What Economists Mean When they Talk About Money (1 of 2)

A while back, I wrote about a pending academic research project I was embarking upon with Jeremiah Newhall, a good friend of the site. Below you will find a draft version of a section of our paper which discusses an economist's view on money. Part of the reason I am posting this is to solicit feedback, so please feel free to submit your thoughts in the comments section below, and please bear with us on the citations.

Economists talking about money refer to a medium of exchange, but even that perambulation is deceptive because the “medium” need not be physical but merely an idea.[1] At bottom, then, money (to an economist) is the idea of value, a universal form of payment that serves as a shortcut to a barter system. But that is not what money means to lawyers talking about counterfeiting laws; they mean “legal tender,” a form of money that only governments may create.

To an economist, that Bitcoin is “money” seems beyond debate: Bitcoin serves as a form of universal payment—indeed, its anonymous inventor created it expressly for that purpose. But the crux of this paper is whether Bitcoin is (or impermissibly apes) legal tender. But what if we answer no—if Bitcoin is money but not legal tender, or counterfeit legal tender, what is it? What other forms of money populate the economist’s definition? In this brief gloss of the global history of money, we will tease out the answer.[2]

Before coins or paper currency, we surmise that trade consisted of barter—that much is a matter of tautology, since “barter” is traditionally defined as trade in which payment is made in goods or services, rather than money.[3] If by a happy coincidence two traders each have something the other wants, barter works quite well—but as Aristotle pointed out, this “coincidence of wants” is the exception, not the norm.[4] That mismatch of needs drives the need for currency, and in the absence of coins or paper money a de facto currency of goods with universal demand arises, as when alcohol became de facto money in former Soviet republics.[5]

The first coin money originated in China.[6] These coins were not round, but in the shape of tools, such as knives.[7] The concept of “knife money” was to nominalize a de facto currency of universal good (knives).[8] Instead of paying in a knife, you promised the value of a knife.[9] Eventually, the concept of value became more abstract, representing objects valued for their beauty rather than utility. The Chinese character for money, , depicts a cowry shell, and the first non-goods coins were bits of bronze fashioned in the shape of cowry shells.[10]

Trading in coins presented two chief advantages over de facto currencies of popular goods: Demand for coins would not drop if a good lost popularity, and coins (unlike goods) were never consumed. The second point bears elaboration. Much has been made of the fact that it costs more than one cent for the Mint to press a penny.[11] But governments are not in the business of minting coins to enrich themselves directly; they create coinage in order to facilitate trade. Terry Pratchett explained the endurance of the penny in a short parable:

In the course of a year, [a penny becomes] just about everything . . . . It becomes some apples, part of a cart, a pair of shoelaces, some hay, an hour’s occupancy of a theater seat. It may even become a stamp and send a letter . . . . It might be spent three hundred times and yet—and this is the good part—it is still one penny, ready and willing to be spent again. It is not an apple, which will go bad. Its worth is fixed and stable. It is not consumed.[12]
The rates of exchange may be inflated, (though perhaps a penny could still buy “some hay”) but the principle is the same: Governments mint currency not to make profits but to make money. The great innovation of coins, and their advantage over de facto currencies of popular goods, was that coins would never be consumed. They were permanent money.

To this point, the money supply could be measured by counting the number of coins in circulation (today, economists call this measure of money supply “M0”).[13] But a new innovation would revolutionize the practice bean-counting: The bank ledger. Before the magic of ledgers, a dollar (or a British pound, or a Roman aureus), though infinitely reusable, existed in one place at one time. But the banking system changed that; a dollar deposited in a bank account (as opposed to a dollar deposited in a safe deposit box) is both in the account—it says so right there in the ledger—and not in the account, having been lent out by the bank at interest. The borrower spends the same dollar that the depositor sees in his ledger statement; it is not two dollars but one dollar in two places. The process repeats ad infinitum: The borrower spends the dollar, and the vendor deposits it in a second bank account, where it exists at the same time that it exists in the first depositor’s account, and simultaneously is lent out to a second borrower, who spends it again.

The limitation of this system was the need to cover deposits: To spend the money, the borrower needed to withdraw physical coins, and thus the bank needed to obtain physical money to pay out deposits. In the eighteenth century, a need for paper currency arose because of the vastly increased number of international commercial transactions, and shipping metallic (and heavy) coins as payment was prohibitively expensive.[14] Paper currency was lightweight and compact, yet too easily counterfeited. The Chinese were centuries ahead in the development of paper currency—in 1275, China used paper money exclusively.[15] To make sure the bills were circulated, Emperor Kublai Khan confiscated gold and silver, and each note bore a stern caveat: To refuse to accept the Khan’s notes was death; and to counterfeit them, also death.[16] But a few centuries later, paper money again fell into disuse [17]

[1] Michael F. Bryan, Fed. Reserve Bank of Cleveland, Island Money 2 (2004) available at http://www.clevelandfed.org/Research/Commentary/2004/0201.pdf.
[2] Too often a discussion of history bears no relation to analysis: “After the introduction, author and reader alike forget about the thirteenth century [or other ancient history], so that no great harm is done.” Grant Gilmore, Formalism and the Law of Negotiable Instruments, 13 CREIGHTON L. REV. 441, 446 n.9 (1980). We assure you, dear readers, that ancient history will figure prominently in our analysis of a decidedly a twenty-first century problem.
[3] There have been suggestions that the earliest economies were “gift” economies that relied on the recipient’s sense of indebtedness and willingness to reciprocate in the future. See _____[citation needed]______. Reciprocity is indeed an enduring and universal social norm. See Joshua Weiss, Medical Marketing in the United States: A Prescription for Reform, 79 Geo. Wash. L. Rev. 260, 266-67 & n.43 (2010) (discussing universal social norm of reciprocity). But in reality the “gift v. barter” debate over the earliest economies is one of semantics only. In modern barter economies, traders variously identify identical transactions as gifts or trades depending on social circumstances, such as when the recipient is a guest or a family member. See Seabright, The Vanishing Rouble.
[4] Politics Book 1:9.
[5] See Seabright, The Vanishing Rouble
[10] These may have been ornamental. (citation needed)
[12] Terry Pratchett, Making Money, 43–44 (2007).
[14] Gilmore, supra note 2, at 447.
[15] Marco Polo, The Travels of Marco Polo 137 (Oliver & Boyd, 3d ed. 1845). Paper money had been attemped previously with disastrous results. See ____[cites needed]____.
[16] Id. at 137–38
[17] Id. at 138 n.*.

Jeremiah Newhall is a graduate of The George Washington University Law School and currently serves as a law clerk in Chicago. He can be reached via the miracle of email. Joshua Sturtevant is also a GW Law grad, and currently serves as an in-house legal fellow at a renewable energy financing and development firm.


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