Redefining Money Based on its Function
The function of money as seen from the perspective of the bartering paradigm.
In this article, I will present my view of what I think money actually is, i.e., when viewed from the bartering paradigm. Previously, I have said that the definition of money as a medium of exchange is very vague and fails to capture the real purpose of money in the economy. The alternative definition of money as a means of payment is in line with the purchasing paradigm, i.e., the view that we exchange goods and services for money. However, the purchasing paradigm is flawed, since it does not capture the true nature of the interactions within the economy, which is the exchange of goods and services for other goods and services. Thus we need a definition of money that is not vague and reflects this.
Bartering Paradigm
In the bartering paradigm, money does two things. First, it allows for the barter transaction to be made more efficient by making it possible for the two halves of the exchange to take place at different times. Secondly, it makes it possible to scale the barter transaction from the traditional two-party exchange to multiple people, because money is transferable to other members of society when it has some perceived value, or when the issuer is trustworthy. But these properties are not enough. We need to see what money is actually doing at a more basic level.
I note that money in the bartering paradigm is not derived from commodity money hence does not have any “intrinsic” or use-value. In the purchasing paradigm, money starts off as a commodity and so has some use-value, but it will always evolve into money that is not backed by anything of value, as we have now. This is not surprising because as the bartering paradigm shows, the function of money in the economy does not require it to have value in and of itself. The difference between the two paradigms is really in how money is created and injected into the economy.
Two Examples
Money in the bartering paradigm is a record of what goods and services have been provided or received. IOU tokens are one way of keeping record of one’s contribution to society versus what one has taken from society. It is not the only kind of token that’s possible though, and I will introduce the other in a future article. Instead of a central authority keeping records of all transactions in the economy, IOU tokens offer a decentralised record-keeping system. To illustrate, let’s look at our two islanders, P, and Q, from before. I will use IOU tokens in this example, but any system of record-keeping will do just fine. When P provides a good or service to Q, Q can hand over an IOU token to P, giving P a claim on future goods to be provided by Q. Thus Q now holds the goods provided by P, while P holds a token reflecting the value of goods he provided to Q. When P uses that token to claim goods from Q in future, he hands over the token to Q, who provides some goods to P in exchange for the token, and then destroys the token as he has no use for it. The net result is a barter exchange but with a delay between the two halves of the exchange. The delay makes the basic barter exchange efficient. We see that this transaction looks a lot like Q maintaining a ledger, with the additional step of him giving a copy of the record, as an IOU token, to whoever he receives goods or services from. These tokens that are handed out by Q can become a currency if Q is trustworthy. In general, not every person in the economy would issue their own brand of these tokens. One or a few trustworthy people will do so, and everyone else uses these as currency. With more people on the island, we would generally find that the token given to P by Q would likely have been received by Q from a third party for goods or services provided by Q to that third party.
Apart from introducing efficiency into barter, money also allows barter to scale beyond the traditional two-party exchange. To illustrate this second function of money, let’s introduce a third person, R, onto the island. Suppose at a given time, R requires some good from Q but Q does not require anything in return from R. Q however requires a good from P, who also does not require anything from Q. Finally P requires something from R, but R does not require anything from P. The problem is that each individual only knows about what he or she wants but not what the others need. In a small 3-person economy it is easy to argue that they should all meet and exchange the goods, but that solution will not scale to a large economy. That’s where money comes to the rescue. Without loss of generality let’s say all goods have the same value. Then R can create an IOU token which she hands over to Q in exchange for the good she requires. Later on, Q can then exchange this IOU for the good he requires from P. Finally P redeems this same IOU for what he requires from R. The net result is that P, Q, and R have all obtained the goods that they required, and the IOU token is back to R, who created it. R has no use for the token since she can’t exchange goods with herself so she destroys the token. With the token destroyed, the outcome is equivalent to a three-way barter exchange, achieved without the three parties having to meet at the same time. This is how money in the bartering paradigm allows multiple people, even in a full-scale economy, to exchange goods and services in a scaled-up version of barter. Notice how the individuals in the exchange do not have complete information about the market but are able to complete a three-way barter exchange in an efficient manner. This is because of the IOU token, which at each point in the series of exchanges, keeps track of who owes what. That token is destroyed at the end of the exchanges because it has no real value. It is just a helper object to keep track of the exchanges.
Function of Money
Money is a means of accounting.
Now consider that generally whenever someone in the economy provides goods and services to another person, they receive a token, maybe an IOU, stating the value of the goods or services that they provided. Thus when you provide a good or service to another person, the total value of the tokens you possess goes up by the value of the good or service you provided. When you receive a good or service, you pay the provider, and the value the tokens you possess goes down correspondingly by the value of goods or services you received. Thus these tokens provide a way to keep track of the value of goods or services you have provided to other members of society, versus the value of goods and services you have received from other members of society. It is doing so in a decentralised fashion, but this is really just basic accounting.
Thus we now know the real function of money in the economy, as revealed by the bartering paradigm, and we can offer a new definition: Money is a means of accounting. Specifically, it is a decentralised accounting system for keeping track of what each person has contributed to society versus what they have received from society. Now we understand the real function of money, it is clear that it doesn’t have to be based on a commodity, nor does it have to be backed by some tangible good or service. If accounting had been invented before money developed, then we would have had a chance to develop a currency system based on accounting, which preserves the bartering paradigm. The idea that currency has to created from, or be backed by some commodity, was useful in the early days of civilisation when record-keeping was not well developed, but it is no longer needed.
Unfortunately, even though money has evolved to a point where it is no longer backed by a tangible good, we are still stuck with the structures and methods that were developed for commodity-based money. We still have banks creating money and injecting it into the economy through loans. With the bartering paradigm, money would be created as a side effect of exchanges between the currency creators and the public, and be injected into the economy as part of the exchange. Exchanges involving only private goods would generate private currencies, while exchanges involving public goods would generate a public (national) currency. There would be multiple currencies in circulation, and you would have true currency competition.
