Money and Banking Study Notes

What is money?
- 1.1 Mengerian theory of the origin of money
- 1.2 Adam Smith – the Wealth of Nations
The evolution of money
- 2.1 The development of outside money
- 2.2 The development of inside money
- 2.3 The development of fiat money

Definition of Money: Money is defined as a generally accepted medium of exchange (GAMOE).
Medium of Exchange (MOE): A good that people acquire through trade with the intention of trading it away later; it facilitates exchange.
Common Acceptance: Money is frequently used in trade and is offered by buyers and accepted by sellers.
Question for Discussion: How many types of money can you think of?

Store of Value: Money serves to store value, enabling individuals to shift consumption into the future.
Unit of Account: Money provides a measure of value for goods and services, and it is used for accounting measures and determining salaries.
Standard of Deferred Payment: Money is the unit or medium in which debts are denominated.
Question for Discussion: Which function of money is considered the most important?

What Money Can Buy (Quote):
- A bed but not sleep.
- A clock but not time.
- A book but not knowledge.
- A position but not respect.
- Medicine but not health.
- Amusements but not happiness.
- Acquaintance but not friendship.
- Obedience but not faithfulness.
- A house but not a home.

Significance: A foundational text that seeks to answer what makes nations wealthy.
Key Argument: Prosperity is directly related to the well-being of citizens.
Concepts Discussed:
- Division of labor leads to economic prosperity.
- Example: The pin factory.
- The Invisible Hand concept and competitive markets.
- Economic actions are driven by self-interest.

Main Point: No single individual can produce a pencil on their own, illustrating complex economic coordination.
Milton Friedman on I, Pencil: Emphasizes the impersonal operation of price systems that enable consumers to buy products at low costs.
Further Reading: See I, Pencil post on Professor Turner’s blog.

Carl Menger: An Austrian economist who died in 1921; contributor to marginal utility theory and the theory of value.
Austrian Economics Overview: An economic philosophy emphasizing individual actions and subjective value.
Menger's Questions:
- Why and how did certain goods arise to perform the role of medium of exchange?
- Why is there willingness to trade goods for mere token money (notes and coins with no intrinsic value)?

Barter Economy Challenge: In a barter economy, you need a double coincidence of wants, which complicates trade.
Definition of Double Coincidence of Wants: A situation where two traders can only trade if they both want what the other has.
Implications:
- Lack of trade limits specialization in tasks where individuals have a comparative advantage, hindering the division of labor.
- Evolution of barter to digital payments represents a significant development in money usage.

Description: A scenario where no pairwise exchange exists that enhances the status of the traders, exemplifying double coincidence of wants.
Consequence: Even with more traders, high search costs for finding a trading partner complicate exchanges.

Scenario with Adam: Adam has a preference for certain goods, leading him to engage in indirect exchanges to optimize his holdings.
Marketability of Goods: Indirect exchange is feasible if goods exhibit different levels of marketability. Adam exchanges his less marketable good for more marketable goods to acquire his desired items.

Marketable Goods: Goods that are widely consumed and traded, with low costs for buying, holding, and reselling.
Role of Inventory: Traders, like Adam, may hold these goods to facilitate future purchases without immediate consumption.
Behavior of Traders: Perceptive traders will adopt practices for indirect exchange, while less perceptive traders will eventually follow suit due to observations of success.

Emergence of Money: Money is not a result of invention; it emerges spontaneously from self-interest.
Network Effects: By custom, certain goods evolve to become the generally accepted medium of exchange (GAMOE).
State Intervention: The need for government involvement in the creation of money is negated, suggesting a natural emergence of the monetary system.
Convergence on the Most Marketable Medium: As indirect exchange becomes common, convergence occurs towards the most accepted medium of exchange through trial, error, communication, and imitation.

Acceptance of Money: Individuals in a monetary economy universally accept money in exchange for goods and services.
Liquidity of Money: Money is the most liquid of all assets.
Non-invention by State: "Money is not an invention of the state. It is not the product of a legislative act." - Carl Menger.
Role as Unit of Account: The role of money as a unit of account emerges naturally. Goods are priced in relation to a common commodity.
Historical Pricing Mechanism: Historically, sellers typically expressed prices in a quantity of a commodity, e.g., weight of bullion (pound sterling).