In 2004 I was in Singapore going through my MBA on INSEAD Asia campus. One of the finance professors was giving his lecture. He was later voted by the students as the finest teacher of the year. During the lecture one student asked “What is cash?”. INSEAD students are notorious for being extremely inquisitive. Questioning just about anything is encouraged on campus. So, I was rather surprised by the answer “cash is cash is cash”. Was it a dismissive answer? Was it an invitation to reflect on our own about the meaning or definition of cash? To this day I am not sure. But I know that it took me 11 more years to understand what money is (in the context of that lecture “money” and “cash” could be used interchangeably, but in this blog I will use the two terms to refer to different things).

It may seem a useless question at first. Sure everyone knows what money is, we deal with it every day, it sits in our pockets, in our bank accounts, we pay for products and services with it, we receive it in exchange of work or when we sell something. Yet, the true meaning and nature of money is elusive for most people. And so are questions like: how is it created and destroyed? By whom? How is it distributed to various agents? How does it influence the economy? Etc.

If you look in university textbooks you may find definitions like store of value, unit of account, medium of exchange, or details like the difference between M1, M2, and other stocks. My definition of money, the clearest I could find, the one that gives the most insights into how money functions and that remains consistent with that framework is in fact very simple. Money is anything that any person trusts she can exchange for valuable goods or services at some future point in time.

I will go through each items in the definition, but the central concept here is “trust”. Money must effectively incorporate trust. And why trust is inscribed in what we call money is a very interesting question and indeed a crucial one. Let me come back to this point later.

Anything. Back to the definition: money can be anything. It can be something without intrinsic value like electronic records in the database of banks (which is where most money is stored nowadays). Electronic records cannot be used for any other valuable purpose, hence they do not possess an intrinsic value. Yet, they can be money. Banknotes and shells are other examples of money without intrinsic value. I will ignore here the possible use of banknotes as fuel or as wallpaper, or collectible banknotes and shells. Otherwise, things with intrinsic value can also be money: rice, barley, salt, tea leaves, can be used for nutrition and have all been used as money. Gold, silver, copper can be used to make other valuable goods and have been used or are still used as money. Note however, that gold (and other metals) has an intrinsic value only to the extent that it can be used to produce other valuable objects (industrial tools, jewels, computer chips, etc.). If we were able to calculate gold’s intrinsic value, we would find that it is lower than the its actual market value. The additional value comes from the fact that many people trust that gold can be used as money.

Any person. Something is money as soon as one person trusts and accepts that thing as money. If someone were so fool to accept my business cards (or a bitcoin) in exchange for coffee, my business cards would qualify as money. Obviously the more people trust that something is money the more that thing is useful and interesting to study. At the moment the most widely accepted form of money in the world is what we call the United States Dollar, which in turn is presented in various forms (coins, banknotes, bank accounts, credit cards, traveller cheques, etc.).

Exchange for something valuable. Money must be perceived as trade-able against something that possesses intrinsic value. An Amazon gift card, a shoe shop discount voucher, credit on your subway card, frequent-flyer miles, tickets to a concert or a football match, are all examples of money.

Trust. Back to the crucial feature of money. The vast majority of money forms used today do not have the slightest intrinsic value. So how is it that so many billion people all around the world accept those media in exchange of valuable goods, services, and work? The reason is that they trust they will in turn be able to use money to acquire something with intrinsic value. Where does that trust come from? It can come from anywhere including instances of people being extremely foolish or extremely kind. But for almost all the money in existence, trust is inscribed in it via the coercive power of the authorities that rule our communities, being governments, monarchs, presidents, police, military, courts or any other such authority or combination of authorities.

Today human communities are organised in many groups. But for the purpose of the use and functioning of money the community level that is of interest is the “country”, with the notable exception of the Euro area. In each country a number of authorities regulate the behaviour of the people living in it. The authorities’ coordinated actions are capable of exerting a truly enormous power of coercion over the people’s behaviour. The parliament, government, courts, police, armed forces, central bank, tax authorities, local authorities and other agents, all function in a way that influences enormously people’s actions. I will often refer to these public authorities collectively as the “sovereign”. Specifically, in many countries the authorities are capable of forcing people to pay taxes in the form of money that can only be created by the country’s central bank and commercial banks. If one does not fulfil the obligation to pay taxes he will be caught and punished. To avoid such destiny people will seek to acquire the money to pay taxes, that is the money issued by the central bank or the commercial banks. This can only be done in one of three ways:

  1. By borrowing the money from a commercial bank;
  2. By receiving the money from the central bank acting for the sovereign in exchange for work done for the sovereign;
  3. By receiving the money from another agent that has it, in exchange for goods, or services (i.e. something with intrinsic value). Obviously the agent that is paying the money in this latter case, must have acquired it in turn. Which means that ultimately everyone must have either borrowed from a commercial bank or worked for the sovereign in order to have acquired money to pay taxes. This is an extremely important observation because it constitutes the foundation for the money creation process, i.e. it answers the question: where does money come from?

These mechanisms for the acquisition of money to pay taxes are capable of inscribing trust in the money created by a country’s central and commercial banks. The amount of trust embedded in the money is a function (among other things) of the amount of power and credibility of the sovereign.

From the above discussion several implications follow that are of great importance and that diverge substantially from the orthodox economics rhetoric found in mainstream press and academia. Some questions that I will seek to discuss along these lines in future posts are:

  • Where does money come from?
  • What is the purpose of taxes?
  • What is the nature of the sovereign debt (also known as government debt, or national debt)?