Balance of Money in the Past, Present and Future

Balance of Money in the Past, Present and Future


by Tommaso Monacelli, Department of Economics

What is money? Economists answer this question pragmatically, indicating the main functions of money, which are mainly three. First of all, anything that is a reserve of value is money (if I work today and earn €1, I can spend it tomorrow). Secondly, anything that facilitates exchanges, so as to solve the so-called double coincidence of wants problem, is money. A professor of economics could pay for mortadella from the grocer with a lesson on tax policy, but the grocer has no interest in being paid in economics classes. Money solves this problem. When a professor enters a shop, he is confident that the shopkeeper will accept his currency (of any material or coinage, even if they are yellow plastic bricks) as a means of payment. And the grocer will do so because in turn he expects that the tire shop around the corner, where he will offer to pay with yellow bricks, will be happy to accept them.
Yet the need to solve the double coincidence problem does not completely explain the existence of money. Think of a family or a small community, such as a group of students who share an apartment. In these communities, exchanges also take place in the absence of money. Which would lead one to think that money is not strictly necessary to solve the double coincidence problem. Yet money also circulates in the student apartment. How so?
Imagine the following example. Ugo and Maria meet: Ugo has apples and wants bananas; Maria wants apples but does not have bananas. How is an exchange possible? In an economy with physical currency (for example, euros), Maria offers Ugo money in exchange for apples. In turn, Ugo uses the money to buy bananas from Paolo in the future. This is what happens in a classical monetary economy.
But is money really necessary for the exchange between Ugo and Maria? Imagine the following agreement. If Ugo gives Maria an apple today, in turn Paolo will give Ugo bananas tomorrow (or maybe not). Where is the currency in this agreement? Seemingly it is not there. But in reality the virtual currency that Maria offers to Ugo is any system that lets Paolo know that (the day before) Ugo gave something to Maria. If this transmission of information is possible, and if it can be kept track of, then in the economy without money the same sequence of exchanges of a classical monetary economy can occur. In other words, we can define as money anything that has the function of connecting a network of gifts over time. To do this, a memory of all the gifts that have been exchanged in the past is necessary.
In an economy that is larger than a student apartment, having a memory of all the gifts made in the past can be very complicated. Here therefore the physical currency that we are used to using plays the role of a substitute for memory. One needs to understand that in its essence money is anything that can replace memory in order to accept that money does not necessarily have to have a physical form. In the technological era we are experiencing, our memory capacity can be expanded exponentially. It is therefore increasingly probable that money will assume a merely electronic form in the near future. The substantial nature of money would not be altered, that is, a memory of all the gifts made in the past by the agents involved.
The idea that money can be created from nothing is very widespread. A central bank simply needs to decide to print it. According to this belief, it would always be possible to generate resources out of nothing, alleviating any fiscal constraints. Thus the idea arose that, if it has an independent central bank, a sovereign state can never default on its public debt. This is because it would always have its own central bank that, by printing money, could buy the issuance of new securities to finance the repayment of circulating funds. With this in mind, the state can finance its own expenses by printing money, even without resorting to taxation. This is real monetary illusion. Actually, when families or businesses lend money to the state, what they expect in return (the financial return) are not euros, but rather, very prosaically, apples. Anyone who lends money to the state expects a real return, because, in giving money to the state they have refrained from using it to buy shoes or go to the movies. Any creditor, when deciding whether or not to lend money, cannot think like that: they lend euros making sure that when the debt expires they do not have fewer apples than before. Otherwise, they would never decide to lend money at all.
The debts that the state must honor, therefore, are always necessarily in apples, not in currency. The idea that these can be honored by printing money is fallacious. Because though it is true that money can be created from nothing, apples cannot. Apples require trees, irrigation, work, and even a little luck with the weather. More technically, printing €100 more currency means, sooner or later, and inevitably, a higher price of apples. And therefore less real resources. At the most, if doubling the amount of money from €100 to €200 led to an immediate doubling of the price of apples, those extra monetary resources would vanish into the same nothing from which they were created: with an invalid contribution to alleviate the state accounts.
Money is therefore trust, memory, but also often misleading mystique.

Read more about this topic:
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Michele Centemero (Mastercard). Smile at the Camera, Your train Is About to Leave
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When Paying Online, People Like to Be Anonymous
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