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Wednesday, August 21, 2013

Money is a Unit of Account

This article presents my answer to the question: What is Money?

From the perspective of someone analyzing developed economies' bond markets (which is the only perspective which matters for the purposes of the Bond Economics blog) the answer is: money is a unit of account.

In other words, money is a unit of measurement, not a thing in itself. Like a kilogram, for instance. You can have a kilogram of feathers, you can have a kilogram of yummy breakfast cereal, but you can't have "a kilogram".

If a kilogram measures mass, what does money measure? It measures debt.

All forms of money in a modern economy are effectively debt instruments, and monetary transactions  are therefore a trade of something for a debt. And these debt instruments are measured in a common unit, which is the domestic currency like the Canadian dollar, U.S. dollar, or the British Pound. If there was no common unit of measure, it would be essentially impossible to pay these debts back. This is because debts are often settled by the debtor handing the lender a debt instrument of a third party, and you need a common measure to compare their values.

What about notes and coins issued by the State? By most formal definitions, these are not considered to be debt. However, they effectively are debt: they could be used to discharge tax liabilities taxpayers owe the State. Since one of the uses of debt is to cancel out other debts, notes and coin effectively act as debt instruments. Alternatively, you can view notes and coin as matured Treasury Bills, and so they fit quite nicely on the government yield curve - and the other instruments on that curve are undoubtedly debt instruments.

Even if you did something crazy like returning to a Gold Standard, you will find that this situation will not practically change. Most transactions in the historical Gold Standard era were settled via the banking system, not via people slapping hunks of metal on a shop counter. The role of gold within the system was largely to settle accounts across countries, as banking systems are national. People only wanted to get their hands on the gold when the system was breaking down (the gold parities were changed versus the unit of account). A Gold Standard is just an attempt at price controls for one commodity by the government, and price control systems are fairly fragile things.

However, many economists have incorrectly attributed many more properties to money than just being a unit of account. This mission creep has lead to many people being confused or even angry about the monetary system. 

The property that causes the greatest grief is that many argue that "money is a store of value". Although it would be nice if the monetary unit had a stable relationship with all other values in the economy, this is not really possible in an economy with a diverse array of goods and services. (Most mainstream economics models essentially have a single good, so it is easier to have a straightforward price relationships.) Since prices shift relative to each other, it is impossible for all of them to have a constant price in the unit of account. 

Economists have created averages, like the Consumer Price Index (CPI) to attempt to create a single "composite good" which could theoretically have a stable monetary price even as some prices rise and others fall. However, I argue that the focus on what goods money can buy (the CPI or gold) is misplaced; the most important price in a capitalist economy is the price of labour. (By definition, you cannot be a capitalist unless you hire labourers.) Wage contracts are specified in the unit of account, and can be viewed as a form of debt contract. They are thus an extension of the web of debts that encompass all the participants of the modern economies. Therefore, the best that you can probably hope for is some stability in the price of labour when expressed in the unit of account.

(NOTE: For a longer discussion of how the unit of account concept fits in with the origins of money, see this article from the Social Democracry for the 21st Century blog. It has a list of references as well.)

(c) Brian Romanchuk 2013

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