Thursday, July 26, 2012

What Is Essential for Money To Be Money?

Suppose we are tradesmen. It matters little to any of us what commodities he takes in exchange for goods (other than commodities he himself can use). But if he takes what others refuse he is stuck with something useless, and if he refuses what others take he needlessly inconveniences his customers and himself. Each must choose what he will take according to his expectations about what he can spend -- that is, about what others will take: gold and silver if he can spend gold and silver, U.S. notes if he can spend U.S. notes, Canadian pennies if he can spend Canadian pennies, wampum if he can spend wampum, goats if he can spend goats, whatever may come along if he can spend whatever may come along, nothing if he can spend nothing. -- David Lewis, Convention, p. 7
Lewis is correct: the essence of money is a convention. Menger may or may not have been correct about how money came into being, but once it did so, the essence of somethings being money is, "I should accept this for my wares since I feel confident others will accept it for their wares."

Fractional reserve bank notes are not claims to "real" pieces of money: they are new pieces of money, manufactured by a fractional reserve bank, not out of thin air, but out of confidence in the bank's sound operations. Gold is merely a prop to bolster that confidence, ad there is no reason to think that even in a free market in banking that prop could not one day be kicked away.


  1. This is probably why "inside money" has begun to substitute "money substitute" as the preferred term for describing circulating substitutes for outside money. But, I don't think full reservists would disagree with you here, which is why money aggregates (like AMS or TMS) composed by full reservists include money substitute/fiduciary media.

    I don't think, though, that we can fairly assume that a free banking system would eventually release gold of its duty of "backing" (a somewhat archaic term, I admit) inside money. In the Selgin/White model, what restrains note issuance is demand for outside money either by the client or, more likely, rival banks. So, while a bank might able to "shed" "a lot," or even most, of its gold, I don't think it could completely. By eliminating this constraint, it would allow itself to endogenously create bank notes to the point where they'd lose value against rival monies and the bank would face a run.

    1. "By eliminating this constraint, it would allow itself to endogenously create bank notes to the point where they'd lose value against rival monies and the bank would face a run."

      But haven't you answered your own complaint here: they don't want their money to lose value against rivals, and they don't want to face a run, so they wouldn't do create that many bank notes.

    2. Under this Selgin/White model, what is a bank's income?

    3. I guess it would be more relevant to point out that as long as there is demand for gold by either clients or rival banks, a banking system can't shed gold completely. Maybe some other form of inter-bank clearing might make outside money irrelevant. I'm not denying the historical possibility; but, there are good reasons to resist it.


      Where are you trying to go?


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