What is money?

A travel in cashland and monetosphere

Money is a crucial tool used to exchange, measure and keep value.

It is an immaterial right under the form of bank accounts and cash.
It comes under various national denominations named currencies.

Legally, it is a commitment backed by other commitments.

Important issues are the incidences of the monetary policy
and of the foreign exchange (forex) volatility

A small step for the purse,
a big step for mankind!

Yes, inventing money gave birth to
arithmetics, writing, and thus History.

An economic and legal instrument

 sous Money is an economic tool tool used practically everyday by
              practically everybody and which has several roles and forms, as
              the Swiss army knife
of the economy.

To define it legally, money is an immaterial right, a kind of contract
Its value rests on a chain of
commit commitments, as explained below.

Three economic roles

and two practical forms

A) Money, as an all-purposes economic tool,
is used to:
1) group Exchange (we pay with it, we get paid, we donate,
                       we lend, we borrow...),

2) measure Measure values (via "prices"),

3) banksafe Keep and store value (mostly in deposits,
                  with or without interests).

There are other savings and investment assets, and
some might protect value better, but money
is the
most basic, easy to use and of course it helps to
measure what
the other assets are worth.
Because of those traits, money:

* plays a crucial role in economic activities
   as a kind of Swiss army knife of the economy.

* has also a crucial social role
psychological implications.

* fascinates robbers, as their preferred target,
   but that is another story.

B) Money has two practical forms:

Either a computer blip,
or a paper with numbers and an image on it.

But nothing "virtual" or "fictitious" here. It is a quite concrete tool, a 
real  buying power, based on real legal counterparts

Nowadays money is an immaterial right that has two forms:
1) The main one, "sight" bank account balances, also called
      "bank money"
(used for transfers, cheques, payment cards...).
      Except maybe for very small expenses it has become the main
      monetary tool
It is well adapted to be used as "electronic cash" .
Receiving, storing and sending money is now done mostly
with electrons.
2) Physical cash (banknotes / coins).

It is also called "fiat money" (fiat = done in Latin, as made
usually by legal authorities, at the difference for example
of gold, that you can find, well, if you are lucky, in mother

You might have some physical cash under your mattress or
in your pocket, but its role is more and more secondary in
developed economies.
Well, it is sometimes preferred, even for big amounts,
of "discretion"
* What about near-money ...and archeo-money?

We do not use any more clam shells, a primitive money.
What has also disappeared, albeit more recently, is luckprecious
which was the usual form of cash some centuries ago
(and is still a, generally minor, component of central bank reserves).
I gave a hint about it above.

Can gold come back ?
Or will it stay a "near-money" hoarded as a precaution ?

One problem of gold is that its price is very speculative
changing (volatility) thus
not giving any certainty of value. Also, even in
case confidence in States and banks plummets and creates a
liquidity systemic liquidity crisis, it is more  than doubtful that there would
be a big enough quantity of gold and gems to become THE alternative.

=> Better put our hope on building a smarter world monetary system
      But this would suppose some sense of the world's interest among
But if a collective fear makes those alternative assets more and
more precious, better keep your wedding and other rings in a safe
if you want your fingers not to be cut off from your hands
at a street corner ;-)
Oh, many things can be used as near money, from candies (to replace small
change) to airline miles.
And now bitcoins, without economic counterparts or legal commitments
to back their value, thus fictitious and in practice erratic (bubble).

Money is a legal commitment
based on other commitments

Money is nowadays created
by the banking system.

Not for itself, mind you, but
for its customers!

Borrowers commitments to banks

A bank loan takes usually the form of
a credit on the borrower's bank deposit account.

This is how money is created essentially as a counterpart of a myriad of
bank borrowers' commit legal commitments.

Those borrowers contractual / legal commitments can be seen as
collaterals in favor of bank depositors (and indirectly of
banknote bearers).

Well, there is a difference to make between long term and short
loansIt would be perilous to grant long term loans via money
creation or
by financing them with short term deposits. Here, savings
and bonds are
more appropriate resources.

What makes banks perfectly entitled (certainly more than States)
to issue money is that they don't create it:

* from nothing ("ex nihilo", as bank bashers say),
* for itself (as those ideologues pretend also).

They only transform economic commitments into liquid
used by those who take those commitments.

As those liquidities do not stay long in the borrowers bank accounts,
any  bank, as seen below, needs to "refinance" itself by attracting
new deposits
, which are actually loans to that bank by other

Thus money creation is done by the whole banking system,
but every bank is individually responsible to have enough
as equil counterpart to its loans. Its balance sheet
must comply to prudential rules on liquidity (enough liquid assets)
and on solvency (enough equity), as defined in the "Basel III"
international agreement

This sophisticated set of rules makes largely obsolete the old "fractional
reserve system" based on freezing a portion of customers deposits in
mandatory reserves at the central bank, at the detriment of the general
liquidity. Those reserves are now null or symbolic.

Bank commitments to depositors

This bank money circulates (by cheques and transfers to pay suppliers
or staff, to invest in assets...).
The people who receive it store it, at least temporarily, in their bank
deposit accounts
, where it is available for them to use it (as payment

Banks are committed to make that money available to its clients
who deposit it, thus lended it to the bank. For that purpose, banks
* the acceptability and availability of this deposited money for payments 
   and other transfers,
* and of course its exchange against banknotes and coins issued by the
   central bank.

This can be called fungibility and liquidity. Big words, yes !

To maintain this ability, banks refinance their loans essentially
with a sufficient amount of customer deposits and savings
  • This helps to reach an "Asset - Liability match"
in bank balance sheets.
One important management issue here is to lessen the "gaps" between
types of assets and liabilities.

For example there should be
* enough long term resources to finance long term commitments,
* enough liquid assets to face potential withdrawals and transfers
    by depositors).
  • This refinancing makes that a portion of the interests
that the borrower pays to the bank for the service given by granting
the credit (*) is transferred to depositors (through the bank services
given  even if some of them are also paid by fees) and savers
(*) normally bank loans finance economic project or agents that
make enough money to pay those interests.

Commitments by public authorities

Central banks add another level of guarantee and security
as their job is to:
  • control that money creation by banks
(and also issue directly fiat money),
  • bring short term liquidity to banks, within limits,
to contribute to the liquidity of the money market (the market
where banks make short term loans between them)
  • are the lenders of last resort in case of crisis,
States and their taxpayers are the ultimate guarantors in case the
banking system cannot face its own commitment to money holders.
Of course, to what extent you can trust States is up to you to consider ;-)

Some still think that money should be created directly
by States

* either via their central banks, which would make the commercial banks
   just distributors (and savings collectors), by lending them that money
   (thus having the hand on those institutions and indirectly on their 
   customers, deciding what they do with the money)

* or by ...giving it directly to its employees, suppliers and other beneficiaries
   via its state treasury network (yes, its tax collectors !).

This seems a perverted solution: the State cannot offer a full
economic counterpart
/ economic commitment for the mass of papers
or electronic blips
it would issue to finance its own good life and short term
political interest
In fact a State that creates money for itself creates ...a tax on people's

What about the last resort?

Is it OK that a central bank be a "lender of last resort" to a troubled State?
Maybe, but there is the risk that a temporary transfusion done in a crisis
changes into a permanent perfusion avoiding the State to look for a real

Oh, by the way, the fact that money is less and less used as cash
(banknotes and
coins), is one of the thing that makes anachronic its
creation by

Monetary policy

Every central bank is responsible to control how a specific money
(Euro, US dollar, Mexican peso, or whatever) is issued by the
banking system
of its related territory.

It regulates the quantity and the price
(the interbank interest rate,
to simplify, and, for some central banks, the foreign exchange rate) of that

It is usually considered, here again to simplify, that:
  • Too much credit and money
might bring consumer price inflation and /or asset bubbles.
Anyway too much money is a signal of overleverage,
with a low
quality of some of the commitments as explained above

Actually, under the lead of the US central bank under the
"Keynesian" alibi the last decades experienced an exuberant
monetary creation that was supposed to boost the economy.

But the real - perverse - results of this overflow were not only
huge economic imbalances but also a huge hypertrophy
and bubble of the whole financial sphere
which players
took advantage of this easy to get and nearly free money.
Thus, the global financial and economic crisis, the worst since
1929, a full instability
that persists since 2007.

  • Not enough money
might bring economic deflation / recession
and/or underinvestment / asset crashes.

Thus, what the central bank should be?

The central bank shall be really independent from the other banks and
from politicians that might think that it should pay for their marvelous
but unfunded promises.

But how to make that separation of powers ?
Why not as an association or cooperative of users?

A related aspect: currencies
and forex (foreign exchange)

As a simplification, it can be said that commercial banks that create
fiduciary money in a monetary area do it under a central bank

Central banks are sovereign bodies.
A central bank has been granted by a State (or a group of States making
a monetary zone as is the case for 18 countries of the European union)
a license to issue money denominated in the related official currency
(Euro, US dollar, Swiss franc, Chinese yuan, Indian rupee, British pound...).

Those currencies are - or not - freely convertible into others, at a
fixed or floating rate of exchange.
The exchange is done according to a price called the "exchange rate",
either via (for non convertible currencies) the central bank or (for
convertible currencies) through a free buysell market called foreign
exchange (Forex
), an institution similar to the assets markets and
commodity markets.
Among all those markets, the forex has become the one with the
largest transaction volume.

It experience also to a high price
This massive instability is sometimes referenced as a "currency

It expresses a lack of a true
world monetary system,
and notably the lack of a common monetary standard
The US dollar has progressively lost its ability to be trusted as the
global monetary pivot and reference.

Like other financial imbalances, instabilities and
bubbles seen in the
past, this could lead to a general distrust of most major currencies
and then to a
systemic liquidity crisis,

By the way, what makes the value of money?

Some would say that money has no gem value by itself, that it is just
an intermediary tool to exchange goods and services and measure their

This can be debated on linguistic grounds, but to make those exchanges
and those measures, the available instrument, and this is what money is
used for, needs a numererical value in the mathematical sense.

Various direct and indirect factors intervene in the value of a currency,
with, in the background, the "trust" it inspires:
  • The health of the debtors of the banks that create bank money,
thus the general health of the economy or economies in
which they are players.
A high volume of bad loans, as it happened in the subprime
crisis and the sovereign debt crisis needed immediate central
banks and states intervention to avoid a global monetary
  • The health (solvency / liquidity) of the banks managing the deposits.
  • The stability and fiscal health of the country or countries.
where it is issued (even if money is less and less created by
  • The consumer priceprice and assets price evolutions
in the zone that uses that money (inflation lowers this money's
value, less goods or services for the same money unit),
  • Also the current interest rates,
  • Of course the volume of the money issued,
  • And practically, its price on the (Forex / foreign exchange market),
either in relation with a common monetary standard (cf. the
above chapter) or with the other currencies.
Such an exchange rate which rests at the same time on objective
and subjective motives (trust, notably).
  • Not to forget that one of the worst enemies of money 
(and of the economy) is lever overleverage (excess of
debt), whether public or private.

Reference and further readings

From the "Economic" section
of my "Behavioral economics / finance" website

Don't miss there t
he "Psychology of money",
that details the human and social side of money.

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M.a.j. / updated : 15 Sept 2015
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