Abstract
Conventional wisdom has it that money is the commonly accepted medium of exchange. Although not incorrect, the statement obscures more than it illuminates. In this chapter I offer an alternative definition of money based on it being the financial asset that exchanges at par value on demand. From this I am able to outline under what conditions money emerges as a solution to the real economic problem of uncertainty. The result is that money also takes on the role of the generally accepted medium of exchange. The causal explanation provided herein sheds light on some oddities of monetary theory that traditional treatments of money do not easily address.
Walking down calle Villajimena on a beautiful early October evening in 2007, my arms were laden with books, too many to carry in any other situation. I just had my first meeting with Jesús Huerta de Soto. On his encouragement, I had moved to Madrid to study under him, an event that would drastically alter the course of my life. At this meeting Jesús gave to me in an almost haphazard way the books I carried, stressing that “you’ll need to read this, and that, and this one for good measure.” Those books formed the backbone of my own intellectual journey, as they did for countless other similar disciples of Don Jesús. They were also, as I discovered quickly, the foundation of his own intellectual tradition. Rothbard, Böhm-Bawerk, Hayek, Kirzner, and of course, Mises, all took central stage. (So too did his own books.) But he steered me towards other eclectic works that I would only appreciate much later as offering a rich complement to the normal list: Lachmann and Polanyi, to give two more well-known examples, but other names and “must read” books cropped up at every meeting. The result was a central pillar, a canon curated by Huerta de Soto, augmented and enriched in unusual and nonobvious but ultimately fulfilling ways. Jesús provided a complete education in economics, plus an emphasis on why one cannot view economics in isolation of law or the moral sciences. Don Jesús, for the continental ideas you inspired within this anglosajon, gracias.
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Notes
- 1.
Menger (1909, p. 5) also expresses similar objections to defining money as the generally accepted medium of exchange as a starting point in monetary analysis.
- 2.
Two examples on this point, chosen only because of their clarity of exposition and representative view of the prevailing doctrine, claim that money is both the generally accepted medium of exchange and the most liquid asset. Huerta de Soto (2006, p. 186 fn. 9, p. 696 fn. 141, and p. 770 fn. 72) repeatedly stresses that money is the only perfectly liquid asset in the economy. Rothbard (1962, p. 375) does not refer to money as a perfectly liquid asset, instead focusing on its related feature as being the “present good par excellence.” To the extent that a present good has a readily available market, the “best” present good becomes the most liquid asset. Both Huerta de Soto and Rothbard illustrate theories of money that amount to two sides of the same coin.
- 3.
In personal correspondence, one well-known member of the “free banking” school asked why I wanted to force the corner solution. In price theory, a corner solution is a common result of a consumption bundle containing a good with no substitutes. His question alluded to my own claim that the bank must hold full reserves in the form of money against its deposit base, and that this money cannot be substituted by other assets (even highly liquid bonds). The corner-solution rebuttal to full-reserve banking proposals has merit. The argument is the logical conclusion of a monetary theory which does not correctly identify the origin of money. The rebuttal also rests on the belief that money’s specific role is not completely different in matters of kind but only in magnitude from that of other goods. This chapter rectifies these shortcomings.
- 4.
In almost all cases, the future value is defined in nominal terms. Although inflation-adjusted bonds exist, the market is small. In this chapter, I deal exclusively with financial assets with nominal claims in the future.
- 5.
A bond holder may, of course, sell their bond before maturity. But in that case, the value is governed by supply-demand conditions prevailing at the time. In effect, the bond is valued as if it were an equity. Futures similarly can be sold at any time, though not necessarily at their predefined value.
- 6.
Whether money has less credit risk than bonds depends critically on the stability of the banking system. During the European debt crisis starting in 2009, the unstable banking system in Cyprus was resolved with a bail in. Under this scheme, depositors with more than €100,000 deposited in a Cypriot bank were forced to take a haircut. Even under less severe banking collapses, deposit insurance schemes pay out on deposits only up to a maximum amount to combat moral hazard. In contrast, US Treasury bonds have never defaulted, and fewer than 5% of high-risk bonds have defaulted over the past twenty years.
- 7.
Hayek (1976, p. 56) tries to solve the ambiguity problem of defining what money is by shifting the discussion to currency. This is particularly dangerous territory. Hayek prefers discussion of currency to money since the former is clearly defined. To the extent that currency is clearly defined through legal tender laws, such an argument seems to bring the economist back to the chartalism theory of the German Historical School.
- 8.
The computational advantage using one good to determine all prices is obvious. An economy with n goods will have n(n−1)/2 prices under conditions of direct exchange but only n−1 prices if one good is used to express all prices.
- 9.
Two legal texts, Senchus Mor and the Book of Aicill both contain tables outlining the prevailing “exchange rates” for a kumal. They also make clear that ultimate payment was to be made in either land or silver.
- 10.
Actually, Mises shows that the demand to hold money as a medium of exchange falls to zero. Money still exists as a numéraire to establish the prices of goods (Howden, 2009).
- 11.
Unwittingly, as the case may be (see Herbener et al., 1998, p. xvi).
- 12.
A bond could also be sold before maturity to the same effect. Recall that the value received from the sale of a bond sold before maturity will be the market value prevailing. This fact makes the early redemption of a bond an economically identical event to the sale of an equity.
- 13.
One strand of literature deals with Knightian uncertainty as an epistemological problem. Knowledge of certain future events is completely absent. While these cases are interesting from a theoretical perspective, they have no bearing on acting man. Man acts on what he perceives. Forces outside of the realm of his consciousness cannot shape the demand to hold an asset. In contrast, some degree of knowledge of the existence of a future state of the world is necessary to influence the demand for money. Such knowledge does not need to refer, however, to the exact temporal or value dimensions of the future state of the world.
- 14.
The reader may object to my characterization of death as a systemic risk. The purpose of pooling insurable lives by a life insurance company is to pinpoint, in probabilistic terms for a class of individuals, when a death will occur.
- 15.
I say “broad” sense here because in some narrow markets a price could be established in terms of, for example, bitcoin, and bitcoin could be exchanged to pay for this good. In practice, prices are established in terms of some other money, for example, US dollars, and then a cryptocurrency is exchanged for dollars at the prevailing market exchange rate. The transaction is no different than an individual selling his equity investment at the prevailing price to buy US dollars to complete a transaction. Given this fact, it is most correct to think of a cryptocurrency as a non-dividend paying stock.
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Howden, D. (2023). Defining Money. In: Howden, D., Bagus, P. (eds) The Emergence of a Tradition: Essays in Honor of Jesús Huerta de Soto, Volume I. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-031-17414-8_15
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