What is Money?

To be concrete, let’s take the US dollar as an example of money. It’s a debt obligation of the Federal Reserve, as the inscription across the top of one of these note indicates.

For comparison’s sake, what about US Treasury notes? They’re debt obligations of the Treasury. If the former is nothing more than an agreed upon convention, then so would be the latter. And so would any number of other securities such as corporate debt, municipal debt, that of foreign sovereigns, etcetera. We can extend that further … if debt obligations aren’t real, then why not equity obligations? Following that reasoning corporate stock isn’t real, and no other security is either.

In each case the security isn’t itself a tangible thing, but represents some kind of obligation of someone else. A form of contract. This distinguishes it from tangible assets like gold and other physical commodities. But if physical tangibility per se were the test of reality, our entire economic system would be a figment of our imaginations. Even if it were, at least an awful lot of people are sharing the same dream. For all practical purposes we can behave as if it’s real.

Are you satisfied that the US dollar is a security … not unlike a stock or a bond? It fluctuates in value just like the others. The only thing that really sets currencies apart in our minds from other securities and obscures their changing value is that we use them themselves as our units of value. We don’t directly notice the change in value because after all, a dollar is always worth a dollar. We only notice that its value fluctuates when we use a third unit, such as another currency, to express its value, or we notice the prices of other things change. If we notice for instance that it takes twice as many dollars as it used to to buy a gallon of gas, a loaf of bread, an ounce of gold, and a share of stock … we surmise that the dollar itself has fallen by half.

Money in general is fantastically useful because it lets us trade with each other without having to barter. If you want a bike and I want a wheelchair, and I have a bike and you have a wheelchair, we can easily trade with each other without it. But if what you want is a bike, I want a washing machine, and a third party wants a wheelchair, it gets complicated. We all have to somehow meet and rotate, and even if we do, the values of our items may not line up exactly. With money, we can all trade without our wants and possessions having to be directly complementary to someone else’s.

If you really want to understand money, I enthusiastically recommend watching the television comedy Raising Hope, Season 4, Episode 2, Burt Bucks. Not only is it heartwarmingly hilarious, but in a half hour it can teach you more about money than a semester of college economics.

8 thoughts on “What is Money?

  1. cb says:

    Apr 29, 2020 at 9:18 am
    There is little hope to assess where you are in the finance quagmire if the most basic question goes unanswered:

    How many dollars, physical and digital, are in existence, who owns them and where are they?

    Without the answer to that question, all financial writers and financial players are blind.

    Thank you for letting me share finances most fundamental question, that no one seems to recognize.

    1. Bill Terrell says:

      There are different ways of defining dollars and it’s a moving target, but the number of what you’re describing sounds like M1.

      The latest figures would put it at about $3.7T.

      As for who owns them … it’s really not knowable since many are in physical form. And they’re changing hands constantly. I think the Fed has estimates though. But even there you could quibble since if I have five of them in my pocket that I borrowed from you, you couldn’t say who owns them without defining exactly what you mean by “own”.

      It’s further complicated by the fungible nature of dollars. If for example you had $1000 in an account and removed one of them, which one was it? If you put another back in you still have exactly the same balance as you would if you put the same one back in.

  2. cb says:

    I fail to see how there could only be 3.7 trillion dollars in existence, given the size of the FED’s balance sheet. Max Keiser says there are 22 trillion dollars offshored.

    1. Bill Terrell says:

      There are different ways of counting them, depending on exactly what you define as a dollar. Ultimately it probably doesn’t matter much … other securities are regularly created and destroyed all the time – stocks, bonds, options, futures – and we don’t sweat it. The dollar isn’t fundamentally different aside from our habit of using it as our unit of account.

      The market value of a dollar is IMO a much more significant issue. Especially since the Fed got on this 2% inflation kick. In the scheme of things, I’m much more concerned about the Fed’s obsession with price fixing in the credit markets – manipulating interest rates – now compounded with targeting an inflation (dollar depreciation) rate that it doesn’t even know how to measure. It’s just an excuse to pound interest rates lower, an enabler for politicians’ reckless spending and playing reverse Robin Hood by kiting asset prices.

    1. Bill Terrell says:

      I agree, CB. A debt default leaves both lender and borrower in exactly the same position as they were before the default. The only thing that has happened is that the borrower did not meet an expectation. No dollars even change hands on a default, let alone get created or destroyed.

      A debt default is a nonevent – the absence of something happening when something was expected to happen.

  3. cb says:

    The below is a post from a poster on Wolf’s site. Do you think it is correct? Thanks. cb

    Jun 14, 2020 at 11:28 am
    The system treats debt as an asset, or money. When you buy something with debt, say on a credit card, the money for that purchase is created out of thin air right at the point of purchase.
    The money in fact only exists because you commit to pay it back with interest at some point in the future. At the point you default on that commitment to pay that debt, the money simply disappears, although the item that was purchased by the debt still physically exists.
    If you multiply that example by millions of transactions of all kinds you begin to see that the result is less overall money, and more overall goods. This has the effect of putting downward pressure on the price of goods and assets. It also has the effect of making credit decrease as risk increases, which tightens money supply.
    Today the vast majority of the money in our system is debt. That money only exists if people pay their debts. This creates another problem because a debt based system creates debt trains. Our entire supply system is based on debt, and interruptions in debt payment effect other entities ability to pay their debt creating a chain reaction. The potential for money destruction due to debt default becomes exponential…

    1. Bill Terrell says:

      The poster has some good insights, but the part about the default isn’t correct. As I pointed out in my last reply, a default per se doesn’t do anything except disappoint an expectation.

      Let’s make this more concrete. So we can focus just on the effect of the default, let’s assume there are no other transactions taking place.

      I borrow $100 from you on January 1. You now have $100 less than you did and I have $100 more. I agree to repay you on April 1. Let’s say I don’t. On January 2, I still owe you $100. On March 31, I still owe you $100. On April 1, I still owe you $100. On April 2, I still owe you $100. I have defaulted on my debt to you, but what has actually changed? The amount of money that you and I both have hasn’t. You still have $100 less than you did before the transaction and I still have $100 more.

      The total amount of money hasn’t changed. Even if I repay you, the total amount of money hasn’t changed, just who has it.

      Now it is also true that when a bank lends you money, the money supply may increase, just as the poster said. But banking is a special case. Whatever change in the amount of money that may occur, it’s not due merely to default, but due to the bank’s special powers to create and destroy money.

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