I submit the following working definition of Real Money as a yardstick to aid in analyzing monetary schemes and innovations.
Real Money means a Currency, of which:
- Some or all Monetary Liabilities denominated in it are suitable for general use as a medium of exchange;
- No Monetary Liabilities denominated in it can be construed as Broad Money of another Currency;
- The Base Money is suitable to be held by Financial Institutions as a reserve asset held against like-denominated Broad Money obligations such as bank deposits;
- The Base Money is:
Let me elaborate a bit since the definition at first read may come across a little stilted or unnecessarily hair-splitting.
First off, I wanted a definition that would include existing brands of conventional money. There are some gold bugs who express sentiments to the effect that modern USD as issued by the US Federal Reserve somehow isn't real money. Most people, however, would find any definition of real money that excludes the money people routinely use useless and ridiculous.
Secondly and similarly; I added the final bullet so as to encompass historic systems that defined full bodied bullion coins as the official money. Such arrangements were real enough although in my opinion, as I will explain in other posts, they were fatally flawed. I see no future for systems that contemplate routine commercial use of bullion coins as money. It especially strikes me as misdirected effort when I observe the futile passion of those who advocate the restoration of some flavor of gold standard.
For present purposes, there are a few point-by-point nuances I'd like to highlight.
Some or all Monetary Liabilities denominated in it are suitable for general use as a medium of exchange.
This stipulation is intended to include USD ( and AUG®) but to exclude SDRs as the latter are currently constituted.
With USD, obviously, the paper cash form of the Base Money as well as Broad Money liabilities such as money in checking accounts are suitable for general use as a medium of exchange. But not all forms of USD are designed for general use. A substantial proportion of the Fed's Base Money liabilities exist only in the form of electronic book entries representing Reserve balances with Federal Reserve Banks. Federal Reserve Banks can be thought of as "bankers' banks" and these balances constitute deposits of member depository institutions. This money moves around in a closed loop, primarily via Fedwire and the National Settlement Service. As such, these balances are not available for general use and, with the way Fedwire and NSS are designed and currently configured, they really wouldn't be suitable either. Neither transfer mechanism is set up to support direct access by the general public.
SDRs would be excluded under this definition because they are used only as an accounting convention and means of book entry settlement between the IMF and its members. SDRs do not exist in any form accessible to the general public for use as a medium of exchange (or store of value for that matter). [Nothing prevents folks from using SDRs as a pricing/invoicing unit though, if they feel like it.]
No Monetary Liabilities denominated in it can be construed as Broad Money of another Currency.
This element provides for the inclusion of Currencies issued by Currency Boards as brands of Real Money in their own right. It excludes credit card brands or credit card intermediaries such as Paypal®.
The Bulgarian National Bank, Issuer of the Bulgarian Lev (BGN), is bound by its enabling legislation "to sell and purchase euro against levs" at a fixed ratio. It holds mostly EUR-denominated assets against its BGN Monetary Liabilities in conformity with this mandate. In this respect it resembles most any commercial bank offering EUR-denominated demand deposits. EUR-denominated bank deposits, however, clearly constitute a component of the EUR broad money supply. BGN, in contrast, in both its Base Money and Broad Money manifestations, is wholly distinct—another brand of money altogether—from EUR. And it is Real Money.
Credit card and Paypal balances are denominated in conventional (national) Currencies. It makes sense to think of them of being part of the Broad Money supply of whichever Currency they are denominated in.
AUG most closely resembles the Currency Board case; it can be redeemed (by a Primary Dealer), for physical gold but in no respect can it be "construed as Broad Money" of physical gold. The Base Money of AUG, which circulates exclusively via the Global Standard System, is obligatorily Backed by a 100% reserve of physical gold but these gold reserves are no more useful as money than are the Treasury bonds and other assets that constitute the value underlying USD. The value of gold is much more effectively mobilized as money when it crosses the balance sheet of the AUG Issuer from asset to Monetary Liability.
The Base Money is suitable to be held by financial institutions as a reserve asset held against like-denominated Broad Money obligations such as bank deposits.
In my view, the criteria for suitability were well expressed by Lawrence Meyer in his 2001 remarks regarding "The Future of Money and of Monetary Policy".
"...central banks, at least in developed economies, issue currency and provide clearing services, at least in part, because their services offer features, such as freedom from default risk and finality of settlement, that private providers cannot match."
I agree that banks—at least banks operating in a world where prudential considerations were of primary importance—would regard freedom from default risk as an imperative attribute for reserve assets. (I respectfully disagree with his contention that only government central banks can assure freedom from default risk and finality of settlement.)
As I write this in 2015, however, prudential considerations would appear to play second fiddle to more actively trending enthusiasms. So while this criterion would normally exclude play money backed by no assets whatsoever, some enterprising bank might garner a few choice tweets or similar buzz (for at least a few minutes) by offering Bitcoin deposits. Which leads me to...
The Base Money is backed at all times by liquid assets held in readiness and in sufficient quantity as to assure its Issuer's ability to buy back all that has been spent into circulation.
Not uncommonly, especially in the context of polemics deriding fiat money, assertions such as "the Fed... creates dollars out of thin air" are uttered. This trope is popular even with sophisticated pundits who are well versed in monetary economics. An unfortunate side effect of such a statement is that it conveys/perpetuates the mistaken impression that fiat money is no different than play money. It ignores the fact that government central banks have balance sheets which balance. Play money, in contrast, is not even recognized as anyone's liability.
The main reason this matters is that Issuers of Real Money, by virtue of the assets they hold against their Monetary Liabilities, have the ability to buy back their Monetary Liabilities and shrink the money supply if needed. In simple terms, when demand for a particular brand of Real Money declines, the Issuer can sell assets and extinguish the money received in payment. This reduces the quantity of their Monetary Liabilities in circulation as reflected/achieved by a symmetric shrinkage of their balance sheet. This adjustment process can occur whether or not a particular Currency is explicitly redeemable.
No such mechanism exists for play money which, as you have surely inferred by now, is the term I use to characterize unBacked money. Like Cyberbucks—the play money version of Digicash that was the direct memetic ancestor of Bitcoin—scarcity alone ("Numbers that are money") is imagined to be an adequate basis of value. The concept of Monetary Liability has no place in a play money paradigm. No Issuer holds assets, liquid or otherwise, affording it the wherewithal to buy back any/all the Base Money in circulation. No one has or could possibly be assigned the obligation to make an orderly market for exchange in all market conditions. In the event of a cascading collapse in demand no one is obliged to offer a bid for (or redeem) any and all money panicking holders are desperate to unload. With play money there is nothing to prevent the exchange rate from dropping to zero and, after a dead cat bounce or two, staying there.
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