Money

What is Money

The image above shows two tokens. They are roughly the same size and both made of metal. Neither has any intrinsic value, but one is considered money and the other only enables video game at play children’s pizza parlors.

The US quarter dollar above is produced by the US Mint (1) and is a token representation of a quarter dollar claim against the US Federal Reserve (in fact, all outstanding physical currency is considered a tokenized claim against the federal reserve). Because the quarter is produced by an agency of the US government and decreed as legal tender it is widely accepted as money.

In a broader sense, money is largely a social construct or convention. We accept a token has value (whether it is made of metal, paper, polymer, …or even code) because we expect that others will also do so readily and easily.

For something to function as money in a society/economy it needs to possess three main properties (…and perhaps a qualified fourth).

  1. Be viewed as a good medium of exchange
    • Ex. You can exchange it for your cup of coffee easily and without question
  2. Function as a base unit of account
    • Ex. It is used as a measure of value for goods and services… like the coffee purchase
  3. Act as a good store of value
    • Inflation aside, its value next week will be the same as it is today
  4. Satisfy a no-questions-asked (NQA) principle - both parties need to accept the transaction at par value (not a penny above or below)
    • During the free banking era in the US (1830’s), paper currency would regularly trade at discounts from face the further they were from each note’s issuing bank
    • This requirement as a function of money is discussed by Gorton and Zhang in Taming Wildcat Stablecoins

Money is also considered fungible => that is a given unit can be replaced with any other unit and considered completely equal in value and utility.

Probably the most obvious benefit of using money is it largely avoids the whole bartering process (note, this is quite different from haggling ). Let’s say you needed some premium grade coal for your furnace and only had Merino sheep to trade. You would not only need to find someone who had the right kind of coal to sell, but was also willing to trade their coal for your sheep. Generally, that’s a tall order. Money clearly solves this problem => sell the sheep for coin and use coin to buy the coal (… hey, there’s that medium of exchange thing again…).


Sidebar:

…Products like cigarettes and soap are appealing because they can perform some of the major functions of money. Since there is a consistent demand and market for them, even when they’re not on store shelves, they retain their value. (Unlike an iPod, they never become obsolete.) Since they have standard sizes, they can also be used as a unit of account. You can pay for a candy bar with a few cigarettes, or pay for an old phone with a few packs of cigarettes *

* (From Why Thieves Steal Soap.)


Money in Circulation

As of December 2021, the Fed estimates there is roughly $2.2 Trillion of currency in circulation (current total, by denomination). Interestingly, as much is one-half of this circulating currency is estimated to be held abroad (mostly in $100 bills).

The physical currency in circulation is considered a small component of the overall money supply in an economy. Other components include demand deposits, savings deposits, and other highly liquid financial products. Taken together, the total money supply in the US is estimated to be roughly $21.8 Trillion as of the end of 2021 (break down) => view Commercial Banking to see how banking activities expand the money supply.

In theory, an increasing money supply tends to increase a country’s GDP by making more money available for spending on goods and services. The US’s GDP is currently around $24 Trillion (…or see real GDP (hint: inflation adjusted)). The velocity of money is a measurement of the rate at which money is exchanged in the economy. It is calculated as a ratio of GDP to money supply. The US currently has a money velocity of 1.1, which from above is roughly $24T GDP / $21.8T money supply (yeah, more than you ever wanted to know…).

Insights

  • In the last two years, money supply in the US has increased over 40% during the pandemic => 4x the amount created in the two years before the pandemic
    • Some think this is contributing to the highest inflation spike in the US since the late 70’s
    • Powell & predecessors, back to Greenspan, say that financial innovations mean there is no longer a link between amount of money circulation and rising prices….instead, current inflation is result of disruptions associated with reopening the economy …..real answer like most things is probably a little of both.
    • Also note that money velocity is at it’s lowest in nearly 65yrs, so while there is more money in the system, it’s moving pretty slow.
    • Reference: Inflation has Fed critics pointing to spike in money supply
    • Another perspective: Corporate Profits Drive 60% of Inflation Increases

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