17: Fiduciary Media and the Demand for Money
The use of fiduciary media reduces the demand for money by providing commercial enterprises the ability to trade in paper rather than physical currency or commodities. (EN: In the current age, one could say that the use of payment cards, credit and debit, have extended this practice to the majority of day-to-day, low-value transactions as well.) This is considered to have an impact on the demand for money - specifically, a significant decrease in the need for money as a token of exchange in transactions.
The development of fiduciary media has a number of influences: the aforementioned convenience and security of transporting a document rather than a sum of money, the need for credit among merchants, and the intervention of government (who sought to serve its own ends as well as facilitating commerce) all influenced contemporary fiduciary media.
It was also driven by the lack, at a given period of time, of commodities (precious metals) in which to trade. The author cites Adam Smith, who reasoned that the subjective use-value of gold and silver would become an obstacle to its use as currency, and that a system of bills and notes would serve the same function just as readily - enabling people to make use of the metals while preserving the system of exchange without them. Another theorist (Ricardo) predicted a situation in which precious metals are not used in commerce at all.
(EN: This came true some years after this book was written, in 1965, when the US broke the Bretton Woods agreement and took itself off of the gold standard, and other nations soon followed. Since then, coins have been of base metal and notes cannot be redeemed for precious metals. Both are merely tokens with no intrinsic value. And, as previously mentioned, the use of electronic accounts and payment cards may even make physical tokens of money obsolete.)
In the early industrial period, populations surged, which would have created a need for small money (coinage) far in excess of supply, which would have caused significant inflation in the value of money. However, during the same time period, the use of fiduciary media also surged, such that the incidence of "money crises" were negligible, short-lived, and largely insignificant.
Yet, there are various suppositions as to what might have occurred had it not been so, the most likely of which would seem to be the explosion of the mining and minting industries, or the adoption of additional metals as money, to fill the demand for additional coinage.
Also, the economic "boom" of the time was driven not by a shortage of money but by an increase in needs: a larger population in need of more goods created scarcity of goods (rather than scarcity of the money to buy them). This would have been true regardless of the money supply.
It's also noted that fiat and credit monies do not suffer the same relation to a physical commodity. It is a very simple matter to extend more credit (or in the case of fiat money, for the government to give itself more purchasing power) because it needs not be backed by any physical item in current existence. This is, of course, provided that the tokens of exchange (coins and notes) can be quickly manufactured from cheap and readily available materials (paper, base metals, etc.)
Some reckoning is given to the physical properties of tokens, such that they cannot easily be forged or counterfeited, but it bears little consideration to the economic value of genuine money unless the practice becomes widespread.
Fluctuations in the Demand for Money
To understand the impact of fiduciary media on the demand for money, it is necessary first to be clear about other factors that have an influence on demand for money.
In general, fluctuations in the demand for money are caused by the amount of commercial exchange taking place that is mediated by money. Demand for money may decrease if there are fewer exchanges taking place overall, or if the means of exchange does not require money 9direct barter).
Large variations in demand for money arise from factors of "general economic development." The most common example is an increase in population in a given location: this leads to increased consumption and production of goods, hence increased economic activity in general. Decrease in population will naturally have the opposite effect.
Likewise, in an are of increasing industrialism, there is a cultural shift from a lifestyle in which each household labors to produce goods for its own consumption to a lifestyle in which people work at factories to earn a wage, with which they purchase goods from others (given they work at a factory, they have less time to produce goods for their own consumption).
Also in regard to wages, the demand for money increases with the payment interval. A worker who is paid weekly receives a smaller amount of money at once than one who is paid monthly. This is not an increase in economic activity, merely an increase in frequency - a worker who is paid monthly likely makes fewer and larger purchases than one who is paid weekly.
(EN: This can be witnessed even today, in that many companies pay on the first and fifteenth of the month, so grocery stores are more crowded on the weekend after a payday than on non-payday weekends. The effect is particularly exaggerated in communities where there is a single large employer, such as a military base.)
The same is true in regard to repayment installments. If rent is paid weekly, rather than monthly, it has the same effect: less money is needed by an individual who makes frequent smaller payments rather than one who makes large monthly payments.
Elasticity of Reciprocal Cancellation
It's typical to credit the banking system, particularly in its capacity to support transactions by use of account balances and extension of credit, for the elasticity of the money supply. Were actual money required to conduct all exchanges, the demand for money would be much greater and fixed to the available supply. But with banking, commerce is independent of the supply of money.
Before considering the soundness of such an assertion, it is necessary to separate the effects of the clearing system:
In terms of the clearing system, the management of account balances by managing claims against counterclaims is itself limited by the number of claims falling due on a given date. Simply stated, if there is no counterclaim, a claim must still be settled in cash. And there are also "very many payments" that could be handled by the clearinghouse system that are still being made by transfer of physical money.
The author indicates we can "imagine" a clearing system that is fully developed, such that all payments, even everyday retail trade, are conducted by credits and debits against account balances. This is not so impossible or farfetched as it might seem. (EN: Given the use of credit/debit cards in the present age, it's definitely worth considering.)
This facilitates commerce by removing the necessity of physical money - any payment made to an individual may be immediately spent by him, with the account balances to be settled later. In such a situation, the demand and supply of money become infinitely elastic - as they are not bound to a physical medium that is available in limited stock.
(EN: I have the sense that the author is still overlooking one important factor: that even in a system of exchange that operates entirely by credits and debits to accounts, there is a limited stock of credit. While traders aren't limited by the amount of physical currency they can obtain, they are still limited by the amount they have in their account; and even though credit can extend this, there comes a point where the trader is "maxed out" on the credit he can draw. Hence, the inconvenience of paper and coin can be eliminated, but elasticity is still restricted by the availability of funds.)
Elasticity of the Credit System
The banking system of the author's time was largely concerned with the way in which fiduciary media adjusted "automatically" to the demand for money - but in a way that "does not correspond to the facts."
Some theorist maintain that banks do not have the power to manage the quantity of their notes in circulation, reckoning that the market determines the demand for bills, and the deposits made by a bank's customers limit the supply of money on which those bills may be issued. As such, the bank may only respond to the demand based on supply, and exerts direct control over neither factor, provided that the bank exists in a competitive environment.
This view, based on commodity-backed money, as transferred as well to fiduciary media: that a bank can supply credit money only to the degree that it extends money, and only if credit money is in demand in the marketplace. However, this is an error that arises from a misinterpretation of the nature of the issue of fiduciary media.
When a bank issues fiduciary media, it is creating money that is not based on a limited stock of a commodity, but on its future expectations of having the means to redeem the fiduciary media when it comes due. This is based on estimation and judgment, which are subjective and, as such, can be fabricated within reason.
In effect, the bank can stimulate the demand for credit, enabling it to increase the supply of fiduciary media, by setting an interest rate below the market, which encourages borrowing and enables the bank to create a greater supply of fiduciary media.
It's also noted that those who borrow money seek to do so with the intention of exchanging it in the marketplace for goods, and will bargain as necessary to convince the sellers of those goods to accept the paper he has obtained from the bank. And recall that, in terms of acceptability, sound fiduciary media is no less desirable to sellers than sound currency.
It is noted that credit policy may have an influence on the banks willingness (though not, strictly speaking, its ability) to issue fiduciary media. The more stringent a bank's credit policy, the fewer debtors will be able to obtain credit, and the less fiduciary media can be issued. This is balanced against the demand for credit, in which debtors may likewise be unwilling to pay interest at a given rate for the sake of having immediate purchasing power.
The author provides an example of the flow of fiduciary media: the cotton farmer takes a loan to purchase the supplies he needs to grow cotton, and repays it when his crop comes in. The spinner borrows money to buy the cotton and repays it when he sells his yarn. The weaver borrows money to buy the yarn and replays it when he sells his cloth. The clothier borrows money to buy the cloth and repays it when he sells his clothing. The injection of fiduciary media thus makes an increase in production possible (presuming the farmer could not have grown the cotton without a loan), and the fiduciary media itself remains in commerce for an extended period of time.
When debts are paid and fiduciary media redeemed, it decreases the amount in circulation, but banks are constantly issuing fresh loans and putting additional fiduciary media into circulation. But unlike a commodity based system, a fiduciary media system is based entirely on credit, so a bank is not limited in the amount of fiduciary media it can float by the amount that it redeems.
There are nonetheless fluctuations in the demand for fiduciary media, as the times at which individuals need credit and are able to repay their debts tend to follow patterns that do not perfectly balance one another. Though it is noted that credit policy that is responsive to demand can mitigate the fluctuations: by charging a higher interest rate when demand is increased, debtors may consider their needs and seek to adjust their use of credit.
But ultimately, banks can be infinitely flexible in their ability to provide as much credit as a market demands, at a rate that the market is willing to pay (provided debtors are reliable in making repayment). There are no natural limits.
(EN: Perhaps the author will address this separately, but it occurs to me that the demand for money and the demand for fiduciary media are independent of one another and quite different in their nature. While they substitute for one another in present economic transactions, the desire for money is driven by the capability of an individual to make payment within his present means, and the desire of an individual in borrowing is to increase his means in future, by a degree that would suffice to earn a profit in excess of the interest charged for credit. One must put the funds to productive use in order to have an interest in credit.)
Periodic Fluctuations in the Requisition of Bank Credit
When money is considered to be merely a medium of exchange, the requests made to banks are in effect requests for the transfer of economic goods: the weaver who takes a loan to buy thread is only interested in money as a means to obtain the thread he needs. There is no point in borrowing money (and paying interest) just to have money.
However, the bank cannot evoke material goods out of nothing, and likewise cannot create commodity-backed money at a whim. However, it can evoke fiduciary media out of nothing - save the confidence that the amount credited will be returned in time.
And as fiduciary media are a substitute for money, the issue of fiduciary media will have an impact on the demand for money. Specifically, "real" money is not needed for any transaction conducted using fiduciary media, so the value of fiduciary media in circulation decreases the demand for money that might have been used for the same purposes.
It's also noted that businesses maintain a cash reserve as part of working capital, to purchase goods and services it needs in the short term without having to rely upon credit. So long as this reserve is well managed and there are no unforeseen circumstances that would cause their expenditures to exceed their predictions, credit is not needed to bolster their cash reserves (or, from the opposite perspective, the cash reserves of a firm decrease its need to borrow money).
Entrepreneurs who seek loans suffer from a shortage of capital, to which a loan is a remedy. It is therefore the availability of other forms of capital that determines the need for fiduciary media as a substitute. The demand for credit therefore follows a pattern: the loan is needed at once, there follows a long period of repayment, during which time there is no demand for additional credit. Typically they borrow to produce, and repay when they sell their product.
Businesses in general tend to manage their operations according to a cyclical schedule: the activities are planned over the course of a week, a month, a quarter, or a year. This causes a systemic fluctuation in the demand for credit. Take the example of an agricultural community, in which the majority of people are farmers who take loans to plant crops in the spring and repay them when crops are sold in the fall.
Add to this the management of the businesses that extend credit, particularly in setting terms for a loan. If a loan is due at the end fo the month, the borrower must take steps to ensure he has the capital in time to repay his loan, which will affect the management of his own business (he will be intensity interested in selling product to raise capital before the payment of his loan is due in order to maintain his creditworthiness). And given that the majority of banks use the same due dates as a matter of bookkeeping convenience (all notes are due at the end of a month or quarter), the majority of debtors must manage to the same cycle.
Taken together, the timing of the needs of entrepreneurs to take loans, and the timing of the requirements of banks to repay them, create a pattern of demand for credit that can become predictable. An example si given from Germany at the turn of the century, where bankers could predict a demand for capital on the last days of March, June, September, and December (four quarters of the fiscal year).