What is Money?

This post is foundational. I know it is not what leftie activists like to read straight up. Definitions about finance and economic systems are for nerds, right?

Wrong. We can point out several things both lefties and conservatives get horribly wrong for their own causes, even when their hearts are in the right place. Foremost among these is the tax payer funding myth.

The trouble is, the requisite background to understanding why “tax payer funding” is a myth, involves an understanding of what money is, in essence, and in practice. That’s what this article is about.

Money is everywhere and always an IOU

From inception, in the earliest records anthropologists (e.g. D. Graeber) and archeologists (e.g. M. Hudson) know about, money has always been a record of accounts: a record of credits and debits.

Socially the money forms are IOU’s (“I owe you”) of the issuers.

This means money things, specifically state currency, are records of account. The currencies are points on scorepoints, trusted scoreboards usually, maintained at the government agents, the central bank and inland revenue service. Of course not all governments are fully trusted, and corruption is a thing, so the state currency is only legally points on a scoreboard.

If you and your cronies can defraud the government then this “debases” the state currency (which means it messes up the scoreboard). Governments have plenty of safeguards to prevent such fraud, which is why their currency units are pretty stable (for the most part).

What about cash?

Cash tokens (notes and coins) are detached parts of the government’s scoreboard that you carry in your wallet.

Note:

• this is why bitcoins and other “cryptocurrencies” are not money forms, because no one stands ready to redeem them for anything. (They are ponzi scams.)
• If someone is trusted to redeem every single bitcoin in existence for something like a bottle of water, then bitcoins would become a de facto money form — redeemable for a bottle of water, that would stabilize the price too (to the price of a bottle of water). But you cannot find anyone on Earth who promises to redeem a bitcoin (and is trusted to do so).
• “Stabilize the price of bitcoin,” already tells you the bitcoin is not the currency, whatever unit the price is denominated in is the currency.
• State currency does also have a price, the “own price” which is the interest rate ~ the price you pay for holding on to cash.

Why do people hold on to cash instead of put it into a term deposit to earn the interest? The answer is for greater liquidity — you can immediately spend cash, you cannot immediately spend out of a term deposit, that’s why they call it a term deposit. The scorepoints you deposit are still forms of money on spreadsheets, but they’re earning interest, and so not 100% liquid.

Most nations permit banks to offer you term deposits, and most nations also sell Treasury securities which are state guaranteed term deposits. The purpose of such instruments is to temporarily withdraw demand from circulation, this can have a temporary effect on cooling off inflation (but is only temporary, and voluntary, no one forces you to put away cash into a term deposit). Longer term the government term deposits (Treasuries) have a pro-inflation bias, because the interest paid on government bonds adds to the money supply but for zero real supply, unless the government raises tax rates to counter this add.

When governments net spend, it increases the money supply, but this is not inflationary if the spending is for the purpose of increasing real output. A growing population needs a growing money supply if the price level is to be stable and real output grows accordingly (no drop in the standard of living).

State currencies are IOUs of the State

State currencies are tax credits. That’s the IOU. So the US dollar, the yen, the renminbi, the UKP, &c., all are IOUs of their nation states. In the case of the eurozone the € is an IOU of the ECB.

What is the state promising in redemption?

The state currency redeems for payment of one unit of tax liability.

What is the state currency worth?

Because the state always makes good on its promise to redeem a tax payment, it never defaults, the state currency unit is worth whatever the State says you need to do to get one.

There are generally only three ways to earn state currency (so we’re not considering welfare payments):

1. Take out bank credit by handing the bank a promissory note that you will repay (that’s what a credit card agreement does, also a mortgage agreement),
2. or work for the state or contract your services to the state.
3. Sell your goods or labour to someone who already has earned the state currency (or received state welfare).

In such cases 1., and 2., the state tells you what their currency is worth, e.g., 35 units for one hour of work as a park ranger. The monopoly issuer of an IOU tells you what their IOU is worth. They are price setter, not price taker. There is no market force at work saying what the currency is worth.

What about private market goods for sale?

The State tells you what their currency is worth. But since land owners and rentiers need to pay taxes, they need to get the state currency units on their scoreboard (their bank account). To do so they will either sell goods or charge you and me rents.

How do they know what prices to charge or rents to charge?

This is determined by the proverbial market forces. But the secondary markets cannot set the price level, because they are competing for the state currency which they cannot issue. They (as a whole) can only get credit from a bank, or sell to the public sector, there is no other legal way they can get the currency to pay their taxes. (They may try dodging taxes, but that’s risky, and in any case requires paying a tax accountant a lot of currency units!)

So private markets can only set relative prices. All goods for sale are priced relatively, relative to what the State says their currency is worth.

Example: police versus farmer

The state says it will pay anyone 10 units (of their tax credits) an hour to work in the police force. A farmer who needs to pay taxes and electric bills (because electricity companies need to pay taxes) says, “Bollocks to that, I can grow on average 10 apples an hour, so I’ll instead sell apples for one unit.” All are happy. The police officer hates digging dirt and likes to police, the farmer likes to farm.

Tomorrow the state comes out and by fiat announces: “We like our police, they’re doing a good job, we are now paying police officers 20 tax credits an hour.” (And they just type the new numbers into all the police officer’s bank accounts, it costs next to nothing to do so, except one single government accountant clerks time.)

The farmer responds, “OK, man, my apples now sell for 2 units each.”

The farmer takes out a marker pen and crosses out “1” and writes “2” on their price tags. You could call that “printing money.”

The state has just caused 100% inflation. They devalued the currency by 100% with a simple announcement. (Technically a currency re-gauging, not inflation, since inflation is a continual increase in the price level. This is a one-off adjustment.)

Such is a good illustration of how secondary market prices get determined. In the real world it’s messier because monopolists for supply of apples and whatnot stuff up the fair relative prices.

Caveats

The posts in this Questions section are not going to trawl through empirical and anthropological data, we’ve instead used references where needed. It is incumbent upon you to check they are valid and have correct information. You can trust me of course, and I’m not thankful if you do, I’m just happy you do. It is better not to trust me until you’ve verified a few of my sources. Then you can thank yourself instead of thanking me, for doing the checking.