Contracts as Money
Contracts arise naturally in economic exchanges and are the true origin of money.
I have written previously about exchange-based currencies which I am proposing as an alternative to our fiat currency system which derives from a commodity-based currency. Exchange-based currencies arise naturally as a side-effect when people exchange goods and services with each other. I have given an example of an exchange-based currency as IOU tokens arising within the bartering paradigm. Note that those IOU tokens arise when people engage in enhanced barter, i.e., barter where the two halves of the exchange are separated by a significant interval of time. In the first half of the exchange, one party provides goods or services to the recipient and in the second half of the exchange, which occurs sometime in the future, the recipient in the first half reciprocates by providing goods or services to the provider in the first half. The link between the two halves of the exchange is a promise by one party to provide goods or services to the other party at some point in the future. That promise is a binding contract. Thus an IOU token is a contract between two parties who are exchanging goods and services, and have only partially executed the exchange. A contract, of course, can be defined as a written or spoken agreement between two or more parties, which is enforceable by law. Exchange contracts, of which IOUs are an example, have a value equivalent to the value of goods or services promised. What is also interesting about these exchange contracts is that they are divisible. One contract worth 100 units of account is equivalent to 100 contracts worth 1 unit of account. Furthermore, exchange contracts may be transferable if they specify a promise to the bearer rather than a specific individual, thereby allowing a third party to accept the contract as payment for goods or services provided. This motivates the idea of exchange-based currencies where we use contracts between parties in the economy as currency.
An Alternative to Commodity Money
Contracts are an alternative to commodities as a fundamental source of money. In Carl Menger’s theory of the origin of money, he deals with money originating from commodities, which is what our current fiat currency system evolved from. Money can alternatively originate from contracts, but that kind of money is not obvious or easy to implement, so it is no surprise that our ancestors went with commodity money. Using contracts as money, however, offers a more natural path to a national currency because there is no need for legal tender laws as you need with commodity money. You simply have a contract between the government and the people, where the government provides public goods and services, and the public promises to provide government workers and contractors with private goods and services in the future. This contract between the government and the people is divisible and transferable between members of society, and it thus becomes the national currency. It turns out that it also provides an elegant way to solve the taxation problem, which is how to efficiently reallocate resources from private to public uses.
How Contracts Arise and Become Currency
Contracts are fundamental and essential to exchanges taking place successfully. There is a contract involved in every single exchange that takes place in the free market. Even barter exchanges involve contracts. Why are contracts essential in free market exchanges and how do they occur as a side-effect of every exchange in the market? The fact is that people do not spontaneously and instantaneously exchange goods and services. Exchanges take place in a series of steps. First, the two parties discover each other and determine that they each have a good or service the other wants. They then agree to make the exchange. Then one party provides the other with his or her good or service. Finally, the other party reciprocates by providing their good or service in return, thus completing the exchange. This procedure applies not only to barter but also to exchanges of goods and services for money as well.
Notice that one party provides goods to the other, then the other party provides goods in return to the first party. This means that the exchange is in two parts, with some time interval between them. In raw barter, this time interval is very short and may be only a few seconds or less. However, even for those few seconds, there is a contract between the two parties. If P and Q meet to exchange goods and services, and P first hands over his goods to Q, there is immediately a contract between P and Q that requires Q to hand over his reciprocal goods to P. If Q fails to do so then P has the right to seek legal recourse. The contract in raw barter is fleeting and does not have to be written or verbalised. However, as in enhanced barter, if Q, instead of immediately providing his reciprocal goods to P, was to provide those goods to P several days or weeks later, then they might need a written contract. This can take the form of an IOU issued by Q to P. This is where it gets interesting and the contract can become money. P may need goods from another person R before he ever needs goods from Q. If Q is trustworthy, then R may accept from P, the IOU issued by Q to P, as payment for goods she provides to P. R can then use the same IOU to redeem goods from Q at a later date. Exchange contracts are transferable, because they usually do not specify that they can be redeemed only by a particular person, but rather that they can be redeemed by the bearer. Since the IOU is a divisible contract, P may only use part of it to purchase goods from R, and both P and R may use part of the IOU to redeem goods from Q. Thus the original IOU issued by Q is divided into several tokens and used as currency.
We also see that contracts can be either explicit or implicit. When the time period between the two halves of the exchange is long, it is desirable to have a written contract which states that the receiving party in the first half has to provide the giving party with a good or service in the future. When the time period is of medium length, you can still have a written document, but a spoken agreement may do. These are explicit contracts. When the time interval is extremely short, there may be no need to even spell out the terms of the contract. This is when you have an implicit contract, which you see in cases such as barter.
A Record of Incomplete Exchanges
An exchange contract is a way of keeping record of the fact that the exchange is yet to be completed. Thus in the bartering paradigm, contracts circulating as currency represent incomplete exchanges and serve as a means of keeping track of the complex exchanges taking place between various parties in the economy. Each contract is a claim to future goods and services to be provided by someone in the economy. In contrast to commodity money which represents actual wealth because of the value of the commodity, exchange contracts as money represent a potential for wealth, or future wealth, where wealth is measured as the value of resources, skills, and knowledge one possesses.
Contracts are important to discuss because they provide an alternative solution to the origin of money. Exchange contracts arise as a side effect of every exchange that takes place in the economy. When the two halves of the exchange are separated by a long enough period, a tangible contract can be issued to serve as a record of the first half of the exchange, and as a claim to goods or services to be provided at a future date by the recipient in the first half of the exchange. This claim is money. We can generalise the concept of contracts as the origin of money to encompass Menger’s theory of the origin of money by allowing the contract to be in specie form. This is easy because all that the contract has to specify is the value and the goods or services that are to be provided. Thus in general, the contract can be in specie form, or in the form of a document, or even in the form of a record on a balance sheet. The function of the contracts when circulating as a currency is clear. The contracts keep track of who owes what goods or services to others, or conversely what society (others) owes each person. This is why I have defined money as a means of accounting under the bartering paradigm. This more general theory of money allows us to have greater insight into what is possible to achieve with money, and to recognise that there are alternatives to the current structures that developed as a consequence of using commodity money.
