Lecture 3

What is money?

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Money is one of those concepts which we think are extremely simple.

This is true; but it is also true that it can be quite complicated.

What is money?

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Money is what we use as money.

Historically, money has been many things. Traditionally, precious metals, like
gold or silver or electrum (a naturally occurring alloy of gold and silver). But
also copper, bronze or iron.

(Historically, precious metals were usually valued by weight, whereas base

metals were tokens. There have been exceptions, e.g., Sweden in the 1600s.)

There have also been other forms of money, like stones or shells or
embroidered belts or animal furs and hides.

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Anything that claims to be money must fulfil the three functions of money,
formulated by Stanley Jevons in the 19th Century. These are to be

• A medium of exchange.
• A unit of account.
• A store of value.
Một phương tiện trao đổi.
Một đơn vị tính toán.
Một kho lưu trữ giá trị.

Anything that does not fulfil all three functions, is not money. For instance,
Bitcoin and other cryptocurrencies or stablecoins are not money.

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The most important of these three functions is that money must be a
medium of exchange. This means that it must be something that is generally
accepted as payment for goods or services or in the repayment of debts.

Medium of Exchange:
Eliminates the trouble of finding a double coincidence of needs
(reduces transaction costs).
Promotes specialization.

A medium of exchange must:

be easily standardized
be widely accepted
be divisible
be easy to carry
not deteriorate quickly
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Unit of Account:

Used to measure value in the economy

Reduces transaction costs

Store of Value:
Used to save purchasing power over time.
Other assets also serve this function.
Money is the most liquid of all assets but loses value during inflation.

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Money is not the same thing as wealth or income.

Money is a stock concept.

Wealth is the sum total of assets that store value.

Income is the flow of earnings per unit of time.

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In contrast to what you may read, there has never been a functioning barter economy.
Money develops spontaneously.

Why?

Throughout history, payments systems have evolved.

Originally, there was commodity money; and payment consisted of physically transferring
this commodity money from buyer to seller.

Eventually, governments got involved in the production and guaranteeing of money.

This gave rise to money whose face value is higher than the precious metal content – and
thus to seigniorage (Điều này dẫn đến sự ra đời của loại tiền có mệnh giá cao hơn hàm
lượng kim loại quý – và do đó dẫn đến chế độ phát hành tiền) . Eventually, it also led to fiat
money, money whose value is decreed by the state. Today, all money is fiat money (tiền
pháp định).
With the rise of banks, payments systems could evolve:

Bank notes (tiền giấy)– pioneered in China in the East and in Sweden in the
West – initially represented bank deposits .
Bank transfers.
Checks (Séc): an instruction to your bank to transfer money from your
account: a piece of paper.
Electronic Payment (e.g. online bill pay).
E-Money (electronic money):
Debit card
Stored-value card (smart card) – e.g., Revolut
E-cash – Apple/Google/WeChat/Ali Pay

What next?

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Predictions of a cashless society have been around for decades, but they have not
come to fruition. Although e-money might be more convenient and efficient than a
payments system based on paper, several factors work against the disappearance of
the paper system.
Why do money still remain? Cz not all the time ww have phone beside and our phone
can be stolen
What are some of these?
Anonymity. Convenience, always working
However, the use of e-money will likely still increase in the future. Perhaps in the
forms already existing, perhaps also as central banks issue Central Bank Digital
Currencies (CBDCs).
(To repeat, cryptocurrencies are not money they are not have 3 functions.)

Why not? Can they ever become money?

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We can also look at money from a different perspective.

This has to do with how we measure money.

Money is the monetary liabilities of the banking system; that is to say, the bank deposits of
households and (non-financial) companies: Tiền là các khoản nợ bằng tiền của hệ thống ngân
hàng; nghĩa là tiền gửi ngân hàng của các hộ gia đình và các công ty (phi tài chính).
Money is deposit/ household
We refer to money as the money stock or money supply. There are different measures of
money, ranging from narrow to broad. The broader the concept, the more inclusive (and
therefore also larger) it is.

By convention, money supply measures are designed as MX, where X stands for a number. The
higher the number, the broader the measure.

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In stylised form:

M0 = notes and coins in circulation

M1 = M0 plus demand deposits/ bank deposits
M2 = M1 plus time deposits
M3 = M2 plus eg money market mutual funds

Some countries go further. The UK has M4 and M4x. Sweden used to have an M5
measure. In others, there are fewer measures. For instance, in both China and the USA,
the broadest measure is M2, although the USA used to have both M3 and L (Liquidity)
and Japan still does.
China using M2 is bad idea cz it is too narrow
The State Bank of Vietnam, by contrast, only has a Total Liquidity measure.

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In addition, there is something called the monetary base. This consists of notes and
coins in circulation (M0), plus the reserves held by banks with the central bank.
Two key points:
Money held by the government is not included in money supply.
Nor is money held by banks with each other or with the central bank.
Hai điểm chính:
Tiền do chính phủ nắm giữ không được tính vào nguồn cung tiền tệ.
Tiền do các ngân hàng nắm giữ với nhau hoặc với ngân hàng trung ương cũng không
được tính vào.
Why not?
Because the government is not constrained in its actions by its cash holdings. Nor are
banks. This is because both these entities create money out of thin air.
As for banks interbank transactions do not involve G&S and there is no payment for
factors of production, and there is no impact on expenditure.
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Monetarists believe that the behaviour of people and of companies is guided by a

desire to hold certain real money balances, that is to say to hold money in the form of
money.

You might, for instance, wish to have đ1.5 million in your pocket; đ300 million in your
bank account; and đ6 billion in a savings account.

If you have less than these amounts, you will curtail your spending or even sell some
other assets to bring them to full strength. If you have more, you will do something
with the money to adjust your balances.

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Importantly, although a single individual can adjust their money balances, the
collective as a whole cannot do this.

This is because there are only five things you can do with money:
1. Buy a good (a pair of shoes).
2. Buy a service (a haircut).
3. Buy an asset, either financial (stock or bond etc) or real (real estate).
4. Pay back a bank loan.
5. Buy shares in a bank from the issuer.

The last two are the only ways in which money can be destroyed! (In the case of a
loan, when you repay a bank loan.)

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Therefore, if one person attempts to get rid of excess money, it usually means that this
money is given to somebody else. Now that person has too much money in the form of
money and tries to get rid of it; and so on.

This shows one important point: the creation of credit is a once-off; the creation of
money is (near) permanent)

Most central banks today ignore money and concentrate on credit. They are wrong to
do so. Although money and credit usually move together, they can diverge. And when
they do, it is money, not credit, that is important.

(Following central banks’ failure to forecast or understand the inflationary bout of

2021-2024, this may be changing.)

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Figure 1 Growth Rates of Broad money and credit, 1964–2024, % per annum

Source: Federal Reserve Bank of St. Louis, F RED database: Stein Brothers (UK) 17
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Which money measure is the most important? This is an issue that divides monetarists.
In essence, there are three groups.

There are those who say the monetary base is the most important. This is because how
it will affect the behaviour of banks. If their reserves are too high relative to their
balance sheet, they will try to bring them down by extending credit, thus swelling their
balance sheet.
Others say that narrow money – the money in your wallet or in your demand deposit
are the most important.
And others again say that broad money – the totality of a person’s liquid holdings – are
what determines their activity. This is because today you can instantly and without cost
transfer money between broader and narrower measures.
Finally, some support following a concept called Divisia money, a weighted aggregate
with greater weight given to more liquid forms. This is really a variant of narrow money
monetarism.
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Cash is not important in most economies. In Vietnam, cash is about 10% of total
liquidity. In the USA it is 8.4%; in the EA it is 9.4%; in China it is 3.8%.

Who uses cash today?

In US, there are 40 $ 100 bills per man, woman & child. In Vietnam, the amount of cash
per man, woman and child is $15,451,000.

The by far most important component of money is therefore held in bank accounts.

1. Remember: money held by banks is not money. Reserves held with the central bank
is therefore also not money. Above all, it is not a pile of money that can be lent.
2. You are often told that banks take in deposits and lend them out. This is wrong!
Banks create money by the very act of lending it.
3. Borrowing from a bank creates money. But borrowing from a non-bank does not; it
merely transfers money between two market actors. 19
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How do banks create money?

Stylised balance sheet of banking system
Assets Liabilities
Cash (as little as possible) Deposits
Deposits with central bank or clearing bank
Claims on private sector (credit) Equity
(about half each corporate and household;
About 90% of household loans – mortgages)
Claims on public sector Reserves
Other assets Other liabilities

Money = most of the deposits

So you can analyse changes in money by looking at changes in the deposits – but also at changes in the
assets, i.e., mainly credit

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How do banks create money?

When a bank extends a loan, it creates – out of thin air – an asset, a claim on the
borrower. This is matched by the creation of a liability, the borrower’s deposit. If the
borrower transfers that to another bank (say by buying someone’s house), the total
banking system balance sheet is unchanged. This only changes if the borrower takes
out the money in cash; that diminishes the bank’s liability, but also its stock of vault
cash.

But if banks do not lend out deposits, why do they need deposits? Because banks need
to fund themselves for other expenditure; and need to hold some cash in case
depositors wish to withdraw it; or for clearing with other banks.

This is the source of the banking system’s fragility! Banks borrow short (deposits
which can be claimed any time) and lend long (loans which are repayable over a long
period). 21
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Legal tender

In most countries, money is legal tender. This is a very misunderstood concept. Legal
tender only means one thing:

If we live in a country (say, VietNam) and I owe you a debt expressed in đong, and I try
to pay this debt by giving you đong, you have to accept that as settlement for the debt.

You may choose to accept US dollars or renminbi; or you can ask for them. But, legally, I
can’t force you to accept that and you can’t force me to pay with them.

Does money have to be legal tender?

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Legal tender? Or not?

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