Imagine you sell me some consulting services. I don't have any cash, so I give you a $100 IOU instead. You now have a $100 Note Receivable on your Balance Sheet.
My question is: Did we just create money?
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3 Answers
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No, you didn’t. All money is debt, but not all debt is money.
There are two easy ways of thinking about this. The first is to think about the properties of money: unit of account, store of value, medium of exchange. Focusing on the latter two:
- Is the money you owe to me a good store of value? No offense, but I’d rather have cash or keep it in an insured bank account. So no, your debt to me isn’t a good store of value.
- Can I use it as a medium of exchange (i.e., can I trade your debt to me to someone else as payment for something)? Not likely, so no, it’s not a medium of exchange.
The second is to do the accounting exercise and compare it to the case where a bank makes a loan. I’ll bold all the things that count as money in the hands of people in the real economy. In this case, it’s:
Me
- My assets: \$100 owed from you
- My liabilities: \$0
You
- Your assets: \$0
- Your liabilities: \$100 owed to me
Now compare the case where I deposit \$100 into the bank and the bank lends out \$50 to you (I’m going to ignore bank capital to make it clearer):
Me
- My assets: \$100 owed from the bank (bank deposit).
- My liabilities: \$0
Bank
- Bank assets: \$50 cash + $50 owed from you
- Bank liabilities: \$100 deposit owed to me
You
- Your assets: \$50 cash
- Your liabilities: \$50 bank loan
You’ll notice that in the first case, no money has been created, because I can’t pay anyone with your promise. In the second case, I have \$100 of money, because I can pull \$100 out of the bank (again, ignoring bank capital here) and pay someone with it, and you have \$50 of money because you have \$50 in cash (though you also have an outstanding loan for \$50), so the amount of “money” in the real economy has increased.
answered Mar 31, 2020 at 17:48
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1$\begingroup$ As interesting and roller coaster-y as the comments were, they are not for extended discussion; this conversation has been moved to chat. $\endgroup$– Kitsune Cavalry ♦Apr 14, 2020 at 23:44
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This question is directly equivalent to "If I issue a bearer bond, is this bearer bond money?"
The answer is yes. It is fungible, transferable and a medium of exchange.
The extent to which it is 'money' depends on the extent people trust you.
Money in prisons is often packets of cigarettes. Is a brick money? Yes. By making a brick, you are making money. By definition "Commodity money solved these problems. Commodity money is a type of good that functions as currency. In the 17th and early 18th centuries, for example, American colonists used beaver pelts and dried corn in transactions"
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$\begingroup$ Agreed with your answer as well. I have some follow up questions on this topic, but might create a new Stack Overflow question so it's cleaner. $\endgroup$– DavidApr 1, 2020 at 15:35
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$\begingroup$ Ehh, this answer says that any commodity is "money". So if I produce tomatoes for my neighbor to eat, I'm making "money". It's not a useful perspective because it makes the notion of money completely irrelevant next to barter. I can't pay my taxes to gov't with my tomatoes alas. I need to get a hold of (the kind of) money they actually accept for that purpose... $\endgroup$– FizzApr 3, 2020 at 3:03
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$\begingroup$ No tomatoes would not be money because they degrade, but yes any exchangeable commodity is in fact money. It may surprise you but this is in fact technically correct @Fizz Paying taxes...you are confusing the concept of money with legal tender. $\endgroup$– FrankApr 3, 2020 at 4:42
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To counter Frank's argument that "any exchangeable commodity is in fact money"... even the economists of shadow banking (Pozsar, 2014) don't hold that view:
Money is usually defined from a functional perspective as a “unit of account, store of value and medium of exchange.” However, this definition does not take into account the quintessential attribute of money — that money always trades at par on demand — and the institutional arrangements that underpin this attribute.
Money claims are also hierarchical (see Mehrling, 2012), in the sense that not all money claims are equally strong in their par on demand promise in all states of the world, and that always and everywhere money is something different for central banks, banks, shadow banks and all other participants in the financial ecosystem.
For example, under the gold standard, gold was money between central banks, reserves were money between banks, and deposits were money between participants in the real economy. At each level of the hierarchy, net payments were settled using the claims of entities at the next higher level of the hierarchy. In normal times, participants in the real economy settled using bank deposits, banks settled using reserves and central banks settled using gold as international reserves. In crisis times, deposits were convertible into currency, currency into gold, and gold into foreign currency all at par on demand due to conversion rates and FX rates fixed in terms of gold.
Until the US gov't decided that something is not convertible into something else that is. And in simple terms that reason was:
“The bigger suppliers of gold would have more control over our monetary policy, and there’s no reason to have it because we can get the advantages of the gold standard and avoid the disadvantages without being on a gold standard.”
Note that this argument, that there's a hierarchy of debts ("money claims") is directly relevant to the OP's question! You have created some "private money" (at best), or better said a private money claim, but not government money with your IOU.
