The quality of money
Money is a means of recording entitlements and obligations. The money we hold is a record of our entitlements. The money we owe is a record of our obligations. Yet the quality of money extends beyond these concepts.
The quality of money depends upon how it was created. For example, money that was created as a perfect forgery has a very different quality from money that was created when a country increased its foreign reserves by exporting more than it imports. If the economy were flooded with forged money, one could imagine that it would deplete the economy of goods. It would, most likely, cause inflation and current account deficits (spending greater than income.) The value of the money we hold depends upon its backing or the obligation associated with it.
Endowed and Unendowed Money
Money created by increasing foreign reserves is endowed money. That is, the entitlement created by the production of this money is backed by obligation on the part of the foreign country. Colloquially, we would refer to this money as being backed by foreign reserves. The critical attribute of money from this source is that there is a concurrent increase in current obligations with the increase in current entitlements. The foreign reserves represent an obligation (of the foreign country) to provide goods and services in exchange for that foreign money whenever it is presented.
A forgery is unendowed money. That is, the entitlement created by the production of this money was is not backed by anything. The forged money represents an increased entitlements to goods and services from the economy without any increase in obligations to supply more goods and services. Forgeries are a serious threat to the economy. They are a form of theft.
Forgeries are not the only form of unendowed money. When banks lend more money than is repaid to them, they create additional money thereby giving current entitlements to the borrowers against future obligations. The borrower's debt represents an obligation to the economy, but that obligation is not current. The borrower does not have an immediate obligation to supply goods. Rather, their obligation is to supply goods in the future, over the life of the loan.
Loan repayments (of principal) to banks represent a surrendering of the debtors current entitlements. If bank lending equals loan repayments, the existing entitlement being surrendered equal the new entitlements being produced. Such lending does not increase the total amount of unendowed money in the economy.
Interest payments on loans represent a transfer of entitlements from the borrower to the lender. It does not reduce the total amount of entitlements in the economy.
If loan repayments of principal to banks were greater than new bank lending, then the entitlements in the economy would fall, reducing the ability of the economy to demand goods and services. This would cause a recession. So, to avoid a recession, the money supply should be maintained and preferably increased to increase demand and stimulate the economy.
Unendowed money in Australia
The unendowed money created in Australia can be calculated from statistics in the Reserve Bank Bulletin. The procedure is as follows:
1. Identify official sources of money comprising:
2. Identify endowed component of the above money supply
3. The unendowed money is the official sources of money identified less the endowed component of money. Read more in Technicalities of the Monetary System.
An Excel worksheet with an example of this calculation using the data currently available from the Reserve Bank website is available. As there are series breaks in the data, it is not possible to calculate the unendowed money supply before April 2002 using the data available on the RBA website. The historical total of unendowed money is provided from November 1980.
There are comparison of this form of money with the current account deficits.
See the application of these forms of money to determine the current account deficit in the formula for the current account balance worksheet.
Note that this analysis suggests that there could be an endowed form of domestic money. This could be where, say, a supermarket chain issues its own currency or tokens to suppliers and they are able to trade these tokens which are redeemable for goods at the store. Like foreign resereves, when this money is redeemed, it ceases to exist.
Last update: 12 September 2010