Following on from Gareth’s Bitcoin post, I would like to initiate a discussion around the functions of money vs. cash (the asset class, not the physical form of currency). My hope is that this discussion forms a sort of case study in economics education (with me as the student). I have an honours degree in economics and my understanding of economics, law, society, history, politics etc. are all congruent with the Austrian tradition. However, I cannot call myself an Austrian economist, since I haven’t consumed nearly enough of the primary literature. Partly as a result, the ideas I have developed privately about money appear to differ from those offered by most Austrian economists. In fact, my impression is that these ideas are quite unique. I consider this highly unlikely – a result of my relatively limited economic education. I shall outline these ideas below (with elaboration to follow in future posts), in the hope that this blog’s authors and readers point out their flaws and original/earlier sources.
Of course, one could argue that I should first properly study the Austrian monetary literature, before wasting everyone’s time with ignorant, half-formed thoughts. However, by publicly presenting my present ideas about money, perhaps I can demonstrate how and why it is often misunderstood, even by anarcho-capitalist libertarians who are economically literate.
Allow me to begin with a question: do we still even need money? Consider the functions of money: medium of exchange, unit of account, store of value. Given modern information technology and advanced financial markets, the first two functions are theoretically obsolete. With appropriate institutional and telecommunications infrastructure, any good or service could easily be exchanged for any financial asset (currency, bonds, stocks, options, unit trust shares, oil futures, platinum ETFs, etc). Similarly, any good or service or financial asset can be instantaneously valued in terms of any other financial asset. For example, at the supermarket till one could pay for your Rand-denominated groceries in Swiss Francs (or copper futures), using the relevant exchange rate at the moment you check out.
What about money’s “store of value” function? Looking at the definition of money, I’m not sure whether this is even a function of money per se. Rather, isn’t ‘store of value’ an attribute that a commodity / currency / other asset gains when it becomes generally accepted as money? Why or how, then, does it gain this ‘store of value’ property?
It is at this point that I should introduce my central proposition, that cash represents an implicit basket of forward contracts. Allow me to attempt to explain this, albeit very clumsily. In current financial systems, money is synonymous with fiat currency, and fiat currency is synonymous with the asset class of cash (the equivalence of cash and money may not necessarily hold in a completely free market financial system, but more on that later). Why do individuals and businesses hold cash balances rather than, say, shares in equity unit trusts? After all, unit trust shares are highly liquid. The reason is that the value of cash is (at least meant to be) fairly stable. Stable in terms of what? In terms of the goods and services you plan to buy in the near-term future (depending on the context, near-term can mean a couple days or a couple of years). This holds true to the extent that the nominal prices of goods and services remain constant. The less stable the relative value of cash (as with hyperinflation), the harder it is to plan for future consumption, production and investment. The consumer or business manager holds cash/currency not because it functions as money, but because he implicitly expects it to function like units of a highly diversified mutual fund consisting of forward contracts for goods, services, and other financial assets. Thanks especially to government involvement, cash/currency doesn’t behave anything like this ideal, but it’s closer than any other asset class available to the average consumer or business.
Thus, fiat currency’s ‘store of value’ attribute is derived from its ‘pseudo forward contract’ properties, which are in turn derived from it’s general use as money. As Robert Blumen puts it, “The reason that a medium of exchange necessarily is also a store of value is the anticipation of its exchange value in the future” (Is Gold Money?).
In a world of insignificant transaction costs and hyper-advanced financial markets (plus other assumptions I can’t think of now), instead of holding cash the economic agent would directly purchase forward contracts for the exact things he plans to use in the short term. For example, I know with a fair degree of confidence how much milk, soap, electricity, petrol etc that I will consume six months from now. I could purchase these goods in advance from the institutions I plan to buy them from (hopefully such contracts could also be transferable, say between Checkers and Spar, BP and Engen).
In a free market monetary system, I think the most successful currencies to emerge would indeed be backed by highly diversified baskets of commodity futures (both hard and soft commodities). An exciting implication of such a system is that consumers’ demand (consumers here meaning households and firms) for different currencies would drive the price of futures contracts, thus giving producers much better information and expectations about the consumer’s future wants.
What of gold? My views on gold are similar to those expressed by Blumen above, and this Business Insider article of the same name. Suffice it to say for now, I think in the long-run market competition between different monies, private commodity-backed currencies (as described above) will be preferred to gold.
I don’t know how much of the above will make sense to my intended audience (which is mostly my fellow co-bloggers), or whether I am successfully conveying the concepts in my head. Please feel free to ask for further explanation – it doesn’t matter how basic the question seems…I could have made a very basic mistake.