Thursday, November 8, 2012

The Medium of Account

After yesterday's post I conclude that a standard of value is a unit of comparison that gives us a way to make comparisons. Just like "the inch" or "the mile".

I knew that.

The difference between money as a standard of value and money as a medium of exchange? Prices are set in terms of "the dollar"; I pay for things with "dollars".

The reason this comes up is that I came across Marcus Nunes' Two Kinds of Money. Marcus identifies two uses of money: as a medium of exchange (MoE), and as a medium of account (MoA). And he identifies his two kinds of money, good and bad:

The good kind is “whole money”. That is, it is both the MoE and MoA. Bad money loses its MoA property, but keeps its MoE property.

This fascinated me. In part, I must admit, the fascination arose because the concepts felt just slightly beyond my grasp. Thus yesterday's post, and this follow-up.

In comments on Marcus's, said I had trouble understanding the "Medium of Account". Marcus said, "I interpret your 'Standard of value' as 'Medium of Account'." That helps.

At the end of his post, Marcus provides links to four other posts on the "MoE/MoA". I printed 'em all out and started reading.

The post that "got the ball rolling," as Marcus says, is Sumner's What is money? What is inflation?. In it, he says money is the medium of account, not the medium of exchange. "Let’s take an example," Sumner says, "to illustrate this confusing issue:"

Imagine Zimbabwe uses gold as the medium of account. Then they have budget problems because their economy crashes when the government tries to take too much wealth from the top 1%. So they decide to print money. But the president (who is a madman) tells his treasury minister that he wants to stay on the gold standard, and will not tolerate any inflation.

Not sure if he stuck that line about taking too much wealth from the top 1% in there as a joke or not; but we can just ignore that part for now, and concentrate on "medium of account".

In this example, gold is the medium [of] account and Zimbabwe dollar is the medium of exchange.

It might make economists shudder, but I will offer a real-world example: the price of gasoline. Sometimes there is one price for cash, and a different (higher) price if you pay with credit. Remember when they used to do that? Nowadays, the price of gasoline is different (higher) no matter how we pay for it.

I want to make economists shudder more now, and say cash is the medium of account, and credit is the medium of exchange.

And I want to reiterate the opening of Marcus's post: There are two kinds of money -- good money, and bad. Good money is "whole" -- it is both the medium of exchange and the medium of account. Bad money loses the MoA property.

I think that's about right. But in order to think about it, I have to think about it in terms of the world I know -- the world where we buy gas on credit, but "money" is still the dollar in the wallet.


Luke Smith said...

According to Barron's Dictionary of Banking Terms, money is "anything commonly accepted as a legal tender currency for payment of debts". Good reasoning on the medium of exchange.

So as far as Gresham's Law, does bad credit push out good credit?

The Arthurian said...

Luke, I'm not sure about good and bad credit. My mind goes to people who don't pay their debts, which is surely off-topic. But let me consider the two kids of money I spend: the kind I earn, and the kind I borrow.

The money I borrow costs me more than the money I earn.

Gresham's law -- I'm glad you brought it up -- says that "bad" money drives "good" money out of circulation. "Good" money might be a full-bodied coin; "bad" money might be worn and nibbled away. There was more gold in "good" money (in Gresham's time) and less gold in "bad" money. Good money was more valuable to the holder. Bad money was less costly to spend.

(As we no longer use money with "intrinsic" value, I have to translate the meaning of "good" and "bad" money from value to costliness of use. Thus the paragraph above.)

Under Gresham's law, less valuable money drives more valuable money out of circulation.
Under Gresham's law, less-costly money drives more-costly money out of circulation.

The money I earn is less costly than the money I borrow. Therefore, Gresham's law should lead people to spend more earned money, and less borrowed money. Thus, the excessive reliance on credit that developed over the 60 years 1947-2007 seems to contradict Gresham's law.

How can this be?

Our policies contradict Gresham's law. Our policies drive down the quantity of circulating money, but encourage spending and borrowing and debt accumulation.

An old post: Gresham's Law Redux