Notes on Money

by Lindy Davies

The funny thing about money is that the better it works, the less we tend to think about it. Yet among economists, there has long been great confusion and controversy about exactly what money is. Henry George observes, in The Science of Political Economy, that those "who differ most widely in defining money find no difficulty in agreeing as to what is meant by money in daily transactions." George saw that something, after all, needed to be said about money -- it plays an important role in political economy. And so, in the final section of that book he went about methodically building a general definition of money. Is his definition useful today? Let's take a walk through George's reasoning on this question, and see.

The Nature of Money

The notion that money has to be precious metal was very common in George's time (and has enthusiasts today). The characteristics of gold and silver -- scarcity, widespread demand, ease of transport, capacity to be coined into definite weights -- made them ideal for use as a medium of exchange. Even today, many people remember times when the notes which circulated as money were redeemable in gold or silver. People had the impression that United States currency was a claim on a fixed amount of gold bullion that was stored in Fort Knox. Nevertheless, common sense shows how precious metals cannot be a universal money. People seeking to use bullion as a medium of exchange would need experts to weigh it and certify its purity. Gold or silver coins are not accepted as money on the basis of the amount of precious metal in them. After 1964, US "silver" coins were made of copper and nickel; they had not a grain of silver in them, yet no one in the US had any trouble exchanging them at their face value. (1)

So, money isn't money because it has commodity, or "intrinsic" value. Its commodity value might be drastically decreased, and it would still function just as well as a medium of exchange. Next, George asks whether this is because of the government's decision, or "fiat," to accept a certain thing as money. Is money, essentially, what government says it is?

That view sounds plausible, and it also has adherents, such as monetary theorist Stephen Zarlenga, who defines money as "an abstract legal power of government." (2) George shows how that definition still does not provide the full answer. He agrees that this is a good way to do things, and that the nature of money as a labor-saving invention leads toward government fiat being the most efficient way of supplying money. However, as has often been seen in history, governments can get into trouble. George cites a few examples of this, such as the French Assignats or the Confederate currency during the Civil War. Since then, famous examples of extreme monetary instability include Weimar Germany in the 1930s, and Zimbabwe in the 2000s. After the fall of the Soviet Union, when there was monetary havoc in Russia, American brand-name cigarettes and blue jeans were used as currency. And today, visitors to any number of developing countries can get discounted goods if they pay in US dollars instead of the local currency.

George presses on. Does this mean, he asks, that money is just anything that can be used to facilitate exchanges, in lieu of barter? No, that doesn't work, because it ignores the crucial distinction between money per se and credit. Henry George acknowledges that credit is very useful and important, and was probably widely utilized in human society long before money came into being. The difference between money and credit, though, is that when money is given in exchange for something, both parties are satisfied that a transaction has been completed. When credit is offered, the payment is deferred to a later time. Therefore, credit depends on a relationship of trust, and if the trust isn't established, then credit won't be accepted in exchange. Money is readily exchangeable; people will happily accept it from a stranger.

Because credit requires trust and does not complete an exchange, it cannot -- in and of itself -- be money. This is not to say, however, that credit (along with gold, or paper, or lollipops, or Levis) can't be made into money. US money on the gold standard was exactly that: credit made into money. Holders of gold or silver certificates were promised that they could redeem that amount of bullion on demand -- but, of course, most people never bothered to do that. (3) The nature of those notes as credits against the nation's stocks of gold and silver, while still guaranteed by law, became inconsequential to the notes' function as money -- just as the precious-metal content of coins became decoupled from their face value.

We find ourselves unable to define money in terms of what it is -- because when it comes right down to it, money can be anything. Many different commodities, or government promises, or scraps of paper or magnetic blips on discs have been used as money. This shows us, as George says, that "the essential quality of money is not in its form or substance, but in its use." Henry George defines money as: "Whatever in any time and place is used as the common medium of exchange is money in that time and place."

A Labor-Saving Invention

Yet that definition seems rather unsatisfactory. Aren't some forms of money better than others? Now that our inquiry has cleared up the definition of money, Henry George says, we are in a better position to figure out what sort of monetary system would be best.

In rough outline, this would seem to be a fairly easy question to answer. Money is a labor-saving invention. Exchange is an incredibly important part of production, and gets more so as civilization grows -- so how is society to facilitate exchange? Outright barter involves great practical difficulty. Various forms of credit are extremely useful in mediating exchanges, but they involve risk and effort, and they cannot be used by strangers. It makes things much easier to adopt a standard medium of exchange, and people have been doing so for thousands of years. It saves work if our medium of exchange is easy to measure, divide and carry (such as salt, or tea). It saves even more work if our money is made out of a commodity that satisfies those conditions, but is also scarce, universally desired, and imperishable: that leads us to gold as an ideal commodity to use as money. In general terms, monetary development stayed there, with gold and silver, for hundreds of years. Indeed, their high suitability as money led to the mercantilist idea that gold and silver were "the coin of the world" and the object of international trade was to secure more gold for one's nation, leaving other nations with mere goods.

However, people keep trying to satisfy their desires with the least exertion. Gold and silver require lots of labor to mine, smelt, certify, coin and store. There would be an irresistible temptation, when using them as money, to try to get a smaller quantity of precious metal to be accepted at the same face value -- or in other words, to "debase the currency." Sir Thomas Gresham, explaining this process to Queen Elizabeth I, coined his famous law that "bad money drives out good." In other words, if money with lower bullion, or commodity value is nevertheless accepted as a medium of exchange, then other coinage that has higher bullion value will tend not to be used as money. Henry George went on to write that a nation could debase the heck out of its money, debase it down to the value of mere paper, and yet the currency would still serve just as well as a medium of exchange, if only its supply were strictly controlled.

This process continues today. I was recently in a grocery store line behind a guy who sought to purchase about $40 worth of goods with a combination of crumpled old bills and bags of quarters and dimes. At first, the cashier refused to accept the coins. But the store had no stated policy on this, and the man was, after all, offering to pay with legal tender. While they haggled, the line behind us lengthened. Finally the transaction was completed. I stepped up and quickly paid for my groceries with $40 in US funds via a debit card.

Indeed, information technology has allowed many transactions that once depended on credit to be made in simple money. If a store has a networked check-reader, it can quickly verify any check it is offered. The same is true of credit-card transactions that are verified in real time. (4) This would seem to represent the practical limit of currency's "debasement" -- in other words, the absolute lowest amount of "commodity value" that money could have. But the debit card works just fine at transferring the medium of exchange. In fact it works better -- as the impatient people behind me in that grocery line will attest -- than actual currency.

Actual currency plays an ever-smaller role in the monetary system. The current level of M1 in the United States (M1 is the term for liquid money: currency plus checking balances) currently hovers around $1.8 trillion, while as of 2008 the value of US currency in circulation was estimated at about $853 billion, two-thirds of which was circulating outside of the United States. Therefore, US bills and coins make up about 16% of the money currently in circulation in the US. (5)

Where Does It Come From?

People talk about "printing money," but clearly there is more to it than that. If 16% of M1 is in the form of currency, then what is the source of the other 84% that sits in checking accounts? How does money come into the world, and how does it leave it? The short answer is that money is loaned into existence by banks, and it is repaid back out of existence by debtors. During any given time period, the overall supply of money tends to increase if more money has been loaned than repaid during that period; it tends to fall if more money has been repaid than loaned.

This system, called fractional-reserve banking, started when banks provided the service of storing people's gold and silver. They issued notes, redeemable in bullion, which were used as money. It soon dawned on the bankers, however, that their depositors seldom, if ever, would all want to withdraw their money at once -- so they could make a profit by issuing a greater value of bank notes than the value of specie they had on deposit. Competition disposed all banks toward utilizing this practice. It could not go on without limit, however; it was checked by the inherent risk involved, and the costs of providing the regular banking services of check-clearing, teller services, etc., and preserving public trust in a bank's promises to pay.

Fractional-reserve banking is yet another labor-saving invention. It makes liquidity -- cash money -- available when it is most needed. Banks charge interest for this service, and borrowers are happy to pay it. Many businesses gain advantages from an ability to make large purchases, such as a grocery chain that buys various goods by the truckload. The price per box of cereal is much lower when one buys by the truckload; this means higher profits when the cereal is sold at retail prices. Yet a truckload of cereal costs a lot of money. Should the grocery chain save up enough money to buy that truckload of cereal? Or should it borrow the money? Clearly, saving up cash to buy inventory has a high opportunity cost for businesses, and therefore a great deal of ongoing business expense is financed by credit. (This is one reason why the 2009 "credit crunch" was so dangerous. Funds began to dry up even for such low-risk, short-term loans as these, which had devastating effect on a great many businesses.)

Fractional-reserve banking has been loudly denounced by a growing cadre of detractors. Authors such as Stephen Zarlenga, and the creators of the viral online video series, Money as Debt, contend that because money is such a vital tool in the economy, it isn't right to allow private businesses to create it. Furthermore, we're told that because money comes into existence as interest-bearing debt, which can only be paid off with money that has come into existence as interest-bearing debt, which can only be paid off with money, etc. -- as a society, we can never get out of debt. Not only that: just to maintain the endless interest payments, we must commit ourselves to an ever-growing (polluting, dehumanizing, war-inducing) economy so that we can keep paying the bankers for the privilege of providing us with the money we never have enough of! It's not hard to see why this thesis would attract enthusiasts. It has all the elements: a clearly identifiable villain who has nobody's sympathy, an increasing drumbeat of doom in the daily news and a monthly kick in our personal pants when we get mortgage and credit bills.

However, this condemnation of "money-as-debt" is wrong on several key points.

First, it's important to realize that money is a medium of exchange that is not consumed. It may come into existence through borrowing -- but it also goes out of existence through repayment. And in the meantime, it circulates. Borrowing is not the only way we can get money; we can also earn it. Interest can indeed be paid back in full, from the value of the goods and services that the borrowed money helps to create (or, if the borrowers consume less in the future).

The Remedy?

Opponents of "debt money" contend that the privilege of creating money should be taken away from private banks, and handled by the government. Instead of being loaned into existence, money would be spent into existence, by the government, to pay for needed public infrastructure. This remedy has strong emotional appeal, but it faces criticism in terms of efficiency. When money gets issued by private banks, its supply is determined by millions of carefully self-interested private decisions. Could the government gather enough information to do this job effectively?

Today, the Federal reserve carefully monitors the money supply, and it has tools with which it can influence it -- but it cannot determine it. Under current conditions it would be possible for either inflation or deflation to run out of control, despite anything done by the Fed. In addition to the uncertainty about how much money lenders will lend, there is the highly unpredictable element of velocity. Effectively, the faster money turns over, the more of it there is to spend. This makes the relationship between the quantity of money and the rate of inflation very difficult to determine. In the 1990s and 2000s, the Federal Reserve declared that M1, first, and then M2 (6) had ceased to demonstrate a "reliable indication of financial conditions in the economy...." (7)

Many subtle factors affect the velocity of money, such as banking regulations and tax rules. Asset bubbles soak up liquidity into long-term investments, whose value can disappear without warning when the bubble bursts. And, remember that at least two-thirds of the US currency in circulation is outside the borders of the United States. This proportion could unpredictably increase or decrease. (8) All of these factors suggest that it would be a huge challenge for the government to maintain an appropriate, stable supply of money. If they issued too much, there would be a threat of runaway inflation, as holders of cash rushed to dump it; if they issued too little the economy would stall, as we are seeing in the current "credit crunch." And then there's the question of all that foreign-held US currency: would we risk runaway inflation in the event of a sudden redemption spree -- or risk losing the US Dollar's preeminent role in the world economy by switching to a new currency?

For all of these reasons, switching to a 100% reserve banking system, in which the government spends money into existence, seems inadvisable as a remedy for our financial problems. Not that there aren't problems! We have seen unthinkably huge government bailouts of arrogantly, grossly mismanaged banks. Meanwhile, scared witless by the depth of the "Great Recession," we desperately seek "growth," regardless of the human or ecological damage it wreaks. There's something terribly wrong here, and to be sure, the financial sector has a hand in it.

Does a Remedy Exist?

To begin to sort this out, we should recall that capital goods aren't the only things that are bought with borrowed money. Some borrowed money is spent on consumption (as in financing a vacation by credit card). A great deal of borrowed money -- most, in fact -- is devoted to buying land. Money spent on acquiring land yields no products of labor in return. As an individual buyer of land, that's fine with you; you wanted the piece of land, so you bought it. But, from the point of view of the entire economy, if money is borrowed to buy land, it has to be paid back out of overall production. Therefore, if, in the aggregate, more borrowed money is used for buying land, less is available to spend on goods and services. If the entire economy is growing, this greater share taken by rent might not hurt much. However, we know that as an economy grows, rent takes an ever-larger proportional share of overall production. This means that land values are rising faster than the prices of goods and services. This puts society in a vicious circle: more and more money is borrowed, more of which is spent on higher land values. Eventually, as Henry George explains, something has to give: the boom suddenly becomes a bust.

Many people blame the banking system for boom/bust cycles, saying that "easy money" -- too many loans made available at low rates to poor credit risks -- is responsible for speculative bubbles. Clearly that is a large factor -- but not for the reasons usually cited. If the majority of borrowed money is used to buy land, then the availability of credit increases the demand for land. The effect of banking and finance is to increase the severity of the fundamental, underlying problem of land speculation. This problem is not caused by fractional-reserve banking -- or, indeed, by any particular financial system. There's no doubt that relaxed banking regulations, real-estate-friendly interest rates, the work of Fannie and Freddie and the mortgage-backed securities markets all did their share of damage. Some argue (plausibly) that recent asset-price bubbles were deliberately created by the financial system in order to consolidate wealth in the hands of the richest people at the top of the system. Yet there has been a similar grab-bag of enabling factors in every bust. For there to be an asset-price bubble, there have to be assets to inflate. This time, and about every 18 years or so for the last two centuries -- the asset of choice has been land. The value of land is the "raw material" that the financial system uses to intensify its hold on the economy. This has been true at many different periods in history, and under many different models of banking and finance. Therefore, the essential thing that must be done is to take away the financial system's access to land value!

So what sort of banking system should we have? That is a big question, and different communities will answer it in different ways. Mason Gaffney makes a cogent case that a fractional-reserve system can function quite well -- if two radical changes are made: 1) banks must not accept land as collateral for loans; 2) bank regulations must be biased toward short-term loans for self-liquidating capital goods such as inventories, accounts receivable or farm crops. (9) This would amount to a return to the "Real Bills" banking doctrine, which was advocated by Adam Smith and others, and was an integral element of all the major banking and currency debates of the 19th century. It is notable that the periods when the financial system has gotten into the most serious trouble -- such as in the early 1930s, and during the recent financial crash that began in 2008 -- were precisely when it moved farthest away from the "Real Bills" approach, basing more and more lending on real estate.

The easiest and most effective way to adopt "Real Bills" banking would be to implement the Single Tax. That would remove the selling price of land, making land unavailable as collateral. At the same time, it would drastically lower the amount of borrowed money needed for housing, and vastly decrease volatility in the housing market. (10)

The recent financial shenanigans perpetrated by the FIRE sector and their cronies in both political parties have been dramatic and tragic. They were in the 1930s, too. But, then as now, there is no getting around the fact that private ownership of land is, as Henry George put it, "the robber that takes all that is left." One economic issue is far more important than any other. Until that fundamental injustice is removed, other reforms will only serve to strengthen it.


1. George also cites the contemporary example of the US Trade Dollar. This coin contained more silver than the Mexican coins that were commonly in use -- but, because traders were not familiar with it, they continued to prefer the Mexican coins, and the Trade Dollar was discontinued after three years. [go back]

2. For example, in "Henry George's Concept of Money," a paper commissioned by the Schalkenbach Foundation in 2001. [go back]

3. The US was betting that they wouldn't. In 1971, when the United States went off the gold standard, the gold stockpile in Fort Knox was approximately 150 million ounces, which at 1971 prices was worth about $6.1 billion. The US had about $50 billion worth of currency in circulation at that time. (Sources: US Federal Reserve data quoted on Wikipedia, World Gold Council data quoted on, and [go back]

4. Of course, credit card payments do incorporate the element of credit. However, this makes no difference to the person who receives such a payment. The cardholder is borrowing the funds to make that purchase, and the credit-card company takes on the risk of the loan -- but the payee gets cash money, and has no worries. [go back]

5. The stability of Unites States currency makes it attractive as an exchange medium in smaller nations. This often happens informally; however, Ecuador, El Salvador and East Timor have officially adopted US currency as legal tender. (Sources:;; [go back]

6. M2 is a more expansive measure of money supply; it includes M1, plus savings and small time deposits, and non-institutional money market accounts [go back]

7. After making this determination regarding M2 in 1993, the New York Fed declared that "... no single variable has yet been identified to take its place." (Source: [go back]

8. For example, during the Y2K scare in 1999 there was a surge in M1 as panicky people sought to put their assets in the most liquid form available. And, after the fall of the Soviet Union, there was a huge demand for US currency in Russia and other post-Soviet states. [go back]

9. See After the Crash: Designing a Depression-Free Economy by Mason Gaffney, Wiley-Blackwell, 2010 [go back]

10. Back in the halcyon years after World War II, the Savings & Loan industry did an acceptable job of providing a stable source of home-mortgage loans. It was characterized as the "3-6-3" system: "Borrow at 3%, loan at 6% and be on the golf course by 3 pm." It was only when interest rates rose precipitously in the early 1980s that the industry, having trouble attracting depositors because of the restricted rate it could pay them, lobbied Congress to remove the restrictions. The S&L debacle of the 1980s ensued, culminating in a taxpayer bailout of approximately $500 billion. [go back]