More and more money just in case. Educational about money and monetary systems


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Here comes the next, hopefully educational piece in Fundamentals of Finance. This time it is about money. Money strictly speaking. This is probably one of the hardest. Money is all around us, whether we have it or not. How to explain something so pervasive? I think the best way is to stick to facts, in the first place. I take my wallet. What’s inside? There is some cash, there is a debit card, and two credit cards. Oh, yes, and there is that payment app, SkyCash, on my phone. All that, i.e. cash + credit cards + debit card + payment app, is the money I am walking around with.

How to explain things which seem really hard to explain? One possible way is to ask THOSE questions. I mean those stupid, out of place questions. One such question is just nocking at the door of my consciousness. Are all these forms of money in my wallet just different forms of essentially the same thing, or are they rather essentially different things which just take a similar form? I mean, if this is all money, why is there not just one form of money? Why are there many forms? Why don’t I use just cash, or just a payment app? See? If anyone was in any doubt as for whether I can ask a really stupid question, here is the answer. Yes, I can.

Now, I need the really hard answer, I mean the answer to that stupid question. I observe things and try to figure something out. I observe my credit card, for example. What is that? It is a technology that allows me to tap into a credit account that a bank has allowed me. Which means that the bank studied me, and compared me to a bunch of other people, and they decided that I have a certain borrowing capacity, i.e. I am able to generate sufficient a stream of income over time to pay back a certain amount of credit. When I use a credit card, I use my future income. If this is a technology, there must have been need for its massive use. We usually make technologies for things that happen recurrently. Banks recurrently assess the amount of credit they can extend to non-bank people, and they take care of securing some kind of technology to do so. Here comes an important distinction in plastic, namely that between a credit card and a debit card. A debit card is a technology that allows me to tap into my own current bank account, which is different from my credit card account. I trust the bank with recording a certain type of transactions I make. These transactions are transfers to and from my current account. The bank is my book keeper, and, as far as a current account strictly spoken is concerned, it is a smart book keeper. I cannot make more transfers from my current account than I receive onto it. It is book keeping with a safety valve. Banks recurrently keep the record of financial transactions that people enter into, they take care of preventing negative balance on those transactions, and the temporary bottom line of such transactions is the current balance on the same people’s current accounts.


Good, now comes cash money. Those notes and coins I have in my wallet are any good for payment because a special bank, the Central Bank of my country, printed and minted them, put them in circulation, and guarantees their nominal (face) value. Guaranteeing means that the Central Bank can be held liable of the total nominal value of all the notes and coins in circulation. This means, in turn, that the Central Bank needs to hold assets of similar liquidity, just to balance the value of cash guaranteed. When I use cash, I indirectly use a fraction of those liquid assets held by the central bank. What kind of assets has a similar liquidity to money? Well, money, of course. The Central Bank can extend credit to commercial banks, and thus holding claims on the money those banks hold. The Central Bank can also buy the cash money guaranteed by other central banks, mostly those reliable ones. We have another behavioural pattern: governments form central banks, and those central banks hold some highly liquid assets, and they use those highly liquid assets to back a certain amount of cash they put in circulation.

Now, there is that beast called « FinTech » and all them Payment Apps we can use, like Apple Wallet. I can use a payment app in two ways: I can connect a credit card to it, or I can directly hold a monetary balance in it. Anyway, I need to register an account, and give it some liquidity. When I pay through connection with my credit card, the Payment App is just an extension of the same technology as the one in the card. On the other hand, when I hold a monetary balance with a payment app, that balance is a claim of mine on the operator of the app. That means the operator has a liability to me, and they need to hold liquid assets to balance that liability. By the way, when a bank holds my current account, the temporary balance on that account is also my claim on the bank, and the bank needs to hold some highly liquid assets to balance my current balance with them. Here comes an even more general behavioural pattern. Some institutions, called financial institutions, like commercial banks, central banks, and operators of FinTech utilities, are good at assessing the future liquidity in other agents, and hold highly liquid assets that allow them to be liable to third persons as for holding, and keeping operational, specific accounts of liabilities: current accounts and cash in circulation.

Those highly liquid assets held by financial institutions need to be similar in their transactional pattern to the liabilities served. They need to be various forms of money. A bank can extend me a credit card, because they have another bank extends them an even bigger credit card. A central bank can maintain cash in circulation because it can trust in the value of other currencies in circulation. Looks like a loop? Well, yes, ‘cause it is a loop. Monetary systems are made of trusted agents who are trusted precisely as for their capacity to maintain a reliable balance between what they owe and what they have claims on. Historically, financial institutions emerged as agents who always pay their debts.


Good, this is what them financial institutions do about money. What do I do about money? I hold it and I spend it. When I think about it, I hold much more than I spend. Even if I count just my current wallet, i.e. all those forms of liquidity I walk around with, it is much more than I need for my current expenses. Why do I hold something I don’t immediately need? Perhaps because I think I might need it. There is some sort of uncertainty ahead of me, and I more or less consciously assume that holding more money than I immediately need can help me facing those contingencies. It might be positive or negative. I might have to pay for sudden medical care, or I might be willing to enter into some sudden business deals. Some of the money I hold corresponds to a quantity of goods and services I am going to purchase immediately, and another part of my money is there just to assure I might be able to buy more if I need.

When I focus on the money I hold just in case, I can see another distinction. I just walk around with some extra money, and I hold a different balance of extra money in the form of savings, i.e. I have it stored somewhere, and I assume I don’t spend it now. When I use money to meet uncertainty, the latter is scalable and differentiated. There are future expenditures, usually in a more distant future, which I attempt to provide for by saving. There are others, sort of more diffuse and seemingly more immediate, which I just hold some money for in my current wallet. We use money to meet uncertainty and risk, and we adapt our use of money to our perception of that uncertainty and risk.

Let’s see how Polish people use money. To that end, I use the statistics available with the National Bank of Poland as well as those published by the World Bank. You can see a synthetic picture in the two graphs below. In the first one, you can see the so-called broad money (all the money we hold) in relation to the GDP, or to Gross Domestic Product. The GDP is supposed to represent the real amount of goods and services supplied in the country over 1 year. Incidentally, the way we compute GDP implies that it reflects the real amount of all final goods and services purchased over one year. Hence, that proportion between money supplied and GDP is that between the money we hold, and the things we buy. You can see, in the graph, that in Poland (it is the same a bit all around the world, by the way) we tend to hold more and more money in relation to the things we buy. Conclusion: we hold more and more money just in case.

In the second graph below, you can see the structure of broad money supplied in Poland, split into the so-called monetary aggregates: cash in circulation, current account money, and term deposits in money. You can see current account money gently taking over the system, with the cash money receding, and deposits sort of receding as well, still holding a larger position in the system. It looks as if we were adapting our way of using money to a more and more intense perception of diffuse, hardly predictable risks.


I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. As we talk business plans, I remind you that you can download, from the library of my blog, the business plan I prepared for my semi-scientific project Befund  (and you can access the French version as well). You can also get a free e-copy of my book ‘Capitalism and Political Power’ You can support my research by donating directly, any amount you consider appropriate, to my PayPal account. You can also consider going to my Patreon page and become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?

Complicated? Certainly, and this is not all

My editorial

I need to shake off a bit, regarding the business plan I am currently preparing for the EneFin project. The thing is supposed to be FinTech in the market of energy, with a special focus of promoting renewable energies and fitting into the technological and socio-economic environment of smart cities. As I was preparing my last update in French (see Une plantation des clients qui portent fruit), I became aware that I am entrenching myself in a frame of mind that one of my friends calls ‘the ferocious bulldog’. Those among you, my dear readers, who have been following my blogging for a while, know that I frequently use a metaphor about myself, namely that I am a combination of a happy bulldog, a curious ape, and an austere monk. The important thing about the bulldog, in that internal trinity of mine, is to keep it happy, and now, precisely, my internal bulldog is progressively getting unhappy, and this is when it becomes visible to my friends. My unhappy bulldog has just bitten so strongly in something (or someone) that it can hardly let go. ‘Hardly’ differs from ‘not at all’, and it means it is still possible to unclench my jaws and to get some distance. It is that or a crowbar forcing my mouth open. Distance is better. Crowbars taste iron. Disgusting.

This is the moment of getting some fresh perspective, whilst maintaining a gentle, possibly a graceful drift in the general direction I want to follow. One of the ways I can make my internal bulldog happy is talking to dead people. I mean, not to all of them, just to some. There is a guy I like talking to about the things of life, the name’s Jacques Savary. He used to be French, before he died, by the end of the 17thcentury. He used to be French in the fullness of what I like in the French: he did a bit of everything, probably could wield a dagger and a quill with equal dexterity, and he wrote an interesting book, “The Perfect Merchant”, published on the same year that d’Artagnan died. You can find the French original of the book with I documented a few conversations of mine with Master Savary on this blog (see Comes the time, comes the calm duke, Judges and Consuls, or  Quite abundant a walk of life). Now, I am reading, and translating on the go in English, what he wrote about the securitisation of contracts by the means of the so-called bills of exchange, or promissory notes.

He starts discussing the issue when I would start, i.e. at the origins. ‘It is one thousand years since we learnt what bills of exchange and promissory notes are, an invention which came from the Jews, who, chased away from France, during the reigns of Dagobert the 1st, Philippe Augustus, and Philippe the Long, in the years 640, 1181, and 1316, took refuge in Lombardy, and in order to retrieve money and other possessions that they left in France in their friends’ hands, necessity taught them to use letters and bills written in few words and containing little substance, as it is the case with letters and bills of exchange today addressed to their friends; and to that purpose they used the intermediary of travellers, pilgrims, and foreign merchants. This means allowed them to retrieve all their assets, but, as these people have mind infinitely what regards gain and profit, they paid attention to make themselves intelligent in the knowledge of the pure and the tarnish in currencies, so as not to mistake themselves at the evaluation and reduction of different alloys in coins, which was strongly variable at the time’.

The turn of phrase you could have just read is my personal translation. I made my best so as to keep the original spirit of the text, and, in the same time, make it intelligible. The linguistic niceties properly introduced, I can give that loaf of information to my internal bulldog, for economic analysis, just to see it happy. The passage mentions two distinct economic functions, somehow coinciding with the use of the bills of exchange: controlling distant assets, and setting the market price of capital goods.

Let’s move forward with Master Savary. A few paragraphs later, he writes: ‘The etymology of the word “letter of exchange” is easy to understand, for it means no other thing than changing the money that a Merchant has in one town, and giving it to another [Merchant], who has use for it, and who has no such sum in the town of his residence, where the letter has been drawn from. This exchange is equally advantageous to them both, for the one who will have money in a town without this commodity would have to have his money transported by messengers and carters, and the one who would have need it in the same town, for doing business, would have to have it carted from the place of his residence. Again, the word “change” comes from the fact that the interest, or profit, offered when drawing or offering letters of exchange is never the same: sometimes it is high, sometimes it is low, sometimes you lose on it, sometimes you gain, and sometimes it is just at par; it means that there is nothing to lose or to gain between the Changers: and so it is perpetual change, which is being encountered in the Commerce [done with] the letters of exchange’.

Language is intriguing. When we deconstruct the etymology of a word, we can find the function that it corresponds, too. Here, Master Savary explains us the etymology of ‘letter of exchange’, and, by the same occasion, unveils the social function behind. When some capital good, coined money in the case of Master Savary’s explanation, is pretty clumsy and costly to transport, homo sapiens invents ways to use just the information about said capital good. Information travels faster, cheaper, and less riskily than coined metal, so let’s use information as payment. Information has its price, too, and, in this case, the price of letters of exchange – thus their exchange value – was made as the local (i.e. in the given transaction) evaluation of how much exchangeable value I can acquire when accepting, as payment, a letter of exchange allowing to draw on that other gentleman’s metal money stored somewhere far (too far for transporting the money physically).

Thus, as soon as an acceptably stable legal system with acceptable reliable property rights emerged, that little idea emerged as well: what has the most bulk value are big things, hard to move around, like real estate, big stocks of metals, big stocks of food etc. They have value, those big things, but they have little velocity, so let’s give them a kick into more velocity by drawing more or less standardized legal deeds, embodying claims on parts of those big things.

If you read carefully Master Savary’s explanation, you will see that letters of exchange, which, centuries after their invention, turned into paper money, were initially options on the value of coined metal. I had money stored somewhere far from the place where I was currently doing business. I offered to other business people to pay them with letters of exchange, giving them claim on some amount of my far-stored money. Those business people weighed the practical value that having a claim on that money had, from their point of view, and proposed a price for those letters. It went (probably, more or less) like: ‘Good, so you want that cart of silk, and you want me to pay with a letter of exchange that gives me unconditional claim on your silver money, and let’s say – for the sake of convenience in those folks who will read it like in four hundred years from now – that silver money is 200 ducats. That money is stored 100 miles from here. I am pondering two things now. Firstly, I am going through the idea of going and physically claiming that money of yours. Secondly, I am thinking about, instead of doing the trip, to hand that letter of exchange over to another business person, who might be willing to go and claim the money, or to make the letter circulate further. I am anticipating both the for and against of claiming physically your money, and the odds that you letter of exchange will have any exchangeable value in itself. All in all, I propose you to buy this letter of exchange from you for the equivalent, in that silk you want to buy from me, of 200 ducats minus one fifth, thus 160 ducats’.

Complicated? Yes, certainly, and this is not all. There was another factor in the game of pricing the letters of exchange: the properties of the metal money they allowed claiming. Here, a little remark is due about the origins of coined money, and, by the same means, another deceased gentleman joins the conversation. Welcome Adam Smith. What Master Smith explained, in a book published 90 years after that by Master Savary, is that coined money emerged out of the necessity to evaluate the true value of metals used in exchanges. Copper, silver, and, less frequently, gold, were the main metal exchangeable, back in the days (many days). Somehow, people came to the idea that the purer is the metal offered in exchange, the more it is worth. The presence of other substances than silver, in your average pound of silver, decreased the exchange value of that pound of silver. I know, I know, from the today’s point of view it is not one hundred percent logical, yet it was what it was. People used small, portable scales to weigh the metal in exchange (this is where the scales held by Themis, the goddess of justice, comes from), but it was a bit slow to use. Besides, once the metal graded by weighing, the question of how precise was the weighing naturally came to the fore, possibly together with skilled labour force, equipped with tools proper for violence.

What the sovereigns (kings, princes, and whoever efficiently claimed to rule the land) came up with was the idea of minting. The local sovereign proposed the following deal to business people: ‘See, here I have that little facility, which I have just named “mint”. The people I employ at the mint will weigh your metal and grade it, and, in order to streamline the subsequent exchanges, will make into small pieces of standard weight each, with my royal/ducal/whatever-I-am-currently stamp on them. My minting stamp will guarantee the exchangeable value of your metal. Isn’t it a tremendous improvement? Oh, there is that tiny little detail: as minting will take off your shoulders the burden of (some) transaction costs, you pay me a fraction of the exchangeable value in the metal being minted. Deal?’.

In the Europe of the past, which, fault of a better word, we call ‘feudal’, there were many sovereigns, living in really complicated, hierarchical combinations. Most of them used to run their mints, whence the presence of many minting stamps in the market. Ducats were metal stamped with ducal minting stamps, for example. A duke was the highest in rank in the feudal hierarchy, regarding the control over precise territories. Kings and their royal families were technically above that hierarchy, but, as regards the claim on territories, kings made themselves into dukes, frequently. You can find a trace of that legal trick in the today’s royal families, whose members, whilst being kings, queens, princes or princesses, are dukes or duchesses of something as well.

That little conversation with two dead gentlemen, Master Savary and Master Smith, helps me to kind of ground my thoughts regarding EneFin, that FinTech project I am business planning. First of all, find something big, valuable and pretty fixed in one place. Big power plants, for one. Populations of consumers of energy, thus the geographical structures of human settlement, for two. Power grids, for three. Now, determine countable claims on those big fixtures. Next, figure out a legal way (a contractual pattern) to derive tradable deeds on the base of those claims. Once this done, think about the pattern(s) of pricing those deeds, and about making profits out of organizing exchange in them. Intuitively, the best FinTech business is to be found where uncertainty as for the market value is the greatest, and where a proper FinTech functionality can contribute to reduce uncertainty.

I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. As we talk business plans, I remind you that you can download, from the library of my blog, the business plan I prepared for my semi-scientific project Befund (and you can access the French versionas well). You can support my research by donating directly, any amount you consider appropriate, to my PayPal account. You can also consider going to my Patreon pageand become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?

Educational (very educational): embarrassing questions about monetary systems

My editorial

This particular update on my blog is both a piece of educational content, and a piece of general research methodology in social sciences. It regards monetary systems. In terms of education, it mostly addresses those 3rd year students, Undergraduate, whom I am currently lecturing about Economic Policy. Still, the graduate Master’s students in the curriculum of International Economic Transactions can have some benefits out of it. I start with an old and classical one: the quantitative monetary equilibrium, or, in fancy economic writing:

P*T = M*V

P – the index of prices

T – the volume of transactions in the economy

M – the supply of money (monetary mass) in the economy

V – the velocity of money

This equation is both a mindfuck and a useful tool to understand how money works at the macroeconomic level. As for being a mindfuck, it is simple: both sides of this equation are equal to Q, or nominal aggregate output, measured in current prices. So you essentially start with the not-too-risky assumption that Q = Q and then you unleash yourself on maths. The nominal output is equal to the real output (i.e. the physical volume of goods and services produced), and it gets nominal by being nominated in a currency, i.e. by being multiplied by the current prices of things inclusive in the real output. Thus, Q = P*T is pretty intuitive. Now, the right side of the equation is more based on the current empirical observation. If you care to have a look at a statistic published by the World Bank under the label of supply of broad money as % of the GDP (you know, you click on the underlined phrase), you will get the current proportion between nominal output and the monetary mass supplied to the economy. The first observation is that it is never equal. In other words, you have very little chances to hit Q = P*T = M, with velocity V =1. When the equation of quantitative monetary equilibrium was being formulated, back in the 1950ies and 1960ies, the supply of money to the economy was consistently lower than the nominal output of the economy, i.e. we recurrently had: Q = P*T > M. Intuitively, you could guess that money supplied to the economy serves more than one transaction a year, or, in other words, money was seen as something circulating pretty quickly across the economy. There were even people who claimed that it circulates at a constant velocity. The well-known master of economic methodology, Milton Friedman, used to be one of those people. Still, as time passes, things change. Since the 1950ies the proportion between nominal output and the supply of money (look up that statistic with the World Bank) has been consistently shrinking as for the global economy. The monetary mass supplied made 50,465% of the global GDP in 1960 (velocity V = 1/0,50465 = 1,981571386). In 1990, the proportion climbed to 88.01%, thus velocity fell to V = 1/0,8801 = 1,136234519. Around 2007 – 2008, the global economy passed the magical threshold of Q = M. Interestingly, the global financial crisis broke out just then. In 2016 the supply of money in the world made 116,411% of the global GDP, with the velocity sadly falling down to V = 1/1,16411 = 0,85902535. Thus, in real life, money works differently in the economy, depending on the period of time. Currently, it seems to slow down its circulation. If people have more goods than money, so if we have like M = 50%*Q, you accumulate real goods rather than money, and you make those coins spin quickly, just to have all your goods well financed. Yet, when you have more money than real goods (case of the present day), you accumulate money and you speed up the flow of goods, so as to have any grounds for having the money. Over the last 70 years, the global monetary system has shifted from one monetary paradigm to another one, and we still don’t understand completely what has actually happened.

Now, when you switch from differences in time to those across space, and you take a snapshot from 2016, you have, for example: Argentina M = 28,9% * Q, Australia M = 118,8% * Q, Hong Kong M = 363% * Q, China M = 208,3%*Q, United Kingdom M = 144%*Q, United States M = 90,6%*Q. You can see that money works very differently across space. Each country seems to be a highly idiosyncratic monetary system. Good, so we keep on asking embarrassing questions. In textbooks, and in my lectures in the first year, you could have learnt that the supply of money is practically equal to the supply of credit from the banking system. It is generally true to the extent, that when banks get profuse on lending money, you can immediately see prices rise in the economy, and one of the best ways to slow down inflation is to make credit more expensive in terms of interest rates. Still, let’s check. In 2016, the global supply of credit (you know, click), from banks to the real side of the global economy, made 177,421% of the global GDP. Simple arithmetic indicate that we had [177,421/116,411] = 1,52 times more credit than money supplied. Back in 1990, the credit supplied from all banks in the world made 126,138% of the global GDP. Once again, we check credit for its attendance to the money being supplied, and we get [Credit/Money] = [126,138/88,01] = 1,433. Interesting: there seems to be more and more credit who lost its way from banks to purses (happens usually on a late hour at night), and there seems to be more and more credit in that awkward situation. Let’s snapshot across space in 2016. Argentina, credit = 38,8%*Q, credit/M = 38,8/28,9 = 1,34; Australia, credit = 183,4%*Q, credit/M = 183,4/118,8 = 1,544; Hong Kong, credit = 212%*Q, credit/M = 212/363 = 0,584; China, credit = 215%*Q, credit/M = 215/208,3 = 1,032; United Kingdom, credit = 167,8%*Q, credit/M = 167,8/144 = 1,1653; United States, credit = 242,6%*Q, credit/M = 242,6/90,6 = 2,677. Each country has a different system of transmission from credit lent to money supplied.

Now, if you are a government, you want two things on the left, P*T side of monetary equilibrium. You want to see your real output, or the volume of transactions T, gallop joyfully forward, i.e. grow like hell, whilst controlling the level of prices P. In order to do that, you need to control, somehow, the way your national monetary system works. As you can see from the numbers presented above, this is not obvious at all. The basic leverages you have are (check them at Wikipedia or elsewhere): the supply of currency through the central bank, the interest rates on credit, the ratio of mandatory reserves (the % of deposits held from customers that commercial banks have to hold, in turn, at the central bank), open market operations by the central bank and sometimes by the national Treasury (Minister of Finance in continental Europe), and the so-called quantitative ease (this is when the government buys financial assets in the domestic market; it acts on financial markets like a toilet plunger, you know, that big rubber sucker that you use to make your plumbing cooperative again).