5. Holding Money
The Purest Form of Speculation
What is Money?
The answer is easy. Money is “the general medium of exchange” that everybody accepts in exchange for every commodity at any time and place. If you have a 10 euro bill or a 100 yen coin, you are able to obtain any commodity worth 10 euro (at least in the euro zone) or 100 yen (at least in Japan).
But why should people agree to accept a 10 euro bill or a 100 yen coin in exchange for something worth 10 euro or 100 yen? This second question is not so easy to answer. Indeed, for more than a millennium, philosophers, historians, jurists, sociologists, economists, and even psychoanalysts have advanced two competing theories to answer this question. They are the “commodity theory of money” and the “chartalist theory of money. 1 The commodity theory asserts that a certain thing functions as a general medium of exchange because it is a useful commodity that has a value independent of its use as money. 2 The chartalist theory, in contrast, asserts that a certain thing serves as a general medium of exchange only because its use as money has been approved by communal agreement or decreed by the head of a kingdom or sanctioned by legal order. Although historians of monetary theory have long been kept busy classifying historical authors on monetary matters into one or the other of these two camps, we now know that both theories are wrong. 3
We are happy to receive a 10 euro bill or a 100 yen coin not because we want to munch the bill like a goat or because we find the coin useful as a screwdriver. There is nothing in a 10 euro bill or a 100 yen coin as a commodity that gives it its value. To be sure, a 10 euro bill is legal tender, and most euro zone countries require their citizens to accept it in settlement of a debt. But 100 yen coins are legal tender only up to 20 pieces. Japanese citizens can legally refuse the 21st coin in any payment, although in fact they happily accept it without exception as money worth 100 yen. (Paper money is legal tender without any maximal limits.) Indeed, monetary history abounds with incidents of monies that continued to hold value long after ceasing to be legal tender, such as the Maria Theresa thalers that circulated widely in many African countries until WWII, long after they lost their status as legal tender even in Austria, their issuing country. 4 Besides, various forms of bank accounts also serve as general media of exchange and are counted as M1 without any legal backing (except, of course, during a bank run). Money can circulate as money not because it has an intrinsic value as a useful commodity or because it has an extrinsic value imposed by communal agreement or political authority or legal order.
Why, then, do we accept a 10 euro bill or a 100 yen coin as being worth 10 euro or 100 yen? Because we expect that other people will be happy to receive it at the same value from us in turn. And why do they accept a 10 euro bill or a 100 yen coin as a thing worth 10 euro or 100 yen from us? Again, they do so neither because they want to use it as a useful commodity nor because they are required to by some communal or political or legal power. They accept the money because they expect that other people will be happy to receive it as a 10 euro bill or 100 yen coin in turn. We have thus reached the third link of a chain of expectations according which we expect other people to expect other people to accept a bill or a coin as having a certain value. In the case of money, this chain of expectations will continue indefinitely. In the end, the only reason a 10 euro bill or a 100 yen coin is accepted as a 10 euro bill or a 100 yen coin is that everyone believes that everyone else believes that it will be accepted as a 10 euro bill or a 100 yen coin.
Money is money simply because it is accepted as money. 5
Here we find the same “bootstrapping” process that we saw in the Keynesian beauty contest. Indeed, what we now see is the bootstrapping process in its purest form. In the case of financial markets, even if the objects being traded are financial derivatives twice-removed from real-world commodities, they are not completely removed from them either, and are capable of providing producers and consumers with opportunities for managing at least some part of the risks and other inconveniences inherent in their real economic activities. Money, by contrast, has no real function to perform. It is by definition the general medium of exchange; we take it from others not in order to gain any return or utility from its use, but for the sole purpose of passing it on to others in the future in exchange for something with real value. (The so-called “liquidity” that money provides to its holder is nothing but the “derived” return or utility of holding money as the general medium of exchange. 6 ) Holding money is the “purest form of speculation .”
Once we are thrown into a capitalist economy, we cannot engage in economic activity without using money as the general medium of exchange. This means that under capitalism every one of us has to live the life of a “speculator” who buys and sells the purest object of speculation—money. In this sense, the ordinary producers and consumers in Main Street are no different from the professional speculators in Wall Street. And what is more: Whenever we circulate money among ourselves as the general medium of exchange, we are all acting like professional speculators who trade objects of speculation with each other, without ever being conscious of the fact. This is what I meant when I said at the beginning of Chapter 2 that capitalism is a system built “essentially” on speculation.
Inasmuch as money is an object of speculation, it is subject to the instability of the Keynesian beauty contest, thereby exposing the entire capitalist economy to the risk of bubbles and busts. In what follows, I will show that a bubble of money is in fact what is usually called a slump or, in extreme cases, a depression, and that a bust of money is in fact a boom—or, when it turns extreme, a hyperinflation. But first I want to dwell a little longer on the essential nature of money and then elucidate the fundamental core of the Wicksell-Keynes school of economics.
1 See J. Schumpeter History of Economic Analysis , Oxford: Oxford University Press, 1954, especially pp. 62-64 and 288-322, for the most authoritative account of this debate, though Schumpeter used the terms: “metallist theory of money” and “cartal theory of money,” or “Metallism” and “Cartalism,” which he borrowed from G. F. Knapp, The State Theory of Money , London: MacMillan,1924 (original publication: 1905).
2 See ibid ., p.63.
3 See Katsuhito Iwai, “Evolution of Money,” in Ugo Pagano and Antonio Nicita eds., Evolution of Economic Diversity (London: Routledge, 2001), pp. 396-431.
4 Monetary history also abounds with legal tenders that did not circulate as money despite the desperate and often heavy-handed efforts of princes and governments.
5 See my “The Bootstrap Theory of Money – A Search-Theoretic Foundation of Monetary Economics”, Structural Change and Economic Dynamics , 7(4) Dec. 1996, pp. 451-477; “Corrigendum,” 9 1998, p. 269 and “Evolution of Money”, op. cit ., pp. 396-431. Both papers are drawn from my earlier paper: “The Evolution of Money – A Search-Theoretic Foundation of Monetary Economics,” CARESS Working Paper #88-03 (Dept. of Economics, University of Pennsylvania), Feb. 1988, and “Fiat Money and Aggregate Demand Management in a Search Model of Decentralized Exchange,” CARESS Working Paper #88-16 (Dept of Economics, University of Pennsylvania), Sept. 1988; “Addendum,” CARESS Working Paper #89-01 (Dept. of Economics, University of Pennsylvania), Dec. 1988. I have also published (in Japanese) Money (Kahei Ron) ,（Chikuma-shobo, 1993; Chikuma-Gakugei-Bunko, 1998）, which discusses the philosophical implications of the bootstrapping nature of money in depth by means of a deconstructive analysis of Marx’s theory of value forms.
6 As John Law said, "Money is not the value for which goods are exchanged, but the value by which they are exchanged: the use of money is to buy goods, and silver (while money) is of no other use." John Law, Money and Trade Considered, with a Proposal for Supplying the Nation with Money , 1705; p.100.