What if we told you that most money doesn’t strictly exist, but we sometimes pretend it does based on what definition of money we are using at the time? Today we will be discussing the different levels of money, and how they are created.
Contrary to popular belief, in order to print money, you don’t necessarily need to *print money* In fact, most currency that exists doesn’t physically exist. How much money exists depends on your definition of what you consider to be money.
Imagine you’re on a desert island where you and your friend use 100 coconuts as currency. Your friend has control of all of them and can issue a loan that charges you an interest rate of 1 coconut. Hence, the economy works as if there were 101 coconuts.
Debt Creates Money
Whenever interest is charged on any asset, this creates paper claims which get treated as new versions of that asset. This is why you can have inflationary price effects on assets that are limited in quantity.
Debt Upon Debt
Your friend now has a right to 101 coconuts on paper. If someone new comes to the island, he can use his assets of 101 coconuts & transform them into even more coconuts by lending against his capital. Real banks have legal limiters to how much they can do this.
You might not have the extra coconut that you owe to your friend. But since you have a good reputation, you can create a contract valued at 1 coconut, which is redeemable for goods or services you produce. This claim can then be used as a coconut substitute.
Dirty Little Secret
The economy might have grown, and outstanding obligations might be over 1000 coconuts, but there are still only 100 REAL coconuts. Depending on the velocity of money, it then becomes increasingly difficult to ever pay all debts without economic collapse.
People eventually harvest coconuts, which are then lent to others like your friend, with the intention that they will loan them out as well. These are central banks, which create money and decide the speed of the economy by affecting the availability of cash.
What is Money?
An economist then comes in a rowboat and a suit, asking how many coconuts your island economy has. What do you tell him? “It depends” would be the honest answer, as your economy might still only have 100 coconuts, but has evolved past needing “real” ones.
A similar situation happens in modern economies. Debt and financial instruments that can easily be converted into cash work almost as well as money, so any frank assessment of the economy should consider them as part of the money supply.
What is it?
Every country has a different way to measure money. In the USA, the monetary base is measured in various levels: M0, MB, M1, M2, M3, MZM. These go all the way from narrow definitions, like physical notes, to broad definitions including airline miles.
Nowadays money has value not because it’s tied to real-world utility, but because big scary men with guns will come after you if you disagree with this status quo. Therefore, as opposed to coconut commodity money, we call our money “fiat” – from Latin “Let it be done”.
Such is our disconnect with what value represents, that modern economies like the USA can lose track of $21 trillion, as it doesn’t quite know or remember where the bureaucrats popped it into existence.
“Money” is a broad term, meaning many things to various people. Once we assign “paper claims” to nonexistent assets, money becomes disconnected from physical reality & evolves to become something different. Debt becomes money, so it is a claim on future benefits.