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SCI LIBRARY

Libertarian Land Philosophy:
Man's Eternal Dilemma

Oscar B. Johannsen, Ph.D.



BOOK II: Exchange and Money

Chapter 4 - Money Aids


Men used money for many years before they evolved money-aids.

A money-aid is a claim to money, payable on demand, which exists in the form of a receipt or a written promise, and which claim circulates throughout a society aiding money in effecting exchanges of goods.

As the above definition indicates, money-aids have two broad classifications. They are (1) receipts for money and (2) debts.

The receipts are divided into money-certificates and tokens. The debts are divided into banknotes and demand deposits.

How can receipts for money, and, in particular, how can debts be used to aid money in its function as a medium of exchange? To answer this question, for the sake of simplicity the explanation will involve hypothetical reasoning.

Initially it may be assumed that coins were minted by goldsmiths upon the order of some merchant who wished his gold to be minted into coins stamped with his insignia guaranteeing their purity and weight. Subsequently, goldsmiths could have become manufacturers of money on their own account when they realized how lucrative the business could be. Most of the ancient history records indicate that the sovereign made the manufacture of money his prerogative. However, we do know that as late as 1848 gold coins were privately minted and circulated in California.[1]

Whenever a sovereign realized the advantage of making money his monopoly, he did. A goldsmith might than be hired to mint the money with the sovereign's stamp on the coins and bars.

Because goldsmiths had the strongest safes, people often stored their gold with them. This money was not loaned to the goldsmiths, it was merely stored much as people may store some furniture in a warehouse.

At first, each individual's money was probably carefully isolated in separate bags or compartments. However, inasmuch as the coins were all very much alike and as the people ordinarily did not care which coins they received, the practice developed of commingling them. Receipts were still made out in the names of the individuals, but implicitly or explicitly it was agreed that they need not receive back the identical coins.

These receipts circulated much as money did. Why bother redeeming a receipt to obtain the money to purchase some article when the seller would very likely redeposit the money with the same or another goldsmith? It would be much simpler to endorse the receipt over to the merchant which he could then redeem, if he so desired. The receipts were endorsed many times. Probably, only when the endorsements filled the back of the receipts were they presented for redemption, and even then, they probably were merely replaced with other receipts.

Eventually, to eliminate the necessity for endorsements, goldsmiths issued receipts made out to 'bearer'. This took the form of certifying that there was a certain amount of money on deposit in the goldsmiths' vaults which was payable to the bearer of the receipt upon demand.

No one assumed these receipts were money any more than anyone assumes that a coat-check is a coat. But just as the ownership of a coat can be transferred merely by giving the coat-check to someone else, so the ownership of the money was transferred by giving the receipts to some other party. These receipts eventually were called money certificates, as they are to this day.

It must be emphasized that although the gold was physically idle in goldsmiths vaults, actually it was very much in use. The ownership of this money was constantly being transferred as these money certificates changed hands. What the certificates did was to aid money to perform its function in exchanging goods. Instead of the actual money being handled physically by people, the certificates were. Goods purchased were not exchanged for certificates but for the money in the vaults.

It is because money-certificates aid money in effecting exchanges that the writer calls them money-aids. Ludwig von Mises, the noted economist of the Austrian School, calls them money-substitutes. It seems to the writer, however, that calling them money-aids is a more accurate description of their function. Money-aids are not substitutes for money. They merely assist money in acting as a medium of exchange. !t is unfortunate that many people believe they actually replace money, for this belief has caused much contusion. Aluminum can be substituted for steel in many applications and can do the job as well or better. It is a true substitute. It can also be used as a steel aid. It can be coated to steel to make aluminum-steel in which case it aids steel to perform its function. Money-aids can never be substituted for money but they can be utilized so as to aid money to perform its function.

A money-aid is no more money than is the deed for a home a house. When a house is sold, the seller gives the buyer a deed. The purchaser is not buying that piece of paper. He is buying a home, and the paper is merely evidence of that fact. Similarly, when a person exchanges a money certificate for a hat, he is exchanging money for the hat. In handing over the certificate, he transfers his right to the money which is in some bank's vault to the seller. The seller accepts it as he is certain he can redeem the certificate for money.

In most countries, money certificates are issued in round denominations to facilitate exchange. The denominations ordinarily are determined by the level of trade. The gold certificates which circulated in the United States before 1933 were money certificates. A ten dollar certificate stated, 'The United States of America will pay, on demand, Ten Dollars in Gold.' (As the dollar was then defined as being 23.22 grains of pure gold, this meant that the government would give the bolder of the certificate ten times 23.22 grains, or 232.2 grains of pure gold. Actually, since pure gold cannot be coined and must be alloyed with another metal, the gold piece given would be one weighing 258 grains, nine-tenths of which, or 232.2 grains, would be gold.)

Inasmuch as gold is money and goldsmiths naturally had plenty of gold, it was not surprising that people who needed money would gravitate to them to borrow it. At first, no doubt, the goldsmiths lent their own money. Later. however, they made the very pleasing discovery that they were not restricted to their own funds because of the practice which developed of the goldsmiths issuing IOUs.

Ordinarily in lending money, gold would be given to the borrower. However, there may have been times when a borrower did not want the actual money. He did, however, want assurance that he could obtain it immediately upon demand. So, he would make a deal with a goldsmith for which he may have paid a small fee. The borrower would give his IOU to the goldsmith, in return for which he would receive the goldsmith's IOU. Since the goldsmith was unlikely to issue one which he could not redeem, this was a good means of assuring the borrower that the money was readily available.

At first when need for the money arose, the goldsmith's IOU was prompt)y redeemed. However, it did not take long before it became obvious that such was unnecessary. Anyone having a goldsmith's IOU, who wished to make a purchase, could endorse it over to the seller just as money certificates were.

Anybody who accepted money certificates was accepting the goldsmith's word that the money was on deposit in his vaults, so it would be logical to take his word that he would redeem his IOUs on demand. The same reasons that impelled people to take money certificates instead of redeeming them applied to the IOU's. Why bother to redeem an IOU and then turn around and deposit the gold with the same or another goldsmith for a money certificate. They both depended on his word. If the IOU was worthless, the money certificate would hardly be any better. These IOU's were thus passed along, each party endorsing them just as they did money certificates.

When it is appreciated that in Colonial Times the IOU's of prominent businessmen circulated throughout the community effecting exchanges of goods, it is not at all surprising that the IOU's of goldsmiths could circulate as readily. In "The Sinews of American Commerce", it is stated that "Promissory notes, especially when signed by men of property.. .often passed from hand to hand for several months, all the time serving as real currency."[2]

Goldsmiths were delighted to discover that their IOU's circulated inasmuch this enabled them to keep money in their vaults longer, and they could make a profit on much of it, as will he shown subsequently.

As money certificates and IOU's wore out, the goldsmiths were expected to issue new ones. This would not disturb them, but in the case of money certificates the problem of the fee involved raised a problem. Money certificates initially were probably issued for a certain period of time. As they represented stored money, those storing it had to pay a goldsmith a fee for his services. But after the time period ended, another fee would be due to the goldsmith. The problem was solved by goldsmiths eliminating the fee for they found it profitable to do so.

What happened may have been along the following lines. A goldsmith could not help observing that only a certain proportion of the gold deposited with him would redeemed He noticed that some of the certificates and IOU's never returned. He became aware that, for all practical purposes, some of the money in his vault would never be redeemed. Very often, the gold he took in during a day was enough to take care of any redemptions and possibly more than enough. His hoard of idle gold tended to keep rising.

It became obvious there were a number of reasons for the increase.

For one thing, some of the certificates and IOU's must have been lost. This raised a pretty question. To whom did the money in the vault now belong? Since proof of ownership was now gone, the goldsmith would feel that the money was his on the assumption that possession is nine-tenths of the law.

(Of course, when the sovereign heard of the problem, he undoubtedly passed some law appropriating such money for himself but he had no superior right to it than the goldsmith.)

As the goldsmith now assumed that the money belonged to him, he began to lend it out. He was, in effect, using the money twice. He had to be careful though and not be too greedy. Through experience he would acquire a fairly good idea of how many certificates and IOUs he could be certain would be lost each year, and if he kept well within this estimate, he was on sate grounds.

The problem was an ethical and a practical one. The ethical one was resolved on the assumption that of all people he had the best claim to the money. The practical one was that he did not know definitely how many were lost. His estimate might be in error. Wisdom demanded that he exercise caution and lend out only a proportion of the amount he believed was lost.

He might lend out the actual gold or issue new money certificates, but common sense dictated that instead he issue IOU's for the money. If he lent out the money, or if he issued new certificates he now would have issued certificates representing more gold than he had in his vault. If, instead, he issued IOUs he would not be violating any ethical criteria. He was merely promising to pay the amount specified in the IOU as he did with any IOU.

Since this process of lending out the same money twice was obviously profitable, the goldsmith was willing to waive fees for money deposited. By this time his customers were accepting IOUs as readily as money certificates. To the extent he could, he issued IOUs. No doubt, to induce people to use certificates and lOUs interchangeably a goldsmith would issue lOUs and certificates which were almost identical in appearance. To prevent forgery, they were produced in distinctive forms and when printing became popular, the dies were designed by skilled engravers.

At the risk of being verbose, it must be emphasized that there was nothing ethically wrong for goldsmiths to issue IOU's in excess of the money in their vaults. After all, you issue an IOU precisely because you have no money on hand. The lender is well aware that you do not have the money on hand to back the IOU or you would not have borrowed in the first place. It is expected that when the note is due you will have the money to redeem your IOU. It is true that the goldsmith's IOU is a demand IOU rather than one which has a certain period of time to run. Nonetheless, it is still merely a promise to pay money and is not a statement that a certain amount of money is on deposit.

It may appear a bit peculiar, yet if you analyze the ethics involved there is nothing wrong. At first sight, it may appear analogous to the action of a warehouse merchant who was hired to store your furniture in his warehouse and who lets someone else use it for a fee. This you know would be wrong. !n the case of the goldsmith, however there was a subtle but important difference. Although the depositor may have considered that all he was doing was storing his money with the goldsmith, actually when he accepted an IOU instead of a money certificate, his position changed with relation to the goldsmith. Now the depositor was giving up ownership of the money deposited in exchange for the goldsmith's promise. The depositor extended credit to the goldsmith. He had engaged in time-barter. He bartered his money in the present on the promise that he would receive some other money in the future. A creditor-debtor relationship had been established which is different from the relationship of a man who merely stored his furniture with some warehouseman, which as a bailor-bailee relationship.

Inasmuch as it was obviously wiser for the goldsmith to issue IOU's for money deposited and as few certificates as possible, this became the general practice. For those people who insisted on certificates, some goldsmiths may have specialized and acted as bailors who issued only certificates for actual money deposited. These goldsmiths were the spiritual, if not actual, forerunners of those banks known as Banks of Deposit, such as the famous Bank of Amsterdam, whereas the others were the forerunners of the commercial banks we have with us today.

So far in the analysis, the reader will note that goldsmiths may have issued IOU's based on a proportion of money certificates and IOU's which they assumed had been lost forever. There were, however, other IOU's issued by goldsmiths which were based on goods coming to market. This probably evolved as follows.

A merchant who found he could not purchase goods on credit would go to a goldsmith who knew him and ask for the goldsmith's IOU with which to obtain the goods. In return, the merchant would give the goldsmith his own IOU backed by the goods he was purchasing. In addition, he would agree to pay a fee for the services rendered. Since the goldsmith's IOU was readily acceptable, the merchant would get the goods, and the IOU would circulate. When the maturity date of the merchant's IOU arrived, he would go to the goldsmith and redeem it in money. Now the goldsmith had the funds on hand to redeem his own IOU when and if it was presented for redemption.

Money certificates and the goldsmiths' IOU's (which today are the banknotes of banks) grew up primarily as a result of trade within a city or town. Paralleling their development was another money-aid which arose out of trade between cities. This was destined to result in a new money-aid which has overshadowed the other two, particularly in a dynamic economy as exists in the United States.

With the expansion of trade between cities, the problem of safety becomes increasingly important. Travel between cities in the Middle Ages was almost an adventure in itself, not only because of the poor roads but because of the highwaymen ever anxious to relieve unwary travelers of their money. To prevent this, merchants evolved a simple but ingenious solution.

It was based on the fact that generally a merchant would not only buy goods in another city but would also sell goods there. Thus, he owed money to some of the people in that city, but at the same time other people there owed him money. The natural thing to do then would be to direct the people who owed him money there to pay it to the people to whom he owed money in that city. In that way, only the goods would be transferred between cities. The mechanics for accomplishing this discharge of debts was by means of a draft or bill of exchange. This is merely a note in which the party writing the draft directs the drawee (the party owing him money) to pay that money to a third party. Just as money certificates and banknotes circulated so did these bills of exchange circulate by means of endorsements.

The bill of exchange is not money. It is a money-aid. It aids money in exchanging wealth. In the past, no one had any illusions about the bill of exchange any more than they had about money certificates and the goldsmiths' IOU's.

No one was under any compulsion to take a bill of exchange. Probably no person took one unless he knew the various parties involved. These drafts ordinarily would circulate only among businessmen dealing with the type of goods which brought the bill into existence. Anyone agreeing to accept one was entering into a conditional agreement, not an absolute one. If the bill was dishonored, each endorsee would look to the party who endorsed it over to him to make good. The money was the actual gold which the party on whom the draft was drawn would give to the individual who presented the draft for payment.

While bills of exchange initially constituted a three way proposition among three merchants, their use evolved into a much more desirable one as a result of making a goldsmith one of the three parties, through a process similar to the following:

A merchant selling goods in a city in which no one owed him money would tell the buyer to deposit the money with a local goldsmith and credit it to the merchant's account. Subsequently, if the merchant purchased goods in that city he would order the goldsmith to pay the money in his account to the person from whom he purchased the goods.

The practice thus arose for a goldsmith (later a banker) to be a third party in most bills of exchange, whether they had to do with the purchase or the sale of goods. A new service, thus, arose for the goldsmiths. They did not initiate it. This service evolved with the needs of trade. The goldsmiths began to act as middlemen in the settling of debts. The goldsmiths were acting more and more as banks.

No doubt, the reader recognizes that a bill of exchange on a goldsmith is what we today call a check. By this time the goldsmith was really a banker. Thus, all that merchants had to do was to do was to draw checks on the bank to the order of those to whom they owed money. And just as you and I can circulate checks among ourselves by successive endorsements, so did they.

A check is a bill of exchange which is drawn on a bank instead of on a merchant. We all know the form. The name of the bank is written on top, and on the check are written such words as "Pay to the order of" with space to write in the name of the person or the business to whom the money is to go and another space for the amount of money involved, with the signature of the party drawing the check on the bottom.

Bills of exchange have been refined in commercial practice into highly technical forms, as bankers acceptances, bankers cheques, etc. But no matter how involved nor what variations may develop, they are all based on the simple bill of exchange. Books on banking techniques adequately describe the various forms.

The goldsmiths had to keep records of all the transactions which took place. They had to have separate ledger sheets for each depositor. On one side they would list the money deposited and on the other side the money the goldsmith paid out to other people at the depositor's order. Possibly at the end of a month or a quarter of a year, they would send a copy of the ledger sheet to each depositor. This was the forerunner of the bank statement which each person who has an account in a commercial bank receives each month.

These ledger sheets, or accounts, have become the device by which much of the debt, arising from the transfer of wealth and services in America is liquidated. The deposits are known as demand deposits or bank deposits. These deposits are debts of a goldsmith or a bank. The checks which are drawn on them are bills of exchange ordering the bank to pay money to those named on the checks. As will be subsequently shown in more detail, by appropriate entries which credit and debit these customers accounts, exchanges of goods are effected without the use of money.

It might not be amiss to point out that the ledger sheet on which the demand deposits are listed can be considered a special form of banknote. A banknote is an IOU of a bank; so is a demand deposit. A ledger sheet with some individual's name on it might be torn out of the bank's books and circulated as a banknote. It would then be merely the bank's IOU to a specific individual and could circulate with the proper endorsements. The only difference between it and a banknote is that the banknote is not made out to an individual. But as both are debts of the bank, as long as the bank is solvent, they would both circulate. Instead of tearing the ledger sheets out of the bank's books, orders are drawn on them by means of checks. The bank is ordered to pay some of the money which it owes to the depositor to the parties listed on the checks.

The token is another money-aid which is important because it aids exchanges involving small sums. Gold can be minted into very small coins, but for most small transactions they would have to be made into such thin pieces as to be impossible to handle. !n 1847, the United States Government minted a one dollar gold coin, but it could not issue one for a smaller sum since it would be far too thin and small.

Gold, silver, copper. or some other material might happen to be the money of a community. When it changes its money from a lower to a higher grade metal, as from copper to silver, or from silver to gold, there are many small transactions which would require extremely small coins in the new money, and which would be difficult to handle. Thus, a society changing from copper to silver would probably find it advantageous to use copper for small transactions, while in a society going from silver to gold, silver would tend to be used. From an economic standpoint, there is no reason why a society should use as its tokens the metal which was previously its money. Any metal, or any other material, could just as easily be used. It is only the result of convenience that it works out that way. All that matters is that the tokens can be redeemed in money without question.

Tokens are receipts for money on deposit with some reputable party. They are no different from money certificates except that they are for smaller denominations. Also, because they are handled so often, they are composed of a durable substance, as metal, whereas money certificates are pieces of paper. Thus we can say that a token is a metal receipt of a small denomination for money on deposit in some reputable party's vaults.

Since they are receipts, the vaults should contain as much money as is represented by these tokens, as is the case with money certificates. But the likelihood is that this is not the fact. The actual proportion of gold back of such metal receipts varies depending on the issuer.

Today, tokens are issued by governments, although in the past they were issued by merchants. Most governments now prohibit the private issue of tokens. Theoretically, the governments should have in their vaults the money to redeem the tokens. Few do, however. Instead, a certain proportion is usually set aside which is believed sufficient to redeem whatever tokens are presented for redemption. The fact that the tokens are not covered 100% by money is not critical as long as the difference between the face amount issued and the money set aside is not too great. After all, many of the tokens will be lost, smelted into jewelry, lie dormant in numismatic collections as well as constantly in use aiding in the exchange of goods. The differential between the amount issued and the money in reserve, after taking into account the costs of manufacture, represents a profit to the governments. It is called seigniorage, that is the 'seignior's share' (the feudal lord's share for coining money).

It must be emphasized that tokens are not money. Many assume that they are because they are in the form of coins, and they are used to aid in effecting exchanges. The money of a country is the gold or silver, whichever happens to be the medium of exchange. Token coins are direct claims on money. This is economically true, no matter how the coins may be treated legally. They are money-aids. The exchange of a token for a good is the same as the exchange of a money certificate for a good. The exchange is really of the money in the government's vaults. The token is the evidence of the transfer of the money just as a money certificate is the evidence of the transfer of money.


Recapitulation


Money-aids are claims to money which circulate throughout a society aiding money in effecting exchanges. They consist of receipts for money, such as tokens and money certificates; and promises to pay money, as banknotes and demand deposits. They circulate throughout a community and goods are exchanged for them. However, in one way or another, the exchange is actually made for money, with the money-aid acting as a convenient device to aid money to do its job as a medium of exchange.

To exchange goods for a banknote is to exchange goods for money indirectly. All one needs to do is to take the banknote to the bank to redeem it in money and the exchange has been finally accomplished. In a dynamic society as the United States, demand deposits are the most important of all money-aids. They are really a form of banknote, the only real difference is that they are made out to specific individuals instead of to bearer.


NOTES


  1. It is estimated that $50,000,000 of private coins were struck. (Cf. Horace White, Money and Banking, P 9)
  2. Ibid., p.63


Preface and Introduction

BOOK 1

Chapter 1 * Chapter 2

BOOK 2

Chapter 1 * Chapter 2 * Chapter 3 * Chapter 4
Chapter 5 * Chapter 6

BOOK 3

Chapter 1 * Chapter 2

BOOK 4

Chapter 1 * Chapter 2

BOOK 5

Chapter 1 * Chapter 2

BOOK 6

Chapter 1 * Chapter 2

BOOK 7

Chapter 1 * Chapter 2 * Chapter 3

BOOK 8

Chapter 1

BOOK 9

Chapter 1 * Chapter 2

BOOK 10

Bibliography