Introduction
It would prove difficult to count the number of commentaries online and in the media that refer to “money,” yet seldom, if ever, do you see a definitive definition of “money.” They proceed with the discussion as if everyone agrees on what “money” means. When people do define money, they frequently confuse “money” with accounting tools that no one would accept in exchange.
In this newsletter, I will provide an annotated definition of “money” that I can refer to in future newsletters. Whether you agree with my definition or not, you will understand me when I refer to “money.”
Definition of money:
Money consists of any economic good, or any claim on such a good, that serves as a general medium of indirect exchange and that acts as a final means of payment.
I will break out the important elements of this definition and provide an annotation for each.
An Economic Good
An economic good consists of any resource used by humans (a good) in sufficiently limited quantities to give it a market price in exchange.
As one of two fundamental types of “money,” a good that does not exist in relatively short supply will not qualify for use as “money.” In a small system, some people might use cigarettes as money but not water. The economic qualification eliminates other “goods” from serving as a substitute for money.
Claim
A claim, as distinguished from a debt, gives the holder the right to immediate return of the goods held to honor that claim.
This element plays an import part in the definition of “money.” First, a claim has a quality distinct from debt; the holder of the claim can redeem it without notice. Frequently, people confuse money claims with debt. The exchange of debt instruments for “money” frequently occurs simultaneously, making some people confuse the two; they are, however, significantly different.
The small word “or” plays an important part in this definition. “Or” connotes that people cannot use the economic good and the claim as money at the same time. The separate of the claim from the “money” good provides a foundation for the argument that dollars held as reserves and dollars held as claims on reserves cannot play the role of money at the same time.
General Medium
To qualify as “money,” a fairly wide range of traders must accept money goods used in indirect exchange (explained below). The definition of “general medium” depends on the boundaries of the economic system. Prisoners in a confined area might use cigarettes as “money.” In the United States’ economic system, cigarettes would not qualify as a general medium.
Dollars held as reserves, in the bank or at The Federal Reserve, do not meet this criterion. Regulations prohibit private entities from having accounts with a Federal Reserve bank; thus, excluding dollars in accounts at The Fed from use as “money.”
Indirect Exchange
Indirect exchange refers to a trade that does not secure the commodity desired in a single exchange, but proceeds by one or more intermediate steps.
An indirect exchange consists of a two-step process in which an individual exchanges their goods or services in the first step for other goods, and in the second step, exchanges the goods obtained for the goods or services desired.
In an indirect exchange, the receiver of goods in the first exchange has no intension of using or consuming those goods. Because traders accept money (goods or claims) for the sole purpose of indirect exchange, a good used for money does not get consumed.
Final Payment
The concept of final payment represents a crucial criterion in defining money.
When people accept a medium as payment, it concludes the transaction. It requires no further collection, such as a credit card or a note. When someone receives “money” in payment for a transaction, they need to take no further action to collect from the payor—the deal is done.
On the other hand, when a seller accepts a note in payment for a good or service, they must still take action to collect the note matures. In the case of using a credit card, the issuer of the credit card must take action to collect from the buyer (the credit card user).
This criterion provides another reason why debts do not equal “money” as some people claim.
Exclude from the Definition
An accurate definition of “money” must exclude three oft-cited criteria for “money”: medium of exchange, store of value, and unit of account.
Medium of Exchange
The distinction here consists of a small but important one. A completely accurate requirement for status as “money” includes indirect exchange, not just direct exchange. This distinction provides the basic reason why the quantity of money need not (should not) change.
Store of Value
Individuals always and everywhere determine economic value. Thus, no good or claim on a good can store value.
Unit of Account
Yes, bookkeeping generally does use “money.” The money quantities in a bookkeeping system account only for “money” quantities; they do not account for the number of items paid for with “money.”
Conclusion
As important as the role “money” plays in free markets, people should understand it better; yet, they often discuss it without a clear and precise definition. When I use “money” as a major topic in any of my publications, I attach the definition I provided at the top to clarify my meaning.
I will also refer to this annotated definition for anyone who requires further clarification.