The Theory of Money and Credit
1. Money and Money-Substitutes
When an indirect exchange is transacted with the aid of money, it is not necessary for the money to change hands physically; a perfectly secure claim to an equivalent sum, payable on demand, may be transferred instead of the actual coins. In this by itself there is nothing remarkable or peculiar to money. What is peculiar, and only to be explained by reference to the special characteristics of money; is the extraordinary frequency of this way of completing monetary transactions.
In the first place, money is especially well adapted to constitute the substance of a generic obligation. Whereas the fungibility of nearly all other economic goods is more or less circumscribed and is often only a fiction based on an artificial commercial terminology, that of money is almost unlimited. Only that of shares and bonds can be compared with it. The sole factor that could possibly prevent any of these from being completely fungible is the difficulty of sub-dividing their separate units; and various expedients have been adopted, which, at least as far as money is concerned, have entirely robbed this difficulty of all practical significance.
A still more important circumstance is involved in the nature of the function that money performs. A claim to money may be transferred over and over again in an indefinite number of indirect exchanges without the person by whom it is payable ever being called upon to settle it. This is obviously not true as far as other economic goods are concerned, for these are always destined for ultimate consumption.
The special suitability for facilitating indirect exchanges possessed by absolutely secure and immediately payable claims to money, which we may briefly refer to as money substitutes, is further increased by their standing in law and commerce.
Technically, and in some countries legally as well, the transfer of a banknote scarcely differs from that of a coin. The similarity of outward appearance is such that those who are engaged in commercial dealings are usually unable to distinguish between those objects that actually perform the function of money and those that are merely employed as substitutes for them. The businessman does not worry about the economic problems involved in this; he is only concerned with the commercial and legal characteristics of coins, notes, checks, and the like. To him, the facts that banknotes are transferable without documentary evidence, that they circulate like coins in round denominations, that no fight of recovery lies against their previous holders, that the law recognizes no difference between them and money as an instrument of debt settlement, seem good enough reason for including them within the definition of the term money, and for drawing a fundamental distinction between them and cash deposits, which can be transferred only by a procedure that is much more complex technically and is also regarded in law as of a different kind. This is the origin of the popular conception of money by which everyday life is governed. No doubt it serves the purposes of the bank official, and it may even be quite useful in the business world at large, but its introduction into the scientific terminology of economics is most undesirable.
The controversy about the concept of money is not exactly one of the most satisfactory chapters in the history of our science. It is chiefly remarkable for the smother of juristic and commercial technicalities in which it is enveloped and for the quite undeserved significance that has been attached to what is after all merely a question of terminology. The solution of the question has been re garded as an end in itself and it seems to have been completely forgotten that the real aim should have been simply to facilitate further investigation. Such a discussion could not fail to be fruitless.
In attempting to draw a line of division between money and those objects that outwardly resemble it, we only need to bear in mind the goal of our investigation. The present discussion aims at tracing the laws that determine the exchange ratio between money and other economic goods. This and nothing else is the task of the economic theory of money. Now our terminology must be suited to our problem. If a particular group of objects is to be singled out from among all those that fulfill a monetary function in commerce and, under the special name of money (which is to be reserved to this group alone), sharply contrasted with the rest (to which this name is denied), then this distinction must be made in a way that will facilitate the further progress of the investigation.
It is considerations such as these that have led the present writer to give the name of money substitutes and not that of money to those objects that are employed like money in commerce but consist in perfectly secure and immediately convertible claims to money.
Claims are not goods;1 they are means of obtaining disposal over goods. This determines their whole nature and economic significance. They themselves are not valued directly, but indirectly; their value is derived from that of the economic goods to which they refer. Two elements are involved in the valuation of a claim: first, the value of the goods to whose possession it gives a right; and, second, the greater or less probability that possession of the goods in question will actually be obtained. Furthermore, if the claim is to come into force only after a period of time, then consideration of this circumstance will constitute a third factor in its valuation. The value on January 1 of a right to receive ten sacks of coal on December 31 of the same year will be based not directly on the value of ten sacks of coal, but on the value of ten sacks of coal to be delivered in a year’s time. This sort of calculation is a matter of common experience, as also is the fact that in reckoning the value of claims their soundness or security is taken into account.
Claims to money are, of course, no exception. Those which are payable on demand, if there is no doubt about their soundness and no expense connected with their settlement, are valued just as highly as cash and tendered and accepted in the same way as money.2 Only claims of this sort—that is, claims that are payable on demand, absolutely safe as far as human foresight goes, and perfectly liquid in the legal sense—are for business purposes exact substitutes for the money to which they refer. Other claims, of course, such as notes issued by banks of doubtful credit or bills that are not yet mature, also enter into financial transactions and may just as well be employed as general media of exchange. This, according to our terminology, means that they are money. But then they are valued independently; they are reckoned equivalent neither to the sums of money to which they refer nor even to the worth of the rights that they embody. What the further special factors are that help to determine their exchange value, we shall discover in the course of our argument.
Of course it would be in no way incorrect if we attempted to include in our concept of money those absolutely secure and immediately convertible claims to money that we have preferred to call money substitutes. But what must be entirely condemned is the widespread practice of giving the name of money to certain classes of money substitutes, usually banknotes, token money, and the like, and contrasting them sharply with the remaining kinds, such as cash deposits.3 This is to make a distinction without any adequate difference; for banknotes, say, and cash deposits differ only in mere externals, important perhaps from the business and legal points of view, but quite insignificant from the point of view of economics.
On the other hand, arguments of considerable weight may be urged in favor of including all money substitutes without exception in the single concept of money. It may be pointed out, for instance, that the significance of perfectly secure and liquid claims to money is quite different from that of claims to other economic goods; that whereas a claim on a commodity must sooner or later be liquidated, this is not necessarily true of claims to money. Such claims may pass from hand to hand for indefinite periods and so take the place of money without any attempt being made to liquidate them. It may be pointed out that those who require money will be quite satisfied with such claims as these, and that those who wish to spend money will find that these claims answer their purpose just as well; and that consequently the supply of money substitutes must be reckoned in with that of money, and the demand for them with the demand for money. It may further be pointed out that whereas it is impossible to satisfy an increase in the demand, say, for bread by issuing more breadtickets without adding to the actual supply of bread itself, it is perfectly possible to satisfy an increased demand for money by just such a process as this. It may be argued, in brief, that money substitutes have certain peculiarities of which account is best taken by including them in the concept of money.
Without wishing to question the weight of such arguments as these, we shall on grounds of convenience prefer to adopt the narrower formulation of the concept of money, supplementing it with a separate concept of money substitutes. Whether this is the most advisable course to pursue, whether perhaps some other procedure might not lead to a better understanding of our subject matter, must be left to the judgment of the reader To the author it appears that the way chosen is the only way in which the difficult problems of the theory of money can be solved.
