1.22 Signs Or Representatives of Money
It has been stated that precious metal is money itself, and that a coin that contains a given weight of metal is not a representation or token, but money itself. There yet remain instruments of trade in common use and circulation that are not money, but are signs or representatives of it.
Bills of Exchange and Letters of Credit
Commercial paper such as bills of exchange, promissory notes, checks, and letters of credit are written obligations to pay a given sum of money under specific conditions of time and place: a note may be redeemed by its issuer or a bank, and its terms may specify it must be redeemed only after a certain date. Among merchants, such instruments function as currency: rather than paying coin for thread, the weaver may instead present a contract that gives his supplier the right to collect a debt owed to the weaver by a tailor.
In this way, they function as the equivalent of paper money issued by the state: their value to an acceptor is based on the faith that it will be redeemed as promised, albeit by a private party rather than the state. Said another way: commercial paper's value as money is based on the faith that it can be redeemed for real money.
The value of such paper in trade is often discounted:
- By the the inconvenience of collecting the debt. If the issuer is in the same town, it is a simple matter - if the acceptor must travel to a remote location, he must deduct the expense of the journey from the face value of the note.
- By faith in the reputation of the issuer. If the issuing merchant is well-known and in good standing with his creditors, his paper is trusted more than a merchant who is unknown and allegedly in good standing. Paper issued by a merchant of poor repute is worthless.
- By the conditions of the paper. If the debt is not due for some weeks, the acceptor considers the cost of doing without the capital for that same period of time.
- By the value of the instrument of redemption. If a note is issued in a foreign currency that will decrease in value, or that must be exchanged at a fee for domestic currency, this expense is likewise deducted from its face value.
In rare instances, commercial paper may command a premium over its face value. For example, a note payable in a stable currency when domestic currency is depreciating offers the promise of profit, rather than loss, to the acceptor, such that he is eager to collect the debt indicated. This is extremely unusual, and the difference is generally small - so it doesn't bear much consideration, except to remark that it sometimes does occur.
It is less common than might be imagined for commercial paper to be used in international commerce, largely due to the distances involved, lack of knowledge among parties, and the functional impossibility of a foreigner gaining the the assistance of a court in compelling its own citizens to honor their debts to non-citizens.
Say makes mention of accommodation paper, which itself has no value, but reinforces the value of another debt instrument. For example, if a French trader wishes to offer a bill to an English merchant, he many not accept it - but if another English citizen promises to pay the debt if the Frenchman defaults, the merchant may be willing to accept the original bill. The accommodation has no value in itself except as an additional guarantee that the original bill will be redeemable.
There is also instance in which governments borrow from one another, which is considered briefly. The ultimate conclusion is that this is of little concern to the supply of money to the market as the borrowing government does not re-issue debt instruments, but holds them for collection from the debtor nation. The only impact is if the debt is not repaid and the creditor nation wishes to recover the funds by taxing its own citizens or using its military to seize foreign property (which is again at the expense of the taxpayer).
Ultimately, commercial paper functions as an instrument of trade so long as there are merchants willing to accept it, at whatever value. It is essentially the same basis as anything used in exchange - it holds value to the extent that the acceptor values it.
International Exchange
In small nations, or on the borders between large ones, there is constant trade with the foreigners, and there is correspondingly greater need to exchange domestic for foreign currencies, and likewise greater inconveniences.
The exchange of money is always at a loss, as the expenses of the money-changer must be deducted. As such, when anyone receives a payment in foreign coin, even if it is paid as a bill, the loss is anticipated and the seller, who can make his normal profit from another buyer who pays in domestic coin, will demand the buyer who uses foreign coin (or any instrument denominated in foreign currency) to pay more to cover the loss.
Commercial Banking
Say asserts that banks were created as a commercial convenience to accommodate payments among private merchants. (EN: Others suggest different reasons, and my sense is that there is no singular answer: each bank was created for a purpose, and different ones may have been established to serve different needs.)
Rather than storing and transporting large amounts of currency, merchants placed their capital in a community vault so that amounts could be transferred on paper, debiting one account and crediting another, rather than in specie. This reduces not only the inconvenience of handling coin, but depreciation by wear, loss by counterfeit, etc. and reduced the need of actual coin for commercial exchanges. In some instances, transferring balances this also exploited loopholes in legislation whose wording applied to exchange of coin.
In some markets, the convenience of bank transfer led to an increase in prices when paid in coin. The author gives the example of Amsterdam, where merchants and traders charged a premium of three or four percent for purchases paid in coin versus those paid with bank money.
Withdrawal of funds was a liability and expense to the bank, whose preference is to maintain deposits in perpetuity. Aside of the cost of managing the transfer of physical coin into and out of accounts, the capital in storage was the banks source of revenue: the more currency in store, the more transactions it made for its depositors, and the more income it made by commissions for facilitating those transactions.
This led to transfers among banks in order to retain their power: they could not prevent customers from withdrawing their funds, but if they could facilitate a transaction by transferring to another bank rather than handing out coin to be deposited in another bank, they remained necessary to commerce.
Say notes that the fees earned for facilitating transactions was a secondary stream of profit for banks, its primary income coming from loans (which will be considered elsewhere), but nonetheless a significant one.
Banknotes and Banks of Circulation or Discount
Another kind of bank, founded on different principles, seeks to profit by the interest or discount upon notes and bills of exchange - that is, the bank issues commercial paper that is payable at some future date, such that there is a difference in the amount received when the note is issued and the amount paid when it is redeemed, which may derive from the face value of the note or an explicit fee charged for issuing it.
Say stumbles across the notion of fractional-reserve banking: because the note is not redeemable until some future time, the bank need not have the gold to redeem it until then. As such a bank tends to presently have only a fraction of the amount it will in future be required to pay to redeem its notes - Say suggests it may in many instances be around half or a third.
This tends to cause the occasional panic among depositors who are disturbed that the bank does not presently have the money to pay obligations that are not yet due. Whether this panic is well-founded or irrational depends on whether the bank's debtors do, in fact, repay their debts in time for the bank to repay its own - and as such is little different than any other line of business.
Banks of circulation profit in an active economy. While the discount or interest it earns on each note is trivial, the collective profit of many such notes is "very considerable" and more so for the amount of bills it has placed in circulation, as the bills earn profit whereas specie in the vault merely lies dormant, it is of interest to the banker to issue as much credit as he can.
There's passing mention of banks that issue bills for government, which tends to be a bad customer: the bills are relayed not with produced value but with stolen value (taxation), and governments show little interest in repaying their debts, but merely order the bills to remain in circulation beyond their redemption date, voiding the certainty of redemption that is the sole reason for anyone to accept a bill. Agreeing to do business with government has been the cause of ruin for many banks in Say's time.
It is beneficial to the consumer for banks to be in competition with one another: the bank that holds a monopoly has not pressure upon it to reduce the interest charged or demanded of its customers. When several banks vie for business, customers will seek the best rate of interest, and business will go to the most efficient operation.
Banks also provide a service in buying commercial paper at a discount: where a producer has a note payable in six months time but needs supplies immediately, he can redeem the paper with the bank for coin. He accepts less than the value of the note for this convenience, and collecting the full value provides a profit to the bank. In this way, merchants of good credit are able to conduct more business sooner than if they were compelled to wait to redeem their paper, and the wages of workers and debts owed suppliers are settled in a more timely fashion.
Another function is that the availability of credit enables the producer and merchant to invest more of their funds in productive activity. Rather than keeping cash in unproductive reserve to guard against possible need, it can be readily employed with the security that any unforeseen need can be fulfilled with credit should the producer happen to need it.
It's important to note that bills and notes play a very important part in the progress of wealth, but are not themselves part of the national wealth. They represent a promise to create value in future, but not the existence of value presently. Many theorists have mistaken the two as analogous, and have made significant errors as a result.
Various economists have considered money as a commodity unto itself, for which there is a specific supply and demand. This is inherently flawed, in that there is no natural demand of money: a man in need of money is in need of food, clothing, shelter, or diversions - of the various things he means to obtain by use of money, but money itself satisfies no want. It may be said that money is wanted for use in trade in the same way that looms are wanted for weaving, and this seems to some degree sensible.
With this in mind, consider that there is a demand for a commodity in a market to the extent the people can make use of it: when people are sufficiently fed, the creation of additional grain is met with no demand. The surplus production is wasted, unless it can be sent to another market where it is wanted. Money can be considered likewise: only a certain amount is needed for all operations of exchange: a dearth of it increases its value and a surplus decreases it. Too great a surplus of money is wasted: it sits idle, or is sent to other markets where there is greater need of it.
As to how much money is needed in circulation, "no writer of repute has ventured to estimate" this value at higher than 20%, and many much lower.
(EN: Say muses on this a bit, but it's entirely pointless, as prices can fluctuate. Traders will make use of as much or as little of it exists, raising or lowering nominal prices. If they cannot obtain money for trade, they will barter, or find another commodity to use as money.)
In this sense, the creation of paper money by banks causes an increase in the amount of money in circulation without a corresponding increase in the goods that can be traded for money - an by that process, money becomes of lesser value. But as with physical goods, an abundance in one market does not mean an abundance in all markets. Where trade is open, excess money flows to foreign markets, who provide goods in exchange, toward restoring the balance of money and goods by decreasing one and increasing the other.
If banks could issue only as many notes as they held the specie to back, then this would set a maximum amount of paper money to equally as much: half a nation's wealth money be coin in vaults, the other half paper in circulation.
Where credit money is issued, the volume of paper in circulation is increased according to the interest rate. Say considers the degree to which this is possible, and that is largely determined by the demand for loans, which is a factor of growth in the economy rather than the whim of bank management. At yet, a bank must show a preference for short-term loans to ensure that it can readily meet the obligation to honor its bills that are payable on demand. A bank that issues long-term loans may find itself with less specie than it needs, and no ability to collect payment before the loan is due.
Those who hold money place confidence not only in the bank, but it the creditworthiness of a bank's debtors - as to honor its bills, the bank must collect on time. This further motivates the bank to seek to loan to the most creditworthy applicants, and at low interest rates, preventing a well-run bank from extending too much credit to too many persons and creating as a result too much paper money and again, the shorter the loan, the less the risk as well as the return.
An odd and seemingly oblique bit comes from a metaphor of commerce and industry being likened to the roads and fields of a nation. A nation that is all roads and no fields has many ways to transport crops that it cannot grow; and a nation that is all fields and no roads can product many crops that it cannot transport to market.
There is also a bit about the vulnerability paper money: when a government collapses or a country is overrun in warfare, the paper money issued is worthless, whereas any money horded in specie maintains its value (so long as it is not seized). Moreover, the fields and mills remain productive (to the degree they have been undamaged), and the citizens still are in need of things (to the degree they have not been killed). That is to say that the economy will carry on as usual, and the only loss that will have been suffered is by those who hold paper money.
Say does note that systems in which paper money is used are more vulnerable to acts of forgery, as the tools, materials, and skills to forge bills are easier to come by than those necessary to produce counterfeit coin. It is even more damaging to the monetary system because the holders of legitimate bills have greater fear, upon hearing rumor of counterfeiting, that the bills they have may be forgeries - and in effect the forger (or even the baseless sense that there maybe a forger at work) casts doubt upon legitimate bills.
It's suggested that an effective method to prevent such problems is to restrict bills to a high denomination of value, so as to make them useful for merchant business but inconvenient to common circulation - they are less common and subject to more careful inspection and inquiry due to the amount. While the idea seems appealing, there is no practical method of limiting such a system, as ultimately what causes bills to be used or rejected is the willingness of the public to take them - and government can no more force them to refrain from using bills than it could force them to use them.
Government Scrip
Say uses the term "paper money" to describe government scrip: these are documents that have no redemption value that are issued by a government as a kind of money that its suppliers are obliged to accept, and that others in the market are compelled by force or fear to accept. Such documents may convey or express a promise of redemption, but as government has no obligation or intent to do so, they have no real value.
It would seem that, by every principle of money, such paper should be destitute of all value and acceptable to none. And indeed, scrip is regarded as utterly worthless as soon as the threat of force that compels its acceptance is removed. In effect, government script is a receipt for assets that have been seized.
In some instances, government scrip is issued to seize assets to undertake military campaigns or other large-scale activities, the face value of which represented an intent to repay, with interest, when the campaign had succeeded. It is unheard of that any government ever redeemed such scrip even in instances where the campaign had been successful - but to the degree that people could be convinced that it might be possible, or to the degree to which patriotic fervor renders them gullible, the scrip was accepted and used.
He details a rather long-term an elaborate swindle by the French government which offered bills to be repaid in some quantity of money. That is, bills issued by private banks promised "100 livres of silver" (the livre being a unit of weight), whereas the state promised "100 livres" without any reference to what a livre might be when the note was paid - copper, tin, or even another piece of paper purporting to be worth a livre. Technically, the government made good on its promises by repaying these "assignats" as agreed upon, though the money in which they were repaid was practically worthless.
(EN: This is interesting as it seems very close to the current swindle being conducted with American money, which has carried on for nearly fifty years to date: the American dollar is not worth a dollar's weight of anything, though the difference is that people seem to recognize this and have no expectation it will be redeemed, but still use it as currency. I expect Say would be confounded by this, and I really can't offer an explanation that would make sense in the context of his theory of value.)