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