane for the pound of sugar, instead of returning it to me…if Jane agrees, you get your pound of sugar…but the debt is NOT extinguished; now Jane has it, and I shall have to give Jane the pound of sugar if she gives me my note. The promissory note served as a medium of exchange; but NOT as a debt extinguisher. The promissory note plays a (false) monetary role, but it is not money, since it cannot extinguish the debt.
Not only that; suppose I don’t use the pound of sugar I borrowed, but lend it to Joe; in turn, Joe gives me an IOU for a pound of sugar… and magically, a pound of real sugar now has two IOUs against it. Who would have thought! One pound of sugar, two promissory notes claiming the same pound of sugar. This process can proliferate with no end in sight; Joe could re-lent the sugar, etc… Endless IOUs ‘backed’ for the same pound of sugar.
If you come to claim your pound of sugar, which I no longer have, I cannot give you your sugar. Joe now has it; All I have is another IOU. Would you exchange the note I gave you for the note Joe gave me? Mere exchange of debt notes… We begin to see how real things are categorically different from promissory notes; promissory notes disguised as money cannot extinguish the debt; they can only change the holder of the debt.
But it gets better, not just for silly debts like a pound-sugar promissory note, but for debts in the real world as well. Let’s look at two companies; call them Co. ‘A’ and Co. ‘B’. Company ‘A’ makes grommets… and Company B purchases grommets to incorporate into their own line of widget products. ‘A’ sells a hundred buttonholes to ‘B’; then in ‘A’s books, in Accounts Receivable, an entry is created for ‘one hundred buttonholes sold to ‘B’ for 100 currency units, payable in 30 days’.
Similarly, in the books of ‘B, in Accounts Payable, an entry is created for ‘one hundred buttonholes purchased from ‘A’ for 100 currency units, payable in 30 days’. So far, nothing unusual; in 30 days, ‘B’ country ‘A’, and the accounts are settled… the promissory note is redeemed. Notice that the promissory note (for 100 grommets) is an asset in ‘A’s books, but a liability in ‘B’s book…just like the pound of sugar in the promissory note. These promissory notes have two sides, assets and liabilities at the same time, depending on the point of view.
Now suppose that the management of ‘A’ and ‘B’ decide to merge the two companies; ‘A’ and ‘B’ merge to become ‘Z’ Company. So what happens? Well, the ‘A’ and ‘B’ books are consolidated; total assets and total liabilities are added together and appear on the books of the newly created Company ‘Z’.
But wait; if ‘B’ owes ‘A’ (payable from ‘B’, collectible from ‘A’) and ‘A’ and ‘B’ no longer exist, these numbers will be transmitted to ‘Z’; that is, ‘Z’ owes 100 monetary units… to ‘Z’? Oops No way; items cancel each other…any debts or payments due to other companies will remain…but ‘AB’ transactions cancel. The IOU is consolidated and ceases to exist by the merger of two previously independent companies.
In the meantime, what about the grommets ‘B’ just bought? Clearly these are now in ‘Z’s’ inventory; and ‘Z’ will incorporate them into their widget product line. The real things stay; the promissory notes disappear. Real things are potentially money; real money can’t just disappear. IOUs are not money; they can and do disappear. It’s that easy. Now replace Treasury and Federal Reserve with ‘A’ and ‘B’, replace Treasury Bills and Federal Reserve Notes with grommets and gizmos!
The bottom line; real things, ‘pure’ assets can be ‘real’ money… good or not so good. Notes that are asset/liability cannot. Unfortunately, the word active is misused, it applies both to ‘pure’ assets and to promises that are active on the one hand but passive on the other. This is the main reason why the counterfeit money system we currently live in is dying… and only real money comprising real assets can save our economy… and our civilization.
