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money-lecture_notes-Lec 02--The Natural Hierarchy of Money

money-lecture_notes-Lec 02--The Natural Hierarchy of Money...

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Mehrling 9/14/2009 1 2. Natural Hierarchy of Money Always and everywhere, monetary systems are hierarchical. One way that economists have tried to get an analytical grip on this empirical fact is to distinguish money (means of final settlement) from credit (promise to pay money, means of delaying final settlement). 1 This is fine so far as it goes. But in one sense it doesn’t go far enough because it posits only two layers of the hierarchy. And in another sense it goes too far because what counts as final settlement depends on what layer we are talking about. What looks like money at one level of the system looks like credit to the level above it. I. To see this point more clearly, think about the monetary system under a gold standard and think not about money and credit in the abstract but rather about the concrete financial instruments gold, currency, bank deposits, and securities. A Simple Hierarchy Money Gold Currency Deposits Credit Securities In such a world gold is the ultimate money because it is the ultimate international means of payment. National currencies are a form of credit in the sense that they are promises to pay gold. National currencies may be “backed ” by gold, in the sense that the issuer of currency holds some gold on hand, but that doesn’t mean that these currencies represent gold or are at the same hierarchical level as gold. When a currency is backed by gold reserves, it is still a promise to pay, just a more credible promise to pay because the presence of reserves makes it more likely that the issuer of currency can fulfill on the promise if called upon to do so. 2 Farther down the hierarchy, bank deposits are promises to pay currency on demand, so they are twice removed promises to pay the ultimate money, and securities are promises to pay currency over some time horizon in the future, so they are even more attenuated promises to pay. The credibility of these promises is an issue here, just as in the case of national currencies, and here as well reserves of the various instruments that lie higher up in the hierarchy can help to enhance credibility. 1 Just so, Ralph Hawtrey’s Currency and Credit (1923). 2 National currency is not in general a “cloakroom ticket” representing ownership of gold that is being held somewhere on behalf of the currency holder. This is true even in the extreme case of 100% reserves (or a currency board arrangement). Even in such an extreme case, there is still a promise to pay, a promise that can be broken.
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Mehrling 9/14/2009 2 In this hierarchy, where is the dividing line between money and credit? It is tempting to draw the line between currency (and everything above it) as money, and deposits (and everything below it) as credit. The source of this temptation is the institutional fact that currency is the final means of settlement for domestic payments. Just so, for a bank settling its accounts at the end of the day, currency or “high-powered money” is certainly the means of settlement.
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