Forms of Money in Finance

& why it mattersa lot

Financiers provide money now

to get more money later
Creditor provides money to borrower
Equity investor provides money to buy ownership
share
Creditor has a contract specifying they will receive
more money in the future
Equity investor expects to receive a positive return
on their money commensurate with the risk of the
investment
The form of money influences the scope and
character of financial transactions
How it is created
Whether it is convertible on demand, etc.

So what is money?
What are the 3 functions of money?
Unit of account
Like an inch, an ounce, a minute: unit in which prices are
quoted, contracts are written, debts are issued

Store of value
An inventory stock of potential ( yet unspecified)
purchasing power

Means of exchange
Common basis of exchange rate between goods

More importantly, money is used as a means of

final settlement
Discharge all existing obligations to pay prices, debts

So what is money?
What are the 3 basic types of
money?
Commodity money
Credit money
Fiat money
Complementary currencies may be a 4th
type

What defines each type of money

and what backs it?
Commodity money
Money created from a commodity that is
produced/,extracted, and bid away from
use as an input to other production
processes
Also money exchangeable on demand in
to a fixed number of units of a
commodity
Backing: the exchange value of the
quantity of the commodity deemed
money (usually precious metals)

What backs credit money?

Credit money
Money created when a Bank makes a loan (or
buys a security), and credits a deposit account
Backing:
The value of the assets on the bank books
Willingness of bank to accept deposits to
pay off loans
What happens if the value of bank assets
drops below bank liabilities?
What is the ultimate backing if a bank is
provided with deposit insurance?

What backs fiat money?

Fiat money
Money defined by law: legal tender
Backing:
Power of the government to impose
payment obligations like taxes in the
units of an item it defines as money
(often paper money )
Power of government to enforce laws
Habit, and appearance of consensus
over voluntary general acceptance

What backs fiat money?

Thinking deeper
What else is required/implied in order for
the government to impose taxes in a fiat
currency?
What do taxpayers need?
How do they get it?
What does that imply for the taxable part of
the private sector?
What does that imply for government finance?

What backs fiat money?

Thinking deeper with the US Treasury Dept.

Federal Reserve notes are not

redeemable in gold, silver or any other
commodity, and receive no backing by
anything This has been the case since
1933.
The notes have no value for themselves,
but for what they will buy.
In another sense, because they are legal
tender, Federal Reserve notes are
"backed" by all the goods and services in
the economy.

https://www.treasury.gov/resource-center/faqs/Currency/Pages/legal-tender.aspx

Is money an asset or a liability?

Commodity money
Liability of no one: just another exchangeable good
Money is an asset of the holder: a durable good
held as inventory

Credit money
Money is a liability of the bank
Money is also an asset of the deposit owner

Fiat money
Money is a liability of the government (or its central
bank)
Money is an asset of the private sector holder

The Love of Money exercise

Count off into 4 teams
Identify 3 main strengths and
weaknesses for each type of money
Team 1: Commodity money
Team 2: Credit money
Team 3: Fiat money
Team 4: Design a hybrid (or entirely
new) form of money that avoids or
reduces the flaws in main 3 types

Convertibility vs. Sovereignty

Money can be convertible upon demand
into:
Specific units of other nations money:
Fixed exchange rate regime

Specific units of a commodity:

a fixed claim on a commodity (like a coat check
claim)

Specific units of another form of currency:

bank deposits converted on demand to fiat
money (currency that comes out of an ATM
machine, deducted value from your bank deposit)

Convertibility vs. Sovereignty

Sovereign money
Government defines unit of account
Government defines acceptable means
of payment it will use when it buys
private sector resources
Also defines acceptable means of
settlement by private sector with
government

Convertibility vs. Sovereignty

Sovereign money
Government is an issuer of money
not just a user of existing money issued
elsewhere

Money is not convertible on demand into

anything except equal units of itself
Money creation is less constrained
Nation has more autonomy in economic
policy to pursue its own domestic goals

What type of money does US have?

Federal Reserve Act 1913, Sec. 6
An Act To provide for the establishment of Federal
reserve banks, to furnish an elastic currency
Federal Reserve notes "shall be obligations of the
United States and shall be receivable by all national
and member banks and Federal reserve banks
and for all taxes, customs, and other public dues.
They shall be redeemed in lawful money on
demand
Federal and state courts since then have repeatedly held
that Federal Reserve notes are also "lawful money." Milam v.
U.S., 524 F.2d 629 (9thCir.1974)
See https://www.federalreserve.gov/aboutthefed/section6.htm

Federal Reserve Notes are a liability

of USor of the Federal Reserve?
Do Federal Reserve Notes show up
on the US Treasury balance sheet?
Or on the Federal Reserves balance
sheet?
What are the assets on the other side
of that balance sheet?
http://www.federalreserve.gov/release
s/z1/current/z1r-4.pdf

Federal Reserve Notes are a liability

of USor of the Federal Reserve?
Congress has specified that a
Federal Reserve Bank must hold
collateral equal in value to the
Federal Reserve notes that the Bank
receives. This collateral is chiefly
gold certificates and United States
securities. This provides backing for
the note issue
http://www.treasury.gov/resource-center/faqs/curr
ency/pages/legal-tender.aspx

What does that imply for the

capacity of US economic policy?
So what backs US dollars aka
Federal Reserve notes?
Can the Fed go bankrupt?
What does that mean?
What backs US Treasury bonds?

What does that imply for the capacity

of US economic policy to pursue
sustainability goals?

Can a govt. with a sovereign fiat currency run out of

money?
What is the actual budget constraint of that govt.?
What has Quantitative Easing demonstrated?
So what is the real constraint on building a renewable
energy infrastructure?
Has the US government ever been able to do anything
right when building infrastructure?

Canals
Ports
Railroads
Airports
Highways

What does that imply for the

capacity of US economic policy?
What does this mean for government
finance?
What is the budget constraint with a
sovereign fiat currency?

What does this mean for the capacity

of government to lead a shift to a
new energy infrastructure?

Summary
The form of money matters a lot to the scope and
capacities of finance
Different forms of money have different backing
National economies with commodity currencies and
convertible currencies have the most restrictions
Economies with credit money, fiat money, and
sovereign currencies have the most autonomy
Most countries have mixed sovereign fiat money
and credit money based financial systems
So what is stopping us from building a regenerative
economy?