Wednesday, November 7, 2012

Medium of Exchange, Standard of Value

Been trying to understand the notion of money as a standard of value, separate from money as a medium of exchange.

From Money and Banking by Raymond P. Kent, 1953:
What is Money?

Though money is much in our thoughts and though it conditions many of our actions, we encounter great difficulty in attempting to state precisely what it is. Definitions of money are legion, and they vary markedly with the divergent points of view of their authors. Some authorities believe that the term money should be restricted to whatever serves as a standard or measure of economic value, and that mediums of exchange should be described by some other term such as currency; others do not make a terminological distinction between what serves as a standard of value and what serves as a medium of exchange, but they narrow their definition of money to include only a few instruments; and still others classify as money numerous instruments which serve as standards of value or as mediums of exchange. The indiscriminate use of such terms as cash and credit adds to the confusion.


Remembering, then, the tentative nature of a definition which seeks to differentiate a complex concept such as money from all other concepts, we shall, for the purposes of this text, regard money as anything which is commonly used and generally accepted as a medium of exchange or as a standard of value.

Kent then examines his definition of money. He dedicates one paragraph to the word anything, one to the phrase "commonly used", and one to the phrase "generally accepted". And then, one on the word or:

In the fourth place, money, according to our definition, is used as a medium of exchange or a standard of value. Thus we classify as money something which is commonly used and generally accepted as a medium of exchange even though it does not serve as a standard of value, and we recognize as money something which is commonly used and generally accepted as a standard of value even though it is not employed as a medium of exchange.

Kent then considers money as a medium of exchange, and as a standard of value.

So closely intertwined are the functions of money as a medium of exchange and as a standard of value that it is often difficult to determine where one leaves off and the other begins. As a matter of fact, money is not used as a medium of exchange until the goods involved in a transaction have been evaluated in terms of money. Thus money usually functions as a medium of exchange and as a standard of value more or less simultaneously. But on many occasions money is used as a standard of value though no exchange of goods for money takes place. If a farmer wants to exchange some eggs for sugar at a grocery store, the value of each commodity is expressed in terms of money and the exchange is made, although no money passes from hand to hand. Again, people continually evaluate goods in terms of money when there is no interest whatever in exchange. A home owner may say that his house is worth $8,000, yet he may have no intention of selling it...

Money and Banking by Raymond P. Kent, Professor of Finance, University of Notre Dame. Revised Edition. Reinhard & Company, Inc. New York and Toronto. Copyright 1947, 1951. Fourth Printing, August 1953.


Greg said...

There is a discussion of this topic over here

I think its a good topic and one where I might actually agree with Scott Sumner who said that the medium of account function is the most important.

Medium of account as I understand it is simply how things are priced. What numeraire is used. In the US we use the "dollar sign" to price things and "the dollar" to pay for things.

But really I think its not very helpful to make this distinction. People should intuitively understand the difference between a dollar bill and a price tag with a dollar on it and not confuse them.

On our balance sheets we do have a variety of things which determine our wealth level. Some are dollar balances in checking accounts, some are dollars owed to other people and others are prices, in dollars, of things we own. The most volatile are the prices in dollars of the things we own. They can change drastically in a minute if they are a stock or commodity.

The problem, or A problem, as I see it is that our financial institutions do much of their transacting behaving as if the stock they hold that has a price tag of 100$ is the same as a 100$ bill. This is completely unreasonable, because this price is at the level it is within a certain range of sellers to buyers. If everyone at once wanted to get their 100$ a share for the stock, and tried to sell, the price would plummet and few would get their price. So at any given time only a percentage of people with the 100$ stock can convert it to a 100$ bill so to speak.
The rest must hold or turn it into a 50$ bill.

When panics happen everyone is trying to get their 100$ bills and only a few can be successful. Another fallacy of composition

The Arthurian said...

Oh, it really is another fallacy of composition. I never thought of that. Great insight there, Big G.

Re-reading tomorrow's follow-up post, I seem to find myself tending to agree with Sumner, too. (But I can't find anything wrong with my thinking in the post!) So perhaps the key point is what Marcus says: when money goes bad the "money of exchange" property and the "money of account" property of money somehow separate.

I'm definitely not clear on this. But I was all over the topic immediately when I read Marcus's post.

Thanks for the link. I go read now.