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If money is just an IOU then the initial creation of money contradicts this assumption, doesn't it? A central bank doesn't owe money to any other entity (national central banks or commercial banks) when creating money. Is there a scientific term for this kind of IOU paradox?

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BlankerHans
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If money is just an IOU then the initial creation of money contradicts this assumption, doesn't it? A central bank doesn't owe money to any other entity (national central banks or commercial banks) when creating money. Is there a scientific term for this kind of IOU paradox?

It is not a paradox.

  1. Money is considered IOUs because it can be considered as an acknowledgement of debt. However, if you hold money you are not the debtor but the creditor. 100 USD is an acknowledgement that society owes you 100 USD worth of goods and services, not that you owe someone else. For a typical person, holding money is an asset, the same way as for a bank debt is an asset.

  2. On a central bank's balance sheet money is recorded as a liability but that is not because the central bank literally owes the money to someone else, rather this is historical convention.

    Under the gold or silver standards, money was issued against gold or silver reserves, making money a liability issued against gold/silver assets. When the gold and silver standards were abolished, the accounting convention still stuck. Central banks still record reserves as assets and money as liability although reserves now are not gold but actually just the nominal value of newly created money and money us a liability so the accounts balance. BoJ has nice article about history of this accounting practice.

  3. Referring to 2. Even though technically the CB records money as a liability, they actually use the asset side of money (new reserves) to make purchases of securities such as bonds, so again the point 1 applies: the money is an IOU in the sense that other people 'owe' the CB securities or other stuff with a nominal value equal to the value of the money the CB holds.

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1muflon1
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  • Thanks.

    1. So it is a more philosophical approach to think about money. Reminds me on the book of Argentarius "Vom Gelde".

    2. and 3. I was not thinking of the accounting part of money creation. For me 2. and 3. do not answer the genesis question here. If money is IOU and you trace the causality back to the initial creation of money a CB can create IOUs but doesn't owe anything to other entities. Maybe I don't get the kind of good claiming attribute of money in the IOU assumption.

     – BlankerHans May 11 '23 at 12:35
  • Great answer, I was also finding this concept confusing. Does this convention hold any practical value nowadays? If I understood correctly, it is still used to prevent the CB from printing money like crazy (as it would feel it would owe a lot of money)? – Nicolas Torres May 11 '23 at 12:38
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    @NicolasTorres it has actually no practical significance. CB cannot go bankrupt and CB leverage ratio does not matter. What stops central banks from printing money like crazy is their mandate. Virtually every central bank I can think of has price stability as a part of their mandate. Another safeguard is that central banks are not allowed to purchase any random asset. For example, Fed cannot purchase new house for Jerome Powell with the reserves. In practice Fed mainly buys government debt, so gov debt can be viewed as another limit on how much money Fed can create (although – 1muflon1 May 11 '23 at 14:49
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    they can purchase private debt as well, it is considered unconventional and frowned upon - but it was done during QE). – 1muflon1 May 11 '23 at 14:50
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    @BlankerHans 1. I wouldnt say its philosophical 100 dollars is actual objective officially sanctioned acknowledgement that other people owe you 100 dollars worth of something (thats why dollar says you can use it to settle 'debts' public or private). So it is actually objectively IOU. Money is basically a zero coupon bearer bond with no maturity. 2. Again, money is not what you owe to another person, but what other people owe you. There are already goods and services in economy, and gov creating money basically implies that you 'owe' part of those goods and services to government – 1muflon1 May 11 '23 at 14:57
  • "rather this is historical convention." As an Accountant, I must clarify this is not a historical convention that just stuck. Just because there is no physical asset backing it, it doesn't mean there is no intangible value backing it (trust). That goes in the asset side. Without it, the double entry accounting becomes unbalanced. – Matias N Goldberg May 11 '23 at 20:46
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    @MatiasNGoldberg of course in double entry book keeping everything has to balance but recording it as a liability is convention in a sense that you could as well record this money as new equity, under gold standard it makes sense for banknote to be actual liability, but under fiat CB could treat money as new equity. Also in economics backing means that money is actually issued against some asset. Of course fiat or fiduciary money is based on trust which gives money value but I would not call that backing under commonly used textbook definitions of the word – 1muflon1 May 11 '23 at 21:59
  • @1muflon1 I would respectfully disagree with you here. I can not force anyone to exchange their goods with my dollar or currency equivalent. I don't have the claim on others good just because I own money. – BlankerHans May 12 '23 at 07:38
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    @BlankerHans but according to law you are forced to accept people’s money to settle any ‘debt’. You can choose not to exchange goods at all, but if you choose to sell goods you are forced to accept dollars in US or euros in EU. That makes money de facto claim to any good and service on market that has the same nominal value as the sum of your money – 1muflon1 May 12 '23 at 08:55
  • This positive law and for me has no meaning in explaining economics. Eventhough these laws differ from country to country. If I wish to get paied in stones in my country I can do this. – BlankerHans May 12 '23 at 09:47
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    @BlankerHans If in your country stones are accepted medium of exchange then the stones represent money and claims to goods and services, if in some country nobody is willing to accept USD or EUR then USD or EUR ceases to be money because one of the most important feature of money at a core definition of what money even is, is to serve as a medium of exchange – 1muflon1 May 12 '23 at 11:17
  • But if we trade goods it doesn't have to be money. Money is a medium of exchange, but not every medium of exchange is money, is it? Money ist the medium of exchange with the highest salability.

    So why shouldn't "normal" goods (for me money is a good too) not have the same claim as money? Beside that a claim is something juridical.

     – BlankerHans May 15 '23 at 07:10
  • @BlankerHans 1. If something is medium of exchange then it is almost guaranteed to be money. Maximum salability does not matter for definition of money. Money has to be medium of exchange, unit of value, and (relatively reasonable) store of value. Anything can serve as a unit of value so that tick is always ticked, and any non-perishable good can be store of value, so if something is medium of exchange, it almost always is money. 2. Even if your medium of exchange is not money it would still represent claims. 3. No this is not Law site, there is nothing judicial about claim from econ persp – 1muflon1 May 15 '23 at 08:39
  • For example, bond would be a claim even outside presence of legal system if two parties agree on it. Whether the creditor reneges on the claim without legal system is another question. 4. Even from 'judicial' perspective virtually every country I can think of forces its legal tender to be accepted by law. – 1muflon1 May 15 '23 at 08:53
  • "Salability does not matter for definition of money" I would disagree here. The salability of any good defines the medium of exchange function.

    Thank you for discussion @1muflon1 I think we can agree to disagree on some aspects. :D The IOU is little more clear to me now.

     – BlankerHans May 15 '23 at 08:59
  • @BlankerHans but that is generally and widely accepted definition not my opinion. That's like disagreeing with biologists that dolphin is mammal arguing that according to you it is fish. Of course, you can create whole new taxonomy where dolphins are fish, but whats the point? thats like disagreeing just for the sake of disagreeing. Also I was referring to concept of 'highest saleability' that you invoked – 1muflon1 May 15 '23 at 09:05
  • I read "Origins of money" from Menger, I think he explained it very well. Von Mises also wrote about the money functions etc. and the conclusion within the Austrians is as I understood it that salability which is medium of exchange is the main determinant and the other money functions follow from the salability. – BlankerHans May 15 '23 at 09:09
  • @BlankerHans 1. but as I said medium of exchange is the most important function, but the concept of 'maximum salability' does not matter whether something is defined as money or not 2. those are 100-150 years old writings, science since marched forward, and in addition I am not even sure if you actually understood what they were writing about because I highly doubt that either Mises or Menger said that only something with highest salability can be considered money, you probably misread what was written, I believe Menger had model where origin of money came from barter and perhaps there – 1muflon1 May 15 '23 at 10:55
  • he argued that whatever good was most desired became money, but that is completely different from an argument that only the most desired good can be considered money, prima facie always in society there were parallel money (in past you had iron, silver, gold, copper all in parallel, now you have different currencies). Historically these metals or present currencies are not equally desired and one might be more desired than another yet they all been money under the standard econ definition – 1muflon1 May 15 '23 at 10:57