Saturday, February 5, 2011

Money is a Social Institution

David Andolfatto brought out the nut-jobs in a recent blog post questioning whether gold is money. His definition  of money is anything that circulates widely as a means of payment and is accepted without discount in the extinguishment (I think I just made up a word) of debts.

David's definition embeds a concept that I want to highlight here: the importance of social institutions. The idea of acceptance has to do with how the receivers of the object of trade view its future tradeability. That was the important feature behind moving from a barter economy to a monetary economy - precious metals were way more tradeable than, say, tons of wool or barrels of fish. Similarly, deposit receipts are more tradeable than precious metals.

Let's say you had a gold-backed dollar economy, such that one "dollar" referred to a specific weight of gold - 5 grains, for example. The exact measure is irrelevant, actually, so long as everyone knows what it is. In a dollar economy, deposit receipts would circulate as currency, so long as people general accept them for trade. I will accept dollar payment for my labor if I know, or reasonable am certain, that I can use the dollars to go trade for goods and services that I want.

In such an economy, gold would probably not be considered "money" because it would not circulate. You wouldn't pay for a fancy coffee with a few grains of gold. If you tried, people would think you're nutty bananas. Even though gold is the asset backing dollars it is not traded and is therefore not money - it's an asset backing money. Thus the value of goods and services can be measured in terms of dollars or gold, this is equivalent, but G&S can only be traded for dollars.

Think of it like this. Let's say you have U.S. dollars in your pocket and you go to Europe, where they trade in Euros (for the most part). Dollars in Europe aren't currency because you will not be able to go to stores and trade them for goods and services. You must first find a money changer (such as Thomas Cook) and exchange your dollars for Euros. This doesn't mean your dollars are valueless but they only have value in Europe because the money changer will give you Euros for them. Dollars are useful to money changers because, say, some Europeans will go to the money changer to get dollars before taking a trip to the U.S.

An object is currency, or money, because of tradeability. Tradeability is a social institution. Which is not to say that I wouldn't accept a few bricks of gold in exchange for my labor right now - but I might discount them a bit.


  1. On a gold currency: Would we care that our currency is backed by gold? When we left in the gold standard, did most people view this as a positive event, negative, or did most people even notice?

    I suppose we might care in that the federal reserve can't manipulate the currency as easily (if at all), resulting in the debasement of our money.

  2. I would be interesting to go back and see the individual's response when Nixon closed the gold window for the final time in '71.

    My hunch is that, after using convertible paper money for a while, people wouldn't notice or even be aware of asset-backing. It takes a crisis to bring these issues to the fore again, even though many economists have been working on this stuff for a long time.

  3. Jeff,

    I just learned that COL Dave Berg is retiring from his position at Syracuse. This group of DCP'ers (2011) will be his last.

    The man was often a pain in the ass, but as for those who have more insight, knowledge, and respect within the FM Army community - there are none. His shoes are unfillable.

    How many DCP groups did you teach?

  4. That sucks for SU. He was indeed a very good leader.

    I only had the privilege of two DCP groups. Yours was my second.

  5. I was thinking about this post of yours today as I read the WSJ (Monday's edition). I read where JP Morgan Chase will begin accepting gold as collateral. Gold is seeing its prominence rise. Is the yellow metal on a long road to becoming a currency again? Time will tell.

  6. Yeah, I just saw that. I haven't been reading the papers much recently.

    In a world where the US dollar is under increasing distrust, gold may return (albeit slowly and by fits and starts) to a reserve status.

    I don't think it is the solution that we actually want to government interference in monetary affairs, however. It is not the source of stability.