An Interactive Working Paper on Base Money vs. Bank Money
By John McCallie

In the wee hours of the morning, Prof. Smith decided to give it one last roll at Caezar’s House. He was, after all, playing with “House money” after a nice run at the tables earlier. He "deposited" a small pad of “Benjamins” on the table. It was promptly converted into several tall stacks of colored chips. He couldn’t help but muse that he had just converted all his cash into something with the intrinsic value of a chunk of clay. While waiting to roll the "bones," a short shoulder rub was sweet after a torturous day of economic seminars. Being cashless, he offered one of his chips for payment. She appreciated that it was a black chip. A cocktail waitress soon returned with his favorite brand. She, too, was grateful when he slid a few reds on her tray as a tip. However, the table was “cold,” and he pocketed his remaining chips, grabbed his drink, and went to cash out. On his way to the cashier, he spotted a gentleman enjoying a Montecristo. To Prof. Smith’s delight, the gentleman was willing to exchange one of his creampuffs for some of his chips. Even if they were just a piece of clay, the chips were indeed generally accepted as money in the economy of Caezar’s House. At the cashier, his remaining chips were converted back into cash, except for one special purple chip that the professor pocketed as a memento. The “House” was okay with patrons walking out with such chips- in fact, it improved its bottom line. Taking a dreamy draw from his Montecristo on his way out, Prof. Smith faintly smirked to himself when it struck him that he had just exchanged his “chunk of clay” for something with the intrinsic value of rag paper and ink.

The Casino Chip Analogy: Understanding Money Substitutes

Bank products such as demand deposits, traveler’s checks, and other negotiable credit instruments serve as useful substitutes for cash, much like clay chips in a casino. These credit devices obviously represent claims on money and function as IOUs, or, more specifically, I-Owe-You-Money instruments. However, in economics, these are not viewed as substitutes but are treated as actual money themselves and are indeed included in the money supply. Although this conventional perspective has been long-standing and is deeply entrenched, this paper explains that the straightforward recognition that these issued credit instruments are merely substitutes for money—similar to casino chips—provides a more precise and clearer understanding of how banks and their products function within the economy, reducing the confusion often associated with this subject.

This recognition also highlights how different monetary entities emerge and operate within a market economy. While these discussions usually center around the banking system, it is important to recognize that substitutes for money can develop outside the traditional banking system—such as stablecoins, cryptocurrencies, and gift cards. The perspective presented in this paper applies to these alternatives and any others that may arise in the future. Therefore, this viewpoint can be generalized to relate to the financial system as a whole.

Not least important, acknowledging that these credits are substitutes for money clarifies what actual money is: the monetary entity they represent. Indeed, these credits are freely convertible into money. Because they can easily be "cashed out," these products are closely tied to money through the unyielding forces of the market. Thereby, money serves as a North Star for all its substitutes, effectively coordinating their supply and use; this is why it is imperative that money be reliable and honest. Being grounded in market fundamentals, their supply and use promote trade and economic growth while helping reduce inflation and prevent recessions. In addition, as demonstrated in this paper, their use enables a more efficient use of actual money, thereby reducing our reliance on its supply.

For generations, the typical economic textbook on "money and banking" inculcated the idea that banks possess a unique power to "create money out of thin air." This notion stems from the fact that banks can produce these products, such as demand deposits, simply with a "stroke of a pen," as often stated. As noted, these issued products are seen as actual money. Therefore, when banks issue deposits to make loans rather than lending out cash reserves directly, it is taught that this "lending effectively creates new money" (e.g., Ammous, 2023, p. 289). This standard banking practice is called "fractional reserve banking," since only a "fraction" of deposits is backed by money reserves. In viewing these issued deposits as additional new money, this outcome is described as a "money multiplier effect," since these typical bank-lending practices result in deposits expanding well beyond money reserves (e.g., Mishkin, 2019).

In stark contrast to this traditional view of a "money multiplier effect," this paper introduces a conceptual model, the Market of Concurrent Trading (MCT), that offers a distinct understanding of standard banking practices and challenges the conventional belief that the financial sector operates like a magical money machine. It patently illustrates how the use of practical alternatives to physical currency substantially economizes on its use. This perspective acknowledges that trades can be conducted in terms of money rather than with money. This is overlooked in the traditional view because of its theoretical framework. This effective economization enables the existing supply of physical currency to accommodate increases in market activity or economic growth. Thus, the financial innovation of utilizing credible substitutes minimizes our reliance on a specific supply of real money or physical currency.

The paper emphasizes the crucial role of money substitutes and their associated clearing systems in a transformative financial strategy aimed at capturing a valuable yet often elusive source of savings. These savings can then be leveraged into investments, fostering growth and economic prosperity. Interestingly, this beneficial outcome is an unintended result of the more efficient use of money substitutes. This increased efficiency allows for a rise in wealth and prosperity without the need to create additional money. Importantly, this innovative banking operation is purely financial and does not involve the creation of new money.

Clarifications on Concepts

As discussed in the paper, when bank customers purchase money substitutes, such as demand deposits, they exchange cash or income for redeemable credit instruments or IOUs. This is similar to when casino patrons "purchase" chips, which also represent redeemable claims to cash. The resulting cash or money reserves essentially reflect preserved purchasing power. It is worth noting that the recognition of a pool of "preserved purchasing power" rests on the assumption that valued goods and services will continue to be produced by others to sustain it. The extent to which a bank can exploit this extra pool of "savings" is limited by how effectively it can provide a reliable alternative to money that people want to hold, while also managing the associated risks. The profitability of this financial innovation depends on the bank's capacity to successfully exploit this extra source of saved purchasing power to finance productive investments.

Real savings, in this case, are represented by actual money reserves that remain unspent for a reliable period and are therefore available for investment. Hence, the inventive introduction of these credible money substitutes enables us to tap into a source of actual savings that would otherwise be challenging to exploit. The financial goal of securing savings or capital to invest is a common objective across various financial products offered on the market. In this regard, financial products that are freely convertible into money, such as demand deposits, essentially function like other bank products that lack free convertibility, such as savings accounts or time deposits. All such financial products can thus be treated equally in economics as means of loaning out other people's money.

The use of money substitutes is therefore purely financial. This means it is not about "creating" or "multiplying" money but about using the existing money supply more effectively. Nor is it a means of conjuring up savings out of nothing, or as commonly stated, "out of thin air." Instead, this innovative financial strategy essentially involves lending actual money that is, in fact, being saved. From this perspective, these financial products indeed facilitate trade as a convenient alternative to cash — like clay chips in a casino — but they also play a central role in financing trade.

And not least important, this perspective on money and banking clarifies that money is the monetary entity that exists independently of financial institutions, such as banks. The rest is simply finance. Indeed, these institutions fiercely compete to secure this entity by offering attractive alternatives to cash to harness it for investment. Again, this understanding raises moral and economic questions of its fiat-driven supply in a free society.

The Rationale Behind the Conventional View

As discussed in the paper, the conventional view has roots in an age-old idea that spending levels directly affect economic conditions, given their strong correlation. Its theoretical framework considers total spending levels as a close proxy of "aggregate demand" for goods and services, the level of which is critical in maintaining full employment. Moreover, this framework is founded on the assumption that money, in some form, changes hands in nearly every market transaction.

This assumption leads to the notion that the "money supply" is a crucial factor in influencing spending levels. This positive relationship between the money supply and spending levels suggests that the money supply significantly impacts what is deemed sufficient aggregate demand. Understandably, this interpretive framework concludes that imbalances in the money supply can significantly contribute to adverse monetary disturbances, including inflation and recessions. For example, an inadequate money supply can restrict economic activity and result in a recession. Conversely, an excessive money supply can overstimulate economic activity, leading to inflation.

While the assumption that money is exchanged in nearly every transaction was plausible in earlier times, before the emergence of money substitutes and advancements in clearing systems—when only physical currency, such as gold coins, was generally used as a medium of exchange—it overlooks the reality that most transactions today are conducted in monetary terms rather than the actual exchange of money. These ongoing financial advances certainly disrupt the consistency and predictability of this framework, which relies on a mechanistic relationship between money supply and economic outcomes. This will be elaborated on later in the paper.

Given that money substitutes are widely used to facilitate transactions, this interpretive framework is obliged to treat these products as actual money to make the theory more plausible and practical. From a scientific nomenclature consideration, this required redefining money, moving away from its previous definition that distinguished money from its substitutes, thus recognizing these products as part of the money supply. Therefore, the concept of money was defined merely as a generally accepted medium of exchange, which could include casino chips if they were widely accepted in the market. The dissemination and widespread popularity of this view can largely be attributed to the iconic works and personages of John Maynard Keynes and Milton Friedman (1969).

The paper further explains that the interpretive framework of these iconic figures, which posits that "banks create new money," provides a "scientific" justification for centralized control over the banking system. This rationale supported the political agenda that emerged around the turn of the 20th century, which heavily favored increased government intervention. Since banks are responsible for the majority of the money supply in this framework, it is easy to see why it strongly advocates for centralized management of the "money supply" and the monopoly on currency issuance. The prevailing belief is that the health of the economy greatly depends on the strict control and oversight of the banking system by monetary authorities. Predictably, this agenda and monetary policy quickly became the uncontestable conventional view.

The conventional view's fixation on spending levels inevitably leads to a heavy emphasis on desirable levels of consumption, since it accounts for the vast majority of total expenditures under national income accounting methods. Notably, this perspective reverses the earlier emphasis on savings in economics. The earlier argument was that savings served as the engine of economic growth through investment, and that there was necessarily a direct trade-off between consumption and savings levels. This paper reflects such classical leanings and aims to challenge the prevailing stance on monetary theory and policy by acknowledging that money substitutes are not money in themselves; instead, they are dependent on what is truly money, which is the specific currency that underpins the financial instruments that substitute for it.

The Classical Perspective

The perspective on money and banking in this paper aligns with the view that prevailed before the longstanding conventional view gained popularity at the turn of the 20th century and supplanted it. As in this paper, the earlier view was straightforward: the monetary use of gold or specie constituted actual money. Similarly, the earlier view identified bank money as a "money substitute," and its issuance was characterized as credit rather than as the creation of new money.

Regarding monetary theory, a free and robust financial system, like the supply of products in other sectors of the economy, effectively meets the community's monetary and financial needs, fully supporting any necessary spending deemed beneficial or profitable. Thus, the earlier view rejected the ever-popular argument that insufficient spending caused recessions. Instead, the cause had to be some form of widespread destruction of value that necessarily leads to reduced spending levels, being the effect of this destruction. Understood as the effect of economic conditions, spending levels were thus considered inconsequential as a causal factor.

From a policy perspective, this earlier view regarded the market supply of a medium of exchange, including that supplied by a free and competitive banking sector, as optimal, in contrast to the modern view that considers this supply unreliable and advocates centralized control. This earlier perspective is dubbed the "classical view," whereas the current conventional stance is called the "modern view," insinuating a shift from an antiquated mindset to a more sophisticated understanding.

The clash between these two views arguably arises from different interpretations of what is meant by the concept of demand. Still, it ultimately stems from the underlying premises on which their theories are built, which inevitably alter their theories on the causes of "wealth creation." As discussed in more detail later, the classical view rests on the premise that value must be created before it can be consumed. This is known as the Primacy of Production Principle and was considered axiomatic in the study of wealth creation. While it may seem commonsensical, this underlying premise profoundly guides the science toward logically sound theories on wealth creation, ruling out illogical contradictions and erroneous theories that were indeed prevalent in the early days of economics, such as mercantilism.

A key example of this guiding principle is the classical concept of demand, which rests on the idea that "the supply of goods and services constitutes the demand for noncompeting goods and services." (For simplicity, "goods" will refer to both "goods and services" hereafter.) This means that their production ultimately creates the demand for goods. In a market society, the production of goods is how one obtains or earns the means to spend money in the first place. Even if money is received through gifting or handouts, it still indicates that goods were previously produced and sold to enable such acts. This classical interpretation is clearly articulated by W. H. Hutt (1974).

Therefore, the ability to demand goods stems from the ability to supply goods. This understanding—that supply or value creation comes before and generates demand—drives the science to concentrate on the most effective ways to use resources to create and enhance value rather than focusing on spending levels. Since resources or the "means" used to achieve desirable "ends" are understood in economics as limited, the classical understanding of demand implies that the employment of such "means" necessarily precludes their use in simultaneously attaining other ends, as captured in the phrase, "there is no free lunch." Additionally, the understanding that supply and demand for goods are interconnected, as described above, is essential to grasp the concept of opportunity costs: that the price of resources tends to reflect the value of their use in the next-best alternative through the bidding processes, where the next-best alternative is associated with other possible ends or goals of market participants.

To highlight how different perspectives on demand lead to a clash of these views: if we understand that “demand for goods” arises from the production of goods, or, more precisely, from the creation of value, then it follows that the destruction of value diminishes this demand. Therefore, the consumption of goods, which was recognized as a form of value destruction by the classical view, leads to a reduction in demand. This viewpoint has profound implications for understanding the factors that enable economic growth. In contrast to the current dominant view that is engrossed with the “health of the consumer” and that too much savings is an "ever-present danger," the classical view argues that policies that overstimulate consumption at the expense of savings or that misallocate resources hamper economic growth.

The classical understanding of demand also helps comprehend what causes economic recessions or downturns. For instance, unprofitable business ventures can be viewed as a type of value destruction that further reduces demand. As detailed later in the paper, the multiple increase in money substitutes—correctly understood in classical economics as credit expansion rather than as a multiple expansion of money—is viable only if this expansion of credit is profitable overall, making debt repayment possible. On the other hand, an overall unprofitable credit expansion leads to substantial demand destruction, as reflected by an economic recession.

As noted in the paper, widespread unprofitable outcomes are improbable in a free market, where market participants tend to rely entirely on their own assets and are careful to profit from their actions. However, poorly conceived banking regulations or legislative acts that overly impede productive endeavors or promote unprofitable business ventures on a broad scale can result in significant demand destruction. Even if the effects are initially positive, the extent of this destruction can be severe enough to trigger a financial crisis or a nationwide recession.

In the classical framework, the available means of achieving ends include the supply of media, which is either money or money substitutes. Both of these monetary entities are marketable goods in their own right and, undoubtedly, valuable tools for market participants to achieve their goals. They both have particular markets that determine their value and the quantity supplied. The classical view understood the Laws of economics that rationally disciplined the value and supply of these goods. Still, our understanding of them has been dramatically enhanced by more recent advances in monetary theory, which this paper draws on and references later.

The MCT model introduced in the paper also helps demonstrate and explain why a limited supply of base money does not necessarily constrain the market supply of media. Moreover, it shows why the so-called magical power of banks does not conjure money — instead, the optimal media supply is achieved by using base money more effectively. Additionally, it is explained that the extension of credit when using money substitutes is made possible and strictly limited by the level of real savings that can be mobilized by the issuance of bank money, without the need to create new money.

These advances in monetary theory reinforce the classical view that an unhampered banking system can meet the demand for media while minimizing the threat of inflation or recessions. In this case, spending itself does not carry any particular significance in economics beyond the recognition that market participants use a monetary good to trade nonmonetary goods indirectly, and to the extent that this reallocation of resources creates and enhances value. Additionally, by integrating the industry that produces monetary goods, comprising money and its substitutes, into a single sphere of market equilibrating forces that explain the allocation of resources in their entirety, the science is unified in describing a general theory of economics.

In contrast to the classical perspective, the modern view considers the demand for goods independently of the supply. They are portrayed as two independent factors, like two blades of a pair of scissors. Hence, the idea of spending money on goods is disconnected from the recognition that the production of goods is what ultimately provides the means to demand other goods. A concept of demand divorced from its underlying principle of production thus promotes the idea that spending itself is a fundamental driver of economic activity and that an insufficient level can cause recessions. As a result, even consumption and government spending can be perceived as positive contributors to creating wealth or prosperity.

To rationalize this story of inadequate spending or "insufficient aggregate demand," this interpretation often relies on value judgments that impugn market participants, suggesting they are irrationally swayed by “animal spirits” or holding unreasonable levels of “idle” money or resources. The interpretive framework is indeed the impetus behind the idea that spending levels can be managed beneficially by controlling the supply of these money substitutes. Moreover, rather than a unified general theory of the economy, this artificially imposed division between supply and demand ultimately accounts for the existence of the two distinct, disconnected branches of modern economics: microeconomics and macroeconomics.

The modern view may argue that autonomous changes in the supply of (base) money defy this underlying principle of production, as it can alter spending levels absent any prior production of goods or creation of value. From the standpoint of a fiat-driven base money supply, in which things like grants and handouts can easily be provided by printing more money, this argument has some validity. However, a fiat-driven system is not a natural or voluntary market phenomenon; it operates through coercion or mandate. For sure, economic laws can be overridden by force, just as dams can defy the law of gravity. Such acts of force alter the dynamics of the market’s equilibrating principles and must be taken into account when assessing the market’s ability to achieve desirable outcomes.

Nonetheless, this underlying principle of production still holds within the context of a market-driven base money supply, just as it did when the monetary use of gold was recognized as the money supply. In this scenario, the incentives to mine gold or convert its nonmonetary uses into currency mirror the market forces that motivate and govern the production of other goods. Consequently, the value creation that creates demand and supports spending in this instance is generated from the production of money itself.

Notably, this classical-leaning understanding illustrates why a free and competitive banking system effectively meets the community's monetary and financial needs without top-down directives or centralized control, all while reducing the risks of inflation and recessions. Additionally, the framework presented in this paper acknowledges the emergence of new forms of money substitutes, which are continually being created and introduced to the market. These substitutes may also originate outside traditional banking systems, such as digital currencies or gift cards. Thus, the concept of "bank money" can be generalized to include these additional forms of money substitutes.

The Model of MCT and Its Value

The paper introduces a conceptual model, called the "Market of Concurrent Trading" (MCT), to clarify why the issuance of money substitutes, such as demand deposits, does not constitute the creation of additional money but instead utilizes money more resourcefully. This model clearly demonstrates how financial innovation, by using credit-based money substitutes, can create substantial benefits by reducing reliance on the existing supply of actual money. Using physical cash or currency in trade can indeed be costly and inconvenient. By utilizing substitutes, we can increase convenience and significantly enhance the efficiency of payment systems. In fact, most trades are conducted in terms of money rather than with physical currency, which challenges the common theoretical assumption that money changes hands in trade. Payment systems can conceivably evolve to the point where little or no cash (i.e., base money) is needed for transactions.

The view of an "economizing effect" from banking operations, as demonstrated by MCT, sharply contrasts with the conventional notion of a "money multiplier effect." The concept of a money multiplier effect gained traction due to the popularity of the quantity-theoretic framework, which is discussed later in the paper. This traditional view redefines the concept of demand from the perspective of how it was understood from a classical standpoint. This reformulated idea of demand leads to a focus on spending levels as a key determinant of outcomes, fundamentally reversing the classical view.

The contrasting effects, as noted above, go beyond a simple semantic debate about whether money substitutes are classified as money. It reflects a fundamentally different understanding of the causes and effects related to the financial operations of banks and their role in the economy. In short, the modern view conflates the concepts of money and credit, necessitating a redefinition of money to include money substitutes to render it plausible. The emphasis on spending levels behind its quantity-theoretic framework tends to embrace government monopoly issuance of currency and centralized control of the "money supply." The political agenda aimed at establishing centralized control, which began around the turn of the 20th century, has regrettably evolved to the point where such control is now viewed as incontestable conventional wisdom.

Notably, the "economizing effect" demonstrated by MCT enables banks to access a unique method of what can be considered an elusive source of savings or capital. While money substitutes allow for cash withdrawals at any time, their financial arrangements are fundamentally similar to those of accounts that do not offer this feature. Just like savings accounts or time deposits, which have withdrawal restrictions, freely convertible money substitutes, such as demand deposits, also enable banks to lend out deposited funds that depict unused or unspent money. This explanation significantly clarifies how money and banking operate, removing much of the mystery surrounding the subject.

The paper discusses why this accumulated pool of unused or unspent money constitutes actual savings. This signifies that it represents unused resources available for investment. As previously mentioned, money deposited in banks reflects saved purchasing power, regardless of whether it is contractually designated or classified as savings. In this context, any bank deposit account facilitates the transfer of savings into investments, irrespective of whether it allows immediate withdrawals. While certain bank products can perform as a medium of exchange, their issuance and use are purely financial operations that effectively utilize the existing supply of actual money. Therefore, contrary to the conventional theory's characterization, these financial arrangements do not create or multiply money. This perspective can also be extended to encompass all financial institutions that provide credible substitutes for money.

A critical factor to consider is that a payment system that uses money substitutes, such as demand deposits, is built on a foundation of trust. Such transactions necessarily involve a third party, such as a banker. Financial products of this nature would hardly be possible without confidence in banks and their credit instruments. In contrast, transactions made with actual money, such as cash, do not require a third party; thus, a high level of confidence in a third party's medium is not required for such trades. These are often described as "peer-to-peer" transactions. The property of requiring a high level of trust in the credibility of a third party's medium is unique to money substitutes. It distinguishes them from the entity of money itself. It is worth noting that accepting currency also implies an underlying trust — a trust that others will fulfill their roles in producing goods and services, which helps ensure that the currency retains its value in trade.

The “House Money” of Banks: Bank Money vs Base Money

The term “bank money” is used in economics to distinguish bank products that function like money from actual money, such as cash or currency. It will often be used in this paper synonymously with the term money substitutes. The term will also encompass other forms of money substitutes, such as cryptocurrencies and gift cards, that arise outside the traditional banking system and function similarly. This paper's perspective can be applied to all financial institutions that provide credible alternatives to money, enabling them to garner funds that can be leveraged into investments. To simplify the terminology without compromising clarity, the term "bank" is used throughout this paper to refer to these relevant financial institutions in general.

The term "bank money" is admittedly used informally in this paper. Unlike its typical use currently in economics, its use here is not intended to imply that it is actual money. Just as “House money” in a gambling setting does not denote actual money, neither does “bank money.” In the same informal sense, bank money can be viewed as "the House money of banks.” And like casino chips, "the House money of banks” is not actual money but a useful substitute for it.

To be clear, money is the entity to which these substitutes have a claim and to which they are converted when "cashed out." Furthermore, this medium of exchange exists apart from and independently of banks. Again, it is specifically referred to as "base money" in economics. Thus, the monetary aggregate of base money is denoted explicitly by the concept of money. In contrast, "bank money" represents a claim on said money. Although bank money can effectively function as a medium of exchange, it is a substitute for money, akin to casino chips, which are not considered money in their own right. Granted, the various substitutes for money are commonly referred to as money in everyday language. Nonetheless, as posited in this paper, distinguishing between money and its substitutes is critical in understanding how markets work.

Why It Matters

A common refrain is that the issue here is merely a matter of semantics; that, for all practical or theoretical purposes, all that matters is whether an entity performs as a "generally accepted medium of exchange." This curt dismissal of the issue understandably follows from what is already ingrained in the modern view. However, conceptual clarity in this context holds profound moral and economic implications. In short, moral considerations pertain to the issues of property rights, freedom of contract, and personal responsibility. These principles in a free society apply to both the production and use of money (i.e., base money) as well as to the issuance and use of its substitutes (i.e., bank money), since the exchange of produced property is involved in both cases.

From an economic perspective, a "classical" approach emphasizes the importance of distinguishing between money and its substitutes. This distinction is essential for seamlessly integrating two currently separate interpretive frameworks: microeconomics and macroeconomics. In this integrated approach, the value of money, or its role as a unit of account, is determined by market forces, much like the value of other goods is established. Additionally, the prices and supply of substitutes, which are also influenced by market dynamics, play a pivotal role in shaping saving and investment behaviors in the financial sphere of the economy. These market processes are crucial for achieving a welfare-enhancing allocation of resources.

Starting with Carl Menger in the 1870s, who was recognized as the founder of the Austrian School of Economics and a key figure in classical liberalism, money is understood as a commodity that naturally emerges from the voluntary actions of individuals seeking to improve their lives. It is not a product of deliberate human design nor a creation of the state. Instead, it is a product of natural market forces. Similarly, the institution of bank money, along with its extension of credit, emerged as an unintended consequence of freely trading producers. Thus, the value and supply of base money, as well as bank money, result from the voluntary decisions made by all market participants. The information held by these decision-makers is distilled into monetary values. Trust and confidence in the value of this condensed information are essential for a well-functioning economy.

Money plays a leading role in coordinating an efficient allocation of resources over time and across the globe. Money is the North Star for the products that serve as its substitute. The integrity of an economy indeed relies on the trustworthiness of its currency. In a free-market society with well-defined and enforced property rights, market-driven forces are understood to be the most effective and least arbitrary means of determining the honest and objective value of goods and services. This certainly applies to the value and supply of bank money, which are "derived" from their interaction with base money, but it also pertains to the value and supply of base money, or money itself. The free-market processes that determine these economic parameters are those that establish non-arbitrary interest rates or define a non-arbitrary price of capital. Economic growth and stability in the global economy depend on such a market-driven price.

The value of money is fundamentally tied to the goods and services produced by individuals striving to improve their lives. Labor is exchanged for money, the value of which represents its contribution to the value of the finished product. The exchange embodies an implicit code of honor characterized by the principle of “honest work for honest money.” Money is expected to serve as a reliable means of measurement and a trustworthy store of value, particularly over time.

When money was gold, the dollar's value depended on the market price of the specified weight and fineness of the commodity. The code of honor functioned well under this arrangement. Under the current fiat standard, base money, or actual money, is determined by decree; this means that monetary authorities dictate what is accepted as money and control its supply. Unlike a market-driven standard, the dollar is not clearly defined by a specific standard. Instead, as the monetary authorities will tell you, its value is merely defined by whatever it can buy—that is, whatever purchasing power the monetary authorities ultimately establish for it.

The dismal track record of price and financial stability under centralized control over money and its substitutes has raised concerns about the integrity and effectiveness of this system. Centralized control and the forced monopolization of the money supply have predictably led to arbitrary decision-making and immense power, which many argue are inappropriate for a free society. Not only has it been significantly destabilizing and economically problematic, but it is also highly questionable from a moral perspective. The interpretative framework of the "modern view" and its expedient redefinition of money to include its various substitutes were key factors in justifying and endorsing centralized control of the money supply and interest rates. This agenda was aligned with the Progressive movement of the early 20th century, which aimed to expand government influence and control over the economy.

As mentioned earlier, the characterization of money and banking discussed in this paper aligns with how it was understood in the early days of economics. Then, money was understood as the monetary use of gold or specie, and money substitutes were credit. This was the commonsense view of the framers of the U.S. Constitution, who sought to establish exact standards for the dollar. Just as a specific length defines an inch, the dollar was defined by a specific weight in gold or silver. Adopting such a standard creates what is known as "honest money." This viewpoint gained widespread acceptance throughout most of the 19th century and served the mostly free market well.

The position of this paper is that a classical characterization of money and banking offers a more coherent explanation of monetary phenomena. It advocates a market-driven supply of money and its substitutes in a free-market society. Under the classical perspective, there is a clear distinction between money and credit. The modern view, however, conflates money and credit, which inevitably leads to confusion on the role money plays in the economy. For sure, this interpretive view of money of banking played a crucial role in establishing heavy-handed, centralized control over the financial system.

By examining the shift in economic thought in response to this historic development, we can gain a deeper understanding of the nature and composition of these monetary entities. Although it is common in everyday language to refer to functional substitutes for money as money, this colloquial language is inconsequential. This paper argues that the terminology and perspective of the modern view lack precision and misrepresent the function of these monetary entities, with consequential effects.

Notes on Banking Practices

The contractual agreement between a bank and a depositor establishes that the bank's money substitutes are redeemable upon demand. This agreement serves as a "promise" to pay money when requested. It is important to note that a "promise" to pay has a specific meaning in commerce and does not impose the same obligations as a "guarantee." Additionally, the agreement does not imply that money substitutes are 100% backed by actual cash, nor is it intended to convey that message.

Bank customers generally understand that banks "put their money to work" in the community to help finance various endeavors. They also recognize that if banks did not use deposited funds in this way, they would likely have to pay banks for safeguarding their money. In certain situations, banks may offer interest on deposits due to the competition to acquire such capital. The fact that such deposits can earn interest also highlights that these arrangements are financial in nature.

As explained above, the conventional view is obliged to include money substitutes in the money supply to make its theory plausible. This view of the money supply is adopted across all schools of thought in economics. Given the role that money plays in this traditional perspective, it is vital for theoretical reasons that these money substitutes function as effectively as actual money. Hence, from a policy standpoint, it is beneficial to treat these contractual agreements between banks and their depositors as guarantees rather than conditional agreements. This explains the government's ardent efforts to ensure that the reliability of these substitutes is never called into question, even if it requires relying on taxpayer support. These efforts include implementing government deposit insurance, adopting no-failure policies, imposing restrictions on competition, and enforcing various other policy requirements. However, it is important to recognize that such heavy-handed interventions can disrupt the market dynamics that naturally aim to produce the most desirable product while balancing profit-making with the inevitability of risk.

However, this common viewpoint often neglects the financial nature of these products and the critical role these substitutes play in essentially attracting and lending actual money. While banks can usually redeem these claims on demand, this "promise to pay" is subject to the vicissitudes inherent in financial operations. These issues can arise even with the most prudent and reputable banks. In the absence of state interference, these financial arrangements constitute a contractual agreement that should be appropriately qualified for such contingencies.

Other Closely Aligned Perspectives

This paper's characterization of money and banking also aligns with the widely accepted “Intermediary” theory. This theory holds that banks do not "create money out of thin air." Instead, banks are considered financial intermediaries that lend out accumulated savings, rather than magically conjuring up savings out of nothing. This theory will be further discussed and cited below. This widely accepted understanding comports with the contention in this paper that the financial innovation of issuing bank money is a financial strategy to harness a source of savings that can be leveraged into investments. This financial operation is integral to the bank’s primary function of "loaning other people's money." The importance of this insight lies in its implications for the relationship between actual savings and investments, where money is not created but used more resourcefully, as highlighted in this paper.

The interpretive framework presented in this paper, centered on the MCT model, also aligns with recent developments in monetary theory known as the “free-banking view.” In response to the stagflation of the 1970s, which occurred under a monopoly-issued fiat currency, these momentous advancements cogently explain why the equilibrating forces of the market drive a free and competitive supply of currency to yield levels that are "optimal." This means that the market-driven supply of currency tends to be neither inflationary nor recessionary. Furthermore, its in-depth historical analysis indicates that notable episodes of financial instability in the past were not due to an inherently unstable competitive banking system but rather to misguided policies or other government interventions. Bank-issued currency refers to private banknotes, which are indeed a form of bank money. Notably, in this paper, bank money includes a myriad of possible money substitutes, including those yet to be discovered. In contrast to the conventional view, which strongly supports the monopoly-issuance of currency and centralized control of the money supply, the free-banking view endorses a competitive, decentralized supply of bank money. This view will be further discussed and referenced later.

The recognition that these bank products serve as a helpful substitute for money reinforces the interpretive framework of the free-banking view. Its framework establishes the economic Laws from which the prices and supplies of these substitutes are derived. The market processes are integrally tied to the value and supply of base money. In essence, the constant force of arbitrage keeps their price at or near par, while their supply depends on the demand for these instruments. Thereby, bank money can be viewed as a financial derivative, given that its price and supply are derived from that of base money.

As derivatives of base money, their price and supply are endogenous variables, meaning they are rationally determined within the system as an effect of economic conditions. Therefore, in contrast to the conventional view, their issuance and utilization are not influential factors or stochastic forces in determining economic conditions, except for some autonomous positive or negative force, such as the positive impact of a financial innovation. The initial effect of such forces is nevertheless quickly and rationally factored in within the system. The market for these "derivatives" is integral to the nexus between savings and investments, playing a vital role in determining interest rates and allocating resources over time. Moreover, the parameters of these derivatives and market processes depend on and are anchored in what is identified as money in this paper, which is referred to as "base money" in economics.

This paper also closely aligns with the monetary theory developed by Ludwig von Mises (1949), a prominent 20th-century economist and a significant contributor to the Austrian School of Economic Thought. Mises emphasized the necessity of distinguishing between base money and bank money, which is aptly referred to as "fiduciary money." Base money, on the other hand, is defined as having the characteristics of a commodity. It is referred to as "proper money" in his famous tome on economics, Human Action (pp. 432-448). By applying the individual decision-making methodology for which the Austrian School was known, Mises laid the micro foundation for a general macro perspective that seamlessly integrates money and its substitutes. His work on this subject was published as early as 1912, yet it was ignored by mainstream economics, which was engrossed by the thought of centralized banking at the time. To his credit, Mises firmly rejected the ever-popular notion that "aggregate spending levels" are in themselves a causal factor in wealth creation.

This perspective in this paper also aligns with Ayn Rand's views on money and its role in the economy, as expressed in her philosophical work Objectivism. Though not an economist, Rand grasped that "[m]oney cannot function as money, i.e., as a medium of exchange, unless it is backed by actual, unconsumed goods." This understanding accords with the proposition posited in this paper that the generated pool of funds that ensues from issuing money substitutes reflects real savings with varying durations, thus representing claims on said "unconsumed goods." Furthermore, she viewed money as a physical commodity that a free market uses as a medium of exchange, advocating for gold as its form. Moreover, she grasped that "wealth creation" was not a matter of a deft hand at bookkeeping, alluding to the dominant view in economics that a solution to a stagnant economy was to accelerate the issuance of bank money.

While covering all the theoretical aspects that explain the various market forces involved in these processes is impractical, the recent advancements of the free-banking view noted earlier have substantially enhanced our economic understanding of the equilibrating forces at play. This paper is indebted to these advancements. However, this paper presents a different perspective on how to think about "money and banking," where money is not created but utilized more resourcefully by banks. This paper illustrates that the financial innovation of utilizing reliable substitutes for money has evolved into a means of accessing an additional source of savings that would otherwise be challenging to attain. This essentially makes the process a financial operation. Base money indeed serves as an anchor for these financial arrangements, as it does in all financial arrangements. Given these considerations, base money is the only entity that can truly be identified as money in the commonsense understanding of the word.

Although money substitutes are continually being introduced and evolving, the price and supply of these substitutes are closely linked to that of (base) money. Again, this perspective has significant economic implications. For instance, it means that, in free societies, the value of any market-driven (base) money reflects the "democratic" forces of all market participants worldwide. As explained by the well-known Purchasing Power Parity Principle in economics, (base) money tends to flow to where it has the highest value, just as other resources or commodities tend to do. As a corollary of the Law of One Price, this process brings about a uniform "price" or purchasing value of money throughout the world. The price and supply of money substitutes respond logically to the market's assessment of this anchor. In contrast to the conventional view, money substitutes are not money but an inventive device to facilitate a financial strategy that captures and transforms savings into investments.

Historical Perspective on Money and Banking

To repeat, throughout much of the 19th century, classical economics defined base money as actual money, while bank money was considered a substitute for money. The issuance of bank money was characterized as a form of credit. Additionally, classical economics proposed that the supply of these monetary instruments was influenced by the same market forces that regulate the supply of goods in other sectors of the economy. As is well understood in economics, these relentless equilibrating forces in the context of a free and competitive market tend to generate optimal, welfare-enhancing levels of not too much or too little.

Optimal levels are known to fluctuate due to changing conditions; however, the processes that restore equilibrium are quick and effective at self-correcting, independent of government intervention. As a result, the classical view rejects the widely held belief that recessions are caused by insufficient spending stemming from a lack of a medium of exchange. David Glasner (1989, p. 63) explores the classical perspective in his insightful book on monetary reform. He discusses J. B. Say's well-known argument against the common view that economic recessions are caused by an insufficient money supply. Glasner clarifies the terminology associated with the classical viewpoint, as quoted in his work:

“In [Say’s] usage, only coin or specie was actual money; banknotes and other credit instruments that performed as a medium of exchange he called money-substitutes. But semantic differences do not alter his basic point that a competitive banking system would never allow an unsatisfied demand for money to turn into a general oversupply of all real goods.”

[For clarity, banknotes in the passage above refer to bank-issued paper money, which resembles fiat paper money today, with the exception that banknotes were backed by and freely redeemable in gold, whereas fiat currency is not redeemable in gold and ultimately backed by taxpayers. The issuance of private banknotes was prohibited long ago to allow the government to issue currency as a monopoly. Banknotes are credit instruments that serve as substitutes for money, eliminating the need to use gold or other forms of precious metals as currency. In contrast, fiat currency is now part of the base money supply and is regarded as actual money in this context of this paper.]

From a classical perspective, economic recessions are more likely caused by an unexpected destruction of value. It is understood that this level of destruction must be significant enough to trigger an economy-wide recession. Therefore, recessions were seen as more likely to be caused by one or more poorly conceived government policies that destroy value. A significant decline in bank deposits and overall economic activity is expected as a result of this destruction. It reflected a restorative effect until the necessary adjustments were made and normalcy returned. At the time, there was high confidence in the competitive financial system operating under the gold standard. Consequently, this earlier perspective was well known for essentially dismissing the possibility of monetary disturbance leading to a recession.

The concept of money in the classical sense is defined and understood as a market-driven good or commodity widely accepted as a medium of exchange (see Jevons, 1875). Money serves as the foundation that rationally connects all the various money substitutes available worldwide. Under the existing gold standard, the money supply was understood as the amount of gold or specie used for monetary purposes rather than its many non-monetary uses. To clarify, the money supply included the gold or specie that circulated outside banks and the reserves held by banks. This monetary aggregate is known in economics as "base money." Due to arbitrage, money flows to where it holds the highest value, equalizing its worth globally.

By the turn of the 20th century, however, the classical view began to lose popularity in favor of the "modern view." This view was a revision of the ever-popular idea that recessions were caused by insufficient spending. The modern view offered a more sophisticated way of showing that recessions, inflation, or episodes of financial instability are blamed mainly on “monetary disturbances” of either “too little money” or “too much money” by influencing spending levels. Thus, the “money supply” is considered a dominant causal factor via spending levels in determining output and price levels. These parameters include interest rates, which is another way of saying the price of capital.

As previously mentioned, the theoretical interpretive framework of this revision of the ever-popular view presumes that money is exchanged in virtually every transaction. It was thus expedient to equate bank money to actual money to square this stance with what is seen and testable. Subsequently, bank money or anything close to the liquidity of bank money is potentially included in the money supply for theoretical and monetary policy purposes. Unsurprisingly, the modern view strongly embraces centralized control over this manufactured “money supply” by banks, given its theoretical importance in controlling levels of employment and prices. The theoretical assumptions underlying modern and classical views will be discussed in the latter half of the paper to clarify the reasons for the sharp contrast between them.

In the modern view, money is merely a useful tool for central authorities to steer the economy. The sanctity of private property and freedom of contract in the production and use of money and its substitutes have either taken a back seat or been neglected altogether. Consequently, over time, the gold standard was supplanted by a fiat standard, in which base money consists of the liabilities of the central bank, the Federal Reserve System. The Fed's liabilities comprise two components. One component is the monopoly issuance of fiat currency (Federal Reserve Notes and token coins) that circulate outside banks. The other component is bank reserves. Bank reserves, in this case, consist of a deposit or a bookkeeping credit at the central bank (although banks hold some fiat currency in reserve for redemption).

Central bank liabilities are ultimately backed by the faith and trust that taxpayers will honor these debt obligations if necessary. In contrast to a market-driven commodity, as under a gold standard, base money is fiat-driven, where legal tender laws abet the “general acceptance” of its currency. Interestingly, under a fiat standard, base money, or what is actual money, as argued in this paper, is entirely based on credit, or on the faith and trust in the monetary authorities to establish a reliable store of value and a steadfast anchor for its substitutes. That is, nothing backs it other than the faith and trust in the monetary authorities and the ability of taxpayers to remedy any shortfalls. This point is well understood even at the outset of its establishment.

Other Dissenters of the Modern View

Despite the dominant stature of the modern view, there were some notable dissenters. For instance, Dale K. Osborne (1985) published an in-depth article titled “What is Money Today,” which cogently argued that base money is the only monetary aggregate that logically satisfies all the required conditions for being identified as money. In addition, Ludwig von Mises, a prominent 20th-century economist, highlighted the distinction between base money and bank money, calling them "proper money" and "fiduciary money," respectively. An entire section in his famous tome on economics, Human Action" (1949), is devoted to "The Money-Substitutes" (pp. 432-434). The attribute of being "the most marketable commodity," which distinguishes money from its substitutes, is a permanent feature in his definition of money. Indeed, he indeed cautions against the common practice of referring to credit instruments as "money" merely because they can provide the same services as money does. Unsurprisingly, these arguments were ignored by academia. Nevertheless, Mise’s primary concern with the popular terminology of equating bank money to actual money is still relevant and noted below:

“The first purpose of a scientific terminology is to facilitate the analysis of the problems involved. The task of the catallactic theory of money—as differentiated from the legal theory and from the technical disciplines of bank management and accountancy—is the study of the problems of the determination of prices and interest rates. This task requires a sharp distinction between money-certificates and fiduciary media.”

The “sharp distinction” between “money certificates” and “fiduciary media” highlighted above is the distinction made in this paper between base money and bank money, respectively. To clarify, “money-certificates” were contractually fully backed by gold reserves. Consequently, these are considered theoretically equivalent to actual money in their use, since the reserves these represent are, by contractual agreement, not leveraged into investments. Fiduciary media, on the other hand, is associated with the arrangement of fractional reserve banking, where only a “fraction” of the issued media is backed by actual money, while other bank assets back the remaining balance. Since this media is built on trust in the issuer, bank money is appropriately described as a fiduciary substitute for money.

In this respect, both base money and bank money fall under a broader economic category of monetary phenomena commonly described as “a generally accepted medium of exchange” (or the widely used acronym, GAMOE). GAMOE indeed identifies the essential attribute, or genus, of this broader category. However, the genus, understandably, does not distinguish between base money and bank money. For example, it does not distinguish between a medium of exchange that does not require the trust of a third party and one that does. From a classical perspective, base money constitutes actual money, whereas bank money, which relies on the trust of a third party, is classified as a "money substitute." The classical perspective, therefore, includes the defining attribute of being a market-driven good or commodity in its definition of what money is for conceptual clarity.

The modern perspective, however, scrubbed the differentia of being a market-driven commodity from the definition of money. As noted earlier, merely using GAMOE to define money was convenient for including bank money in the money supply. Its theoretical framework is obliged to equate money substitutes, or even “near monies,” with actual money. Again, this helped make their theory more plausible and more practical to apply. It also helped justify the agenda that supported centralized control over the banking system. Under this interpretive framework, GAMOE serves as the benchmark for determining whether a particular monetary entity qualifies as money. Predictably, this identification approach generates a massive body of literature that wrestles with the question of what the appropriate money supply is for economic analysis and forecasting. Theoretical aspects underlying this agenda are discussed later in the paper.

As noted, economics is greatly indebted to recent developments in monetary theory, known as the "free-banking view." Without this school of thought, it would not have been possible to fully grasp how the exploitation of the pool of savings generated by the issuance of bank money leads to welfare-enhancing outcomes from the natural forces of the market. This prodigious body of work emerged after the enigmatic episode of stagflation in the 1970s and the seminal work of F. A. Hayek (1977) on the competitive, decentralized issuance of currency. Hayek theorized that decentralization could cure recurring bouts of inflation and monetary instability. Additionally, the free-banking view aligns with the classical view that also supported a free banking system. Indeed, the free-banking view significantly elevates our understanding of how a free and competitive banking industry, like other industries, is disciplined by the equilibrating forces of the market to supply an optimal level of its product, bank money. That it would fail in this endeavor is indeed considered implausible. The extensive historical studies conducted on this topic also show that most, if not all, past episodes of financial instability and maladies resulted from legal restrictions or misguided policies, rather than the industry being inherently unreliable in supplying an optimal level of media.

Notably, George Selgin (2024), a prominent figure in the free-banking school of thought, has recently touted the Intermediary theory in a working paper. The Intermediary theory holds that banks do not have a special power to “create money out of thin air” or to conjure up savings for investments out of nothing. Selgin concludes that the Intermediary theory of banking more accurately reflects the functioning of banking systems than the idea of "creating money out of air." In making the case for the Intermediary theory, Selgin (p. 12) necessarily invokes the critical distinction between "base money" and what is referred to as "bank money," as shown in the passage below:

“Although it has long been standard to regard such deposits, and current account balances in particular, as “money,” there was a time when they were instead considered money “substitutes,” and when the unqualified term “money” was reserved for the stuff banks promised to pay holders of their liabilities if asked. Once upon a time, that stuff consisted of precious metal coins. Today it means fiat paper money or deposits at a central bank, also known as “base” money. The modern view is a natural counterpart of the definition of “money” as any “generally accepted medium of exchange.” Yet there are times when it’s worth recalling the old-fashioned distinction between bank liabilities that serve as such and “real” (“base”) money, one of which is when trying to understand how modern payments are accomplished.”

As mentioned above, understanding that bank money is linked to and leveraged on base money is crucial to grasping the intermediary role of banks, regardless of whether the “stuff” that bank money is linked to is gold or fiat. Furthermore, given the recognition that banks are financial intermediaries and do not create money, it follows that the financial strategy of using “bank money” does not reflect a supply of money apart from what already exists outside banks (i.e., base money), thus validating the “old-fashioned” classical view of characterizing the financial arrangement of bank money as credit and not as money. Again, as will be shown and explained, the financial arrangement of bank money merely reflects an innovative means of leveraging actual money or real savings into investments; that is, banks essentially loan out money that exists independently of banks and that which is unspent or saved.

Creating Credit and Not Money

The paper introduces a practical conceptual model, referred to as a “market of concurrent trading” (MCT), that clearly illustrates how the issuance of bank money significantly reduces reliance on (base) money. This perspective highlights an “economizing effect,” which stands in stark contrast to the modern view of a “money-multiplying effect.” While there are well-defined natural limits to this effect, its potential for economic efficiency can be truly remarkable and beneficial. This “economizing effect” is a key component of an inventive approach that helps banks access an additional source of savings or capital. As a result, a bank's competitive success in economizing money directly impacts its ability to attract such savings. This innovative financial strategy allows the bank to enhance its bottom line by converting these savings into interest-earning assets or investments.

The financial operation of lending out money that is saved or unspent obviously does not constitute the creation of new money. Instead, it generates credit by leveraging such unspent funds into investments. As a result, even though money substitutes allow cash withdrawals at will, the accounts created through this financial strategy are fundamentally similar to those without this feature, such as savings accounts or time deposits. This holds despite differences in liquidity and interest rate risks. Similar to accounts with withdrawal restrictions, accounts that allow cash withdrawals reflect credit rather than actual money. While banks have undoubtedly improved trade and finance through the introduction of bank money, this paper argues that the idea that these significant benefits stem from the creation of new money misrepresents this phenomenon.

Alternatively, this paper demonstrates and explains that the "economizing effect" entailed in "gathering" money substitutes creates an additional source of savings that can be leveraged into investments. This understanding, again, is indebted to the advances in monetary theory made by the free-banking view discussed earlier. These recent developments in monetary theory suggest that market-clearing equilibrium in the supply of bank money tends to be optimal. In other words, the free and competitive issuance of bank money promotes financial stability and mitigates the risks of inflation and economic downturns, also known as recessions. Conversely, arbitrary centralized control is considered a significant source of instability. In contrast to the traditional view, the free-banking perspective advocates a competitive and decentralized supply of currency. Currency, in this context, refers to bank money —specifically, private banknotes rather than Federal Reserve Notes or central bank notes. For clarity, central bank notes are a component of base money in the central banking framework. Notably, however, "bank money" also encompasses many other forms of issued money substitutes, such as cryptocurrencies and gift cards.

In contrast, the prevailing conventional view supports arbitrary centralized control over the "supply of currency" because it views the supply of bank money as an unreliable causal factor rather than a rational response to economic conditions. Thus, economists wrangled incessantly for decades over what "money supply" should be controlled. Virtually every school of thought had its own version of what constituted this appropriate "money supply." Unsurprisingly, this hopeless task, primarily due to ever-changing financial innovations, was finally abandoned by the 1970s. These disputes over which monetary aggregates to control have now shifted to heated debates over interest rate control. Viewing the money supply as a critical causal factor leads to a strong inclination to control either money or credit. This agenda is misplaced and potentially harmful if market-driven levels of bank money are rationally reflective of economic conditions. In this case, arbitrary intervention distorts market decision-making.

Another notable implication from this alternative characterization of bank money is that it establishes the microeconomic foundation for a macro view of the economy. Unlike the disconnected theoretical framework between micro- and macroeconomics in the current curriculum, the alternative perspective presented in this paper creates a seamless transition from the micro to the macro landscape, leading to a unified general theory of the economy. This is discussed in the latter part of the paper, which also examines the philosophical underpinnings and presuppositions of the modern view that led to this interpretive framework equating the “House money of banks” with money. It is also helpful in understanding the economic implications of inevitable changes in financial innovations, such as gift cards and cryptocurrency accounts, which serve as money substitutes and are closely tied to base money. The paper concludes by briefly “prospecting” for a viable entity that can serve as both a medium of exchange and a reliable anchor for its various substitutes.

Capturing and Leveraging Money

The Market of Concurrent Trading and the Economization of Money

This paper introduces a conceptual model that demonstrates how the use of reliable money substitutes can effectively economize on money. The model, referred to as a “market of concurrent trading” (MCT), patently illustrates why it is more precise to consider the innovation of issuing and using bank money as a mechanism for economizing money, in contrast to the traditional view of multiplying money. From that insight, the next part will further explain that the economizing aspect of this innovation led to a novel means of capturing yet another source of savings that banks can leverage into investments.

Conceptual models can carry substantial explanatory power in economics. They arguably provide a deeper understanding of the logic behind economic principles than mathematical or graphical-type models. The pedagogical advantage of conceptual models lies in their ability to explain cause-and-effect relationships within the principle. Mathematical or graphical depictions can certainly offer a shorthand for economic principles. Still, by their nature, they cannot demonstrate cause-and-effect in the market on their own. They merely present the mathematical version of a given state or condition. No matter, the ideas that ultimately explain the economic logic behind these principles must come from outside these depictions. These depictions add little or nothing to our comprehension beyond what is already logically understood about the principle.

The Law of Comparative Advantage is a prime example of the explanatory power of a conceptual model. It is still widely regarded as one of the most robust principles in economics. This principle was decisively substantiated over two centuries ago by David Ricardo with a conceptual model. A mathematical or graphical representation of this Law no more elevates its significance than it already holds. Another good example is Carl Menger's (1976) conceptual presentation of the Law of One Price, advanced over 150 years ago. His conceptual presentation emphasizes the importance of the bid and ask prices in determining the market price of a good. As it turns out, in real life, the equilibrium price can occur within a range of prices. This presentation of a range of possible prices is more precise than the intersection of two lines, which indicates that only one price establishes equilibrium. The graphical depiction of two lines intersecting reveals little beyond the logic already understood about this principle.

The conceptual "model of concurrent trading" (MCT) effectively simulates how a financial innovation that uses a reliable substitute for money can economize on money and reduce or eliminate its use in trade. The model's discernible aspects clearly distinguish between the entities involved and the processes that use them, removing any ambiguity about whether these market processes create money. Essentially, the logic underlying MCT patently demonstrates the economizing effect of utilizing money substitutes and shows that these processes do not generate additional money. The key insights from this model will be valuable throughout the paper.

For clarity, first consider a market of concurrent trading with only three vendors. Fungible clay chips are used as money, and these alone perform as a medium of exchange in the model. Banking, thus bank money, is absent from the model, so there is no question about what money is. Barter is also ruled out, as the focus here is on indirect exchange, or the use of money as a tool in the exchange of goods. Each vendor in this scenario produces a different good each day and sells it to one of the other vendors. Again, for simplicity and conceptual clarity, the same daily exchanges are assumed to continue indefinitely as in a continual “steady state.” All goods tendered by the vendors are priced equally at one chip. A scenario of such a three-vendor market that rules out both barter and banking is depicted below:

Market of Three Vendors

A produces a but wants only b

B produces b but wants only c

C produces c but wants only a

Given a money supply of three chips, with each of the three vendors possessing a chip, the desired outcome of daily purchases could occur, as illustrated in Diagram 1. The three daily trades could happen at almost any time or place during the day and in no specific order.

However, it would still be possible to achieve the same desired daily outcome if only one vendor possessed a chip. In this case, the money supply would consist of only one chip. For instance, if A was the only vendor to own a chip, then A could pay B for “b.” This would provide B the means to pay C for “c.” To continue, then C would have the means to pay A for “a.” This is shown in Diagram 2. Thus, a money supply of only one chip, rather than three, would suffice to consummate all three daily transactions.

As shown above, this outcome, achieved with only one chip, requires a specific order for the three daily trades, starting with the vendor who owns the chip. This requirement could be inconvenient or troublesome, depending on the vendors' normal routine or locality. To mitigate this potential inconvenience, the three vendors could agree to gather daily at a specified time and place to make the appropriate sequence of trades in short order (or concurrently). This gathering strategy thus enables the desired trade outcomes to be consummated expeditiously, with a money supply of only one chip.

Although the voluntary gathering strategy described above is hypothetical, it closely resembles the common observation that buyers and sellers often convene at a "village square" or marketplace to facilitate trade. This concept is also well illustrated by the account of the islanders on Yap Island, as discussed by S. Ammous (2018, pp. 11-13) in his exceptional book on a Bitcoin standard for money. In this real-life example, extremely heavy Rai stones were used as currency. The islanders gathered at the custodian of the stones' location to declare ownership of specific stones acquired through trade. What is relevant here is that money did not physically change hands under these arrangements. Only the ownership of the stones changed. The stones remained with the custodian due to their enormous size and weight. Trust existed within this group because the islanders were familiar with one another; therefore, transferring ownership of money required only a verbal "order to pay."

To expand on this beneficial effect of MCT, the proposed “gathering strategy” of concurrent trading can be applied to a market with more than three vendors. For example, a community of ten vendors could also agree to this mutually beneficial gathering arrangement. As before, each vendor produces a different type of product, all priced at one chip. This scenario, which requires indirect exchange, is illustrated here, with producers identified by caps and their products represented by lowercase letters.

Market of 10 Vendors

A produces a but wants b                   B produces b but wants c
C produces c but wants d                   D produces d but wants e
E produces e but wants f                    F produces f but wants g
G produces g but wants h                  H produces h but wants i
I produces i but wants j                      J produces j but wants a

If all ten vendors each possessed a chip, that would indicate a total money supply of ten chips. In this scenario, all ten daily trades could be executed at any time and place throughout the day. However, again, all ten trades could still be completed efficiently through a coordinated trading arrangement, even if only one vendor had a chip, as illustrated in Diagram 3.

Compared to the alternative of no gathering, this gathering arrangement of concurrent trading suggests that the need for chips could be reduced from ten to possibly as few as one chip, thereby requiring a money supply as little as one-tenth of that of the alternative.

Despite the added complexity, it is reasonable to conclude that a money supply of only one chip is required for a community of a hundred or more vendors to achieve the same desired daily outcome under such a gathering arrangement of concurrent trading. Again, this suggests an even greater economization of money. This greater economization of money can be expressed as a reduced need or demand for money. The money supply could conceivably be one-hundredth or less in the absence of such a “gathering” arrangement.

To illustrate the remarkable effectiveness of MCT in economizing money, consider this: if this same desired daily outcome described above occurs repeatedly, a money supply consisting of just one chip could facilitate an indefinite number of transactions over an extended period. Given this daily-gathering strategy for concurrent trading, individuals within a large market economy could indefinitely fulfill their economic goals with just one chip of money. This remarkable possibility of utilizing such a gathering strategy creates enormous benefits for the community. For sure, it dramatically reduces the need or demand for money to just a "fraction" of what would otherwise be required to accomplish the same desired ends. For example, in the ten-vendor scenario, the necessary supply of money to achieve this continuous beneficial outcome for the community could be reduced to one-tenth of what might otherwise be required. Additionally, the economization of money reduces the risk and cost of holding and transporting it, which can be substantial.

As a matter of pondering further implications of MCT, suppose this "economization" process were “taken to the limit,” as in a mathematical sense. In that case, a money supply of only one chip is sufficient to satisfy this perpetual achievement for an infinite number of vendors under the arrangement of “concurrent trading.” It is even conceivable that no money at all is needed in an immutable and “perfect” world of trust. Still, this incredible possibility is neither realistic nor desirable. Even if it is “mathematically” conceivable, this would understandably depend on an implausible set of circumstances, apart from a horrid force of law. Indeed, as referenced below, the economization of money described above is constrained by rational economic limits and can only be stretched so far.

While not delving too deeply into future implications, it’s important to understand the concept of bank money within the framework of monetary theory. Beyond legal restrictions, such as required reserve ratios, there are inherent limits on the efficient use of money. These limits are known as “The Principle of Adverse Clearings” (see Selgin, 1988, pp. 40-42) or “The Law of Reflux” (see Glasner, 1989, pp. 64-66). In summary, these natural constraints necessitate that banks maintain a sufficient buffer of money reserves and capital as a precautionary measure. Understandably, as will be explicated later, these precautionary acts by banks chip away at their ability to maximize profits, but the benefits of lower risk are understood to outweigh the costs.

To summarize, due to the economization effect of MCT, fewer chips of money are needed to consummate a day's worth of transactions, plus this desirable daily outcome can occur continuously with just a “fraction” of the money otherwise needed. Moreover, the same number of chips could support an increase in transactions as the community grows. Since there is no ambiguity about what money or the money supply is in this model, the perpetual desirable outcome cannot possibly be construed as resulting from “the creation” of chips or a “chip multiplier effect.”

It is essential to emphasize a crucial aspect of the daily outcomes made possible by the "economizing effect" of the market of concurrent trading (MCT) before discussing this gathering strategy in relation to bank money. Once all the trades have been finalized and expectations met upon gathering, the outcome for all participants at the end of each trading day depicts an improvement in their lives. If this were not the case, the participants would not engage in such an arrangement. We can say that this daily outcome is "profitable" in the eyes of the participants. Realistically, factors constantly change, and these processes may not always yield a profitable outcome. Nevertheless, unprofitable outcomes that inevitably occur immediately prompt individual actions aimed at restoring profitability. Well-understood market forces effectively guide these actions.

Consequently, this daily outcome reflects an allocation of resources that tends to benefit all participants, even though only a fraction of the money is needed to sustain this continuous, beneficial outcome compared to what would be required without MCT. This positive outcome is shown in the exhibits above, where MCT is demonstrated with three or more vendors in the market. It is crucial to keep in mind that this perpetual daily outcome reflects a profitable allocation of resources that is not strictly dependent on the supply of (base) money, as it can be achieved through a more effective use of the money supply due to the "economizing effect" of MCT. This observation will be applied to banking in the following section.

The Gathering Strategy of Bank Money

The “gathering” strategy of the concurrent-trading model adequately simulates how the financial strategy of using bank money economizes the use of money. For example, every transaction that uses bank money as a means of payment creates a “document of payment” (or "an order to pay"). As noted previously, these documents reflect a means of credit and can take many forms, such as checks or digital tokens. In whatever way these “documents” are fashioned, they specify which individual accounts are debited and which are equally credited.

These payment documents are gathered daily at a designated time and place for clearing and settlement, whether physically or digitally. This clearing process typically occurs at a "clearinghouse." Thus, the daily “gathering” at a specific time and place in the MCT framework aptly simulates the daily collection of these payment documents at the clearinghouse, usually, but not necessarily, at the end of the day. Again, these payment documents reflect a type of credit device or IOUs that, at least temporarily, serve as a reliable stand-in for actual money. Then, upon gathering, the clearing and settlement of such payments, using the effective means of bookkeeping adjustments to settle accounts, is simulated by the model's “expeditious sequential trading” of concurrent trading. Importantly, only upon clearing and settlement are the transactions finally consummated.

MCT makes a clear distinction between the entity money and the processes entailed in its use. Thereby, the discernible aspects of the model demystify the processes by which the gathering strategy economizes the use of the entity money. The difference in the settlement mechanisms or in the level of expediency between the model and banking are immaterial concerning this issue of economization, nor does it matter if the documents of payment are tangible or digital; nor is it relevant whether a transaction is cleared at a particular time during the day, just as it is irrelevant when chips at a casino are cashed out or redeemed. Furthermore, it is irrelevant if payments are settled instantaneously, as with direct debits. Technological advances, in fact, only improve the economization of money. As an interesting extraneous observation, however, the “gathering strategy” of banking has a significant advantage over the gathering strategy of concurrent trading by allowing daily commerce to be conducted in its normal or preferred routine rather than the daily necessity of traders having to gather at a proposed trading site or marketplace to conduct trades.

Bank money undoubtedly performs as a medium of exchange, but it also serves as an adequate stand-in for money until it is cleared or “cashed out.” The daily “gathering” of these money substitutes at the clearinghouse enables trades made with bank money to be settled or consummated through efficient bookkeeping adjustments. Hence, the use of credible money substitutes eliminates the need for physical cash in a vast number of daily transactions. Like the gathering strategy of concurrent trading, the gathering strategy using bank money enables the community to achieve its desired ends perpetually with just a fraction of the (base) money that would otherwise have been required. And, just as the discernible mechanics in the concurrent-trading market cannot possibly be construed as the creation of chips or a chip-multiplier effect, the favorable outcome facilitated by the innovation of bank money cannot possibly be construed as a money-multiplier effect nor as a marvel of “creating money out of thin air.”

The exceptional advantages of using bank money rather than actual money certainly explain its widespread use and high demand, provided it is creditworthy and reliable. Using bank money certainly lowers the risk and cost of holding or transporting (base) money, but it also understandably creates great utility as a means of payment. As is well understood, the innovation of bank money, within said limits, dramatically reduces the need or demand for (base) money, other things equal. In other words, the need or demand for a medium of exchange can largely be met by trusted bank money.

The financial innovation of bank money reduces the need for physical currency in trade. However, it also minimizes the costly money flows between banks, known as “interbank payments.” While a detailed explanation is impractical, this beneficial aspect is enabled by the advanced, innovative clearing mechanisms, in which the "gathered" payment documents are ultimately settled. In short, as a result of these daily clearing mechanisms, the debt obligations between banks generally offset each other by the end of the day. Banks indeed have a clear profit incentive to carefully manage the issuance of their bank money to achieve this balanced outcome. As a result, the movement of base money between banks is greatly minimized or eliminated.

Due to the remarkable innovation of bank money, the exchange of actual money by both the community and banks can be reduced to just a small fraction of the total value of daily commerce. MCT enables more efficient use of physical money by allowing trades to occur without cash. Again, this daily outcome is achieved through the use of money substitutes, such as demand deposits or digital tokens, which are used like "chips" in a casino to conduct trades. Nonetheless, these substitutes are always anchored to money, meaning they can be freely exchanged for it. Therefore, their value is strictly tied to that of base money due to the relentless force of arbitrage.

As will be explained further in the paper, understanding the MCT perspective helps grasp how the banking system can meet the demand for a medium of exchange without being strictly limited by a fixed supply of base money. In the prevailing dominant view, each transaction requires a specific amount of money, creating a direct correlation between the number of transactions and the amount of money needed. As a result, a given money supply constrains the potential number of desirable transactions. Therefore, the optimal number of transactions hinges on an adequate money supply, taking into account its turnover rate, which is often deemed capricious and unreliable.

This traditional perspective fuels the argument for arbitrary centralized control of money. In contrast, the MCT framework suggests that economic agents can facilitate numerous transactions through coordination, trust, and technology without being limited by a money supply inconsistent with the number of optimal transactions. MCT fundamentally highlights how financial innovations can enhance the efficiency of money usage. This ensures that the physical availability of cash or base money does not hinder economic activities, while still aligning with the economy's underlying fundamentals. As explained in the next section, these underlying fundamentals revolve around the availability of real savings that the financial system can garner and utilize. The amount of such savings acts as a natural limit on the issuance of money substitutes and the overall expansion of credit. This framework promotes an unimpeded banking system that enables greater market self-regulation through competitive forces and arbitrage, challenging the traditional view that centralized intervention or control is needed.

From the MCT perspective, it is evident that upon clearing, the community's resources have been reallocated from hands that value them less to hands that value them more. This means resources are distributed to align with individual interests, thereby improving the community's overall situation. Thanks to the innovations associated with MCT and its advanced clearing systems, this favorable outcome can be achieved with minimal cash or money involved, while bank reserves remain relatively stable. The significance of this perspective lies in the fact that the underlying fundamentals of the economy ultimately dictate what the financial system can rationally provide as a medium of exchange to facilitate trade. In other words, the supply of a medium of exchange relies on the market's ability to create legitimate claims to resources. This insight helps address the question of what bank money balances constitute if not money. This is addressed in the next section.

Extracting and Exploiting an Elusive Source of Savings

Again, the modern view equates bank money with actual money. This perspective necessarily follows from its theoretical framework, in which the "money supply" plays a critical role in determining economic outcomes, such as employment and price levels. It is expedient to equate bank money with actual money to satisfy the logic of its theory. Consequently, the multiple expansion of bank money resulting from bank lending practices is interpreted as creating actual money and greatly multiplying its supply. Alternatively, if it is understood that bank lending practices in issuing bank money do not signify the creation of money but rather the economization of money, as clearly demonstrated by the MCT model above, then it raises the question of what these banking operations reflect in reality. This section helps address that issue.

The MCT perspective presented in this paper holds that the financial innovation of incorporating credible money substitutes offers a creative means of capturing an additional source of funds. These funds are essentially another source of actual savings. Savings in this sense reflect and are supported by the value produced in the market and still retain the potential to be used for investment purposes. These are often referred to as "real savings."

It follows from this understanding that the issuance and multiple expansion of bank money balances is more precisely viewed as an effective financial method of leveraging such savings into investments. As expanded on in the next section, this financial operation is best understood as a creative way to loan out (base) money that is not being used or spent. Hence, no additional money is created by these banking operations. Such banking practices are entirely financial in nature.

The act of saving is clearly shown when cash is deposited into savings accounts or time deposits. The money in this instance represents the tradable value produced that initially led to its ownership. These bank products, as well as many others, are contractually designed to harness money that is not being used or spent. The fierce competition to capture money results in competitive interest rates being paid on such balances. Again, it is essential to recall that the deposited money in the case is an implicit claim on the produced value it represents in the context of freely trading producers. Additionally, these particular products have withdrawal restrictions to instill confidence in the duration of bank liabilities or lending purposes.

This contrasts with bank-money products, like demand deposits, which impose no limitations on withdrawals or convertibility. However, the pool of reserves generated from the issuance of bank money can still be viewed as a collection of unused or unspent money, as described in this section. This pool of unspent money reflects real savings in the sense that it is backed by previously produced value that has yet to be consumed. Thereby, this pool of money reserves implicitly reflects a claim on such unconsumed value, just as any holdings of actual money.

In this regard, the pool of savings garnered by banks selling demand deposits is similar to that of savings accounts or time deposits. However, in this case, the pool of savings was not the result of a contractual agreement stipulating that the bank would loan out the money, requiring the customer to retain the product for a specific duration. It occurred despite the lack of such a contract. Given the contractual agreement on free convertibility for products such as demand deposits, it is reasonable to conclude that confidence in the duration of these funds is lower than that for products with withdrawal constraints.

As long as money remains unspent, it reflects the value produced and exchanged for it. This implicit claim can be exercised immediately or “stored” for later use. This implicit stored value is thus a claim on unused value or resources that are produced or exist. Granted, the ownership of these claims within this pool of savings frequently changes hands—similar to the "pool" of Rai stones managed by the custodian on Yap Island, as previously mentioned. However, despite all the daily churning of ownership, the issue of who owns such claims is immaterial for theoretical purposes. What is of particular interest is whether the level of this pool of savings remains relatively stable and predictable, allowing these funds to be loaned out, irrespective of who is credited with these claims.

The innovative settlement mechanism at the clearinghouse plays a crucial role in this process. For instance, by using a reliable stand-in for money, daily trades can be consummated "at the end of the day" through highly efficient clearing mechanisms. The bank can then assess the overall impact of all these daily trades on the pool of savings. Although the ownership of these implicit claims within the pool is constantly changing, these changes are made simply through bookkeeping adjustments. Again, what matters is the net effect on money reserves, regardless of these shifts in ownership.

Despite the multitude of daily transactions expected to create value, the key concern is the net effect on the value that remains unspent, as reflected in changes in the bank's total money reserves. This is again reflected in how trades affect the pool of money reserves. Therefore, the clearing and settlement mechanism provides a novel means of evaluating the net effect of an entire day's worth of transactions on this particular source of savings.

If the funds generated from the issuance and use of bank money are considered an additional source of savings or capital, then the innovation of bank money created an inventive means of capturing an often difficult-to-harness extra source of capital. This can indeed be considered an unintended consequence of the innovation, as the beneficial effect was not the product's initial purpose.

Despite its redeemable-on-demand feature, the financial arrangement involving bank money operates similarly to arrangements with withdrawal constraints, such as savings accounts. In this scenario, banks do not create money; rather, they essentially lend out money deposited by individuals. This understanding aligns with both the classical economic viewpoint and the “Intermediary Theory” previously mentioned.

As a practical example of this bank-money “gathering” strategy and how it harnesses a unique source of savings to facilitate financial needs in the community, consider a Montana rancher who sells alfalfa in the summer for 10 gold coins. The rancher plans to buy 50 brood cows in the winter with the 10 gold coins. These coins, kept by the rancher for several months, represent savings, which again is defined as the creation of value that remains unused. At the same time, a nearby farmer needs a temporary loan of ten coins to acquire a combine for a fall wheat harvest. Borrowing coins from the rancher is possible, but personal loans can be problematic for various reasons. The strategic advantage of the bank-money “gathering strategy” is that the payment for alfalfa can be deposited directly into the rancher’s bank-money account. This affords the banker the means of making a short-term loan to the farmer to finance his need for a combine. Consequently, the responsibility for conducting due diligence on a loan lies with the banker, not the rancher. However, the bank assigns a bank-money account from which the farmer can draw, rather than loaning out the actual gold coins directly. Therefore, the innovation of the bank-money strategy significantly reduces the risk and cost of holding and transporting the gold coins. Notably, this bank-money strategy is a win-win-win arrangement for the rancher, the farmer, and the banker. All three participants benefit from the banker's strategy. A community-wide collection of such accounts, of course, creates an even more dependable and consistent pool of funds to address the community's financial needs further.

Despite the cash-out-at-will feature of bank money, when individuals or businesses choose to deposit money with a bank in exchange for bank money, a pool of money is created at the bank. Although a vast number of transactions occur daily using bank money, these transactions typically have little effect on the level of this pool of money reserves. In short, this is because the instructions, as directed by the bank money instruments, for withdrawing money from the reserves are generally offset by instructions to add money to the reserves. As is well understood, this stable outcome can be primarily attributed to the "Law of Large Numbers." Nonetheless, as noted earlier, banks have a profit-maximizing incentive to manage their business to achieve this outcome. Consequently, under careful bank management, a steady pool of money reserves can be expected to persist indefinitely.

As an example of this phenomenon, clay chips serve as a substitute for money in a casino's economy. When patrons exchange their cash for chips, a pool of money reserves is established. This pool of cash can be expected to persist indefinitely, even though the chips can be used for numerous transactions or cashed out at any time. Based on extensive experience, the "House" can generally expect that when chips are cashed out, the cash reserves will be replenished by patrons buying chips. Such offsetting transactions thus tend to keep the cash reserves at suitable levels. Prudent management will maintain a precautionary cash reserve in case of an unexpected high level of cash-out. While it is impractical to address all the potential incongruities that could negatively affect these expected outcomes, these issues are well understood and discussed in standard textbooks on money and banking. Nonetheless, these considerations are irrelevant regarding the central proposition in this paper.

Issued bank money that remains unredeemed essentially presents the bank with a source of savings or capital, similar to that when casino chips remain uncashed out in the House's "community." Moreover, bank money that, for whatever reason, is never redeemed provides the bank with capital of timeless duration. This was alluded to in the preamble when Professor Smith left the casino with a special purple chip as a collectible. This was recognized long ago by John Fullarton (1845, pp. 64-65), a preeminent monetary economist of the 19th century. His pertinent observation was that “banknotes which are not in use are the same as if they are not in existence.” Indeed, this insight suggests that at the end of the day, the amount of money reserves reflects the extent to which bank money holdings remain unredeemed. Thus, the issuance of bank money affords the bank with a source of capital to the extent that it remains unredeemed. And an issuance of bank money that remains unredeemed indefinitely results in a pool of capital or savings with an indefinite duration.

In a market with freely trading producers, acquiring either base money or bank money requires producing tradable value. Even if the possession of money resulted from a gift or handout, tradable value had to be created earlier to acquire the money. Consequently, a bank's stable pool of money reserves reflects unredeemed bank money, which corresponds to the tradable value that was created to obtain that money in the first place. Recall the earlier illustration with the rancher who grew alfalfa to trade for brood cows, for instance. As a result of trading this value, the gold coins she possesses reflect an implicit claim on the produced value of the alfalfa. Her willingness to accept coins hinges on the presumption that these will be useful in acquiring brood cows in the future. The postponement of exercising such claims is, by definition, saving. As evident in this example, the act of saving is not necessarily an explicit contractual proposition or something that establishes explicit data. Again, broadly speaking, saving is the act of postponing the consumption of produced value.

When cash or income generated from the production of marketable goods is deposited into a bank, the resulting money balances represent savings. The consistent pool of money reserves accumulated through these bank deposits serves as a source of savings or capital that the bank can utilize. If the community collectively deposits a steady stream of income, the bank can leverage these deposits into investments. Investments in this case can be considered as enhancing the management of a household or a business. This process plays a substantial role in the allocation of resources through time.

Traveler’s checks, which were once popular and still viewed as a component of the money supply, are also instructive in this regard. The issuance of traveler’s checks is comparable to the idea of cash being converted into casino chips (or traveler’s checks) that are generally accepted as a means of payment in the economy of the “House” (or in the commercial world of the issuer). Even though the chips (or checks) can be cashed out at will, a relatively stable pool of cash is nevertheless garnered at the “House” (or by the issuer). This steady pool of cash indicates that a certain amount of uncashed chips or checks exists. This represents a pool of unspent cash or unused stored value, which can be viewed as accumulated savings. These savings afford the issuer the potential to invest them in appropriate interest-earning assets. Hence, the issuance of traveler’s checks does not constitute the creation of money. Instead, it illustrates an effective strategy of using credit as a substitute for money, thereby creating a means of exploiting an additional source of "savings".

The financial innovation of credit-card usage is also noteworthy. Like bank money, credit cards serve as an effective means of payment in lieu of cash. However, in this case, the payment documents generated through credit-card usage are typically gathered and reconciled monthly rather than daily, as described by the MCT framework. Therefore, this innovation can be understood as taking stock and reconciling a month’s worth of commerce rather than just a day’s worth. Notably, the innovation yields even greater economization of actual money, much like a “concurrent-trading market” on steroids, further reducing our reliance on the supply of actual money, that is, base money.

Despite the technical differences in their applications, extending credit through credit cards and bank money usage relies on similar financial principles. In both cases, credit is extended to borrowers based on an analysis of their ability and character to honor their debt obligations. Given these considerations, borrowers in both strategies are provided with an account, subject to assigned limits.

Notably, a significant number of transactions are conducted using credit cards. This widespread use has sparked debates among economists about whether credit card usage should be included in the money supply, specifically by considering the sum of the "authorized credit limits". Due to the modern interpretive framework, these quandaries about the actual money supply are common and ongoing in economics.

Nonetheless, the financial arrangement underlying credit card use is clearly recognized as credit rather than money. Consequently, there is a general reluctance in modern economic thought to include these "authorized credit limits" in the money supply. If this restraint applies to credit cards, then, for similar reasons, it should also apply in regard to bank deposits assigned to bank customers.

In the next section, it is further explained why the expansion of bank-money balances resulting from bank lending does not constitute money creation. Instead, it reflects an innovative strategy that uses credit to loan out actual money that is essentially being saved.

The Bank-Money Strategy of Leveraging Base-Money

In the traditional view, the multiple expansion in bank money balances resulting from banks' lending practices equates to the creation of new money. Equating bank money with actual money thus leads to the notion that banks are magical money-making machines. This perspective is understandable given its theoretical foundations. The underlying presumptions and impetus behind this view will be explored later in the paper.

From the MCT perspective in this paper, the emergence of reliable money substitutes, along with their efficient clearing and settlement mechanisms, led to one of the greatest market discoveries: the ability to effectively tap into a substantial reservoir of savings that is otherwise very challenging for the market to extract and utilize. For sure, this discovery enabled banks to transform this previously elusive source of capital into fruitful, welfare-enhancing investments in the community. What began as a more convenient and cost-effective means of payment has, as an unintended consequence, evolved into a remarkable tool for meeting a community's financial needs. This financial innovation certainly stands as one of the most significant developments in the market since the discovery of money itself, proving to be an enormous boon to economic growth and prosperity.

Money being a store of value, this pool of actual money represents a claim on produced goods and services that remain available for use. In this sense, this pool signifies real savings, even if not officially designated as such. This situation allows banks to leverage these funds for suitable investments, thereby exercising their claims on resources. To be precise, the process of leveraging such reserves is based on the expected level of these savings, rather than the amount that exists at any given moment.

While it is true that this bank operation of tapping into this elusive reservoir of savings involves a significant expansion in bank-money balances, such as demand deposits, this section of the paper explains that this expansion is the effect of a financial strategy that uses a credit device as a credible substitute for money. The device is a critical tool for extracting the additional savings noted above, which means more capital for banks.

To emphasize, savings in this scenario refer to real money (or base money) that banks fiercely compete for by offering desirable products, such as demand deposits, that people want to hold or use. These products are what is meant by bank money. As it turns out, much of the collected money that is obtained from selling the product of bank money tends to remain unused or unspent for an indefinite duration. In this sense, it can be considered a collected pool of savings.

The banking method of capitalizing on these savings then involves expanding the supply of bank money, from which borrowers can draw for their investments. For sure, when these borrowers draw on these accounts, much of the money collected in the pool is then spent on those investments. As explained further in this section, this is, in essence, merely an act of using unspent money for investments for the duration of the loan.

To elaborate, the standard banking practice for leveraging this pool of money into investments is to issue a loan in the form of a bank-money balance that can be drawn on, rather than disbursing cash directly to borrowers. Similar to the "authorized assigned limits" on credit card usage, the amount of this issued bank-money balance can be understood as an assigned limit on how much a borrower can withdraw from this collection of base money. As is well understood, when borrowers spend this money by drawing from these accounts, the amount of this collected money can be expected to diminish in short order by the amount of these "assigned limits". Hence, the money in reserves is loaned out indirectly to exercise its claim on resources during the loan term.

This standard practice allows a pool of collected money to be effectively used to earn interest on investments. To clarify, this stable pool of money is base money, and it is not expected to be used or spent indefinitely. Furthermore, this banking strategy can only be successful in a culture that values honor and trustworthiness.

Importantly, this standard practice of leveraging such savings applies to all banks. When actual money is withdrawn from a bank's reserves due to this leveraging, it is redistributed among other banks or financial institutions. This redistribution is driven by the fierce competition among these institutions to attract actual money from the market into their reserves. The money they capture determines the level of savings they can leverage, while the intense competition for this money strictly limits their capacity to do so. Importantly, the profitability of this bank-money strategy hinges on banks' ability to promote the use of their bank money. This is reflected in total money reserves.

This fierce competition among financial institutions, including banks, to capitalize on such savings is governed by well-understood economic principles, as discussed earlier. Issuing bank money involves appreciable costs for banks, contrary to the notion that it's as simple as "the stroke of a pen (or keyboard)." As efforts to increase supply intensify, these costs are expected to rise. This serves as a limiting factor in the issuance of bank money.

From this understanding, market forces work towards producing an optimal outcome that enhances welfare. This occurs when the benefits of further efforts to exploit them no longer exceed the additional costs. At this point, any remaining profit opportunities have been exhausted, and the economy's capacity for savings has been fully utilized within its rational limits. This well-understood equilibrium point balances profitability and safety, allowing for maximum profits while minimizing risk.

The observation that the level of demand deposits significantly exceeds that of bank reserves merely indicates that the pool of money in the reserves has been loaned out. Consequently, the value of a vast majority of these claims now appears as loans on banks' balance sheets. Instead of loaning out the entire pool of savings, a relatively small portion is maintained for redemption and precautionary purposes. This implies that maintaining a safe level of reserves is worth more than investing it.

To the extent that the additional source of savings has not been fully exploited, any reserves exceeding the considered safe level present a profit opportunity for banks. They can invest these excess reserves by lending them to borrowers. Once this potential is fully exploited, the pool of saved money in reserves is effectively used for investments, leaving a safe level for redemption or precautionary purposes. From this understanding, the bank-money strategy reflects a financial innovation that incentivizes the capture and productive use of savings in the market.

The proposition above illustrates how the value and supply of financial assets are closely linked to the fundamentals of the economy. It highlights the importance of real money as a crucial factor in coordinating this process, serving as a guiding anchor for its substitutes. However, this connection can be disrupted or unhinged by external factors, such as harmful legal restrictions, misguided monetary policy, or widely impactful legislative acts. These must be taken into account when considering this connection between the fundamentals of the economy and the value of a nation's currency.

It is this standard banking practice of making loans that is typically described as the "money multiplier effect" in economics, since these deposits are considered real money rather than mere substitutes. Consequently, this banking practice is viewed as increasing the money supply. It indeed leads to a significantly higher amount of demand deposits compared to bank reserves. As a result, only a small portion of demand deposits, or bank-money balances in general, is backed by actual money. This paper offers a perspective that meaningfully changes the way this process is typically understood in economics.

For sure, just a "fraction" of bank money balances is supported by the base money reserves in the banking system. This is because banks invest a significant portion of this base money, which reflects the additional real savings mobilized from offering desirable money substitutes. However, this does not mean that money has been created or multiplied. It simply means that banks have discovered a financial approach to capture money that is not being used and, within certain limits, putting it to work in productive investments. Again, this does not constitute the creation or multiplication of new money. It merely means that banks have engineered a more effective use of the existing supply of money. The following section is meant to help visualize how this proposition works.

The Dynamics of MCT Through Time

The dynamics of the MCT framework illustrate why the multiple expansion of bank-money balances, such as demand deposits, does not reflect the creation or multiplication of money but instead enhances the efficiency of money usage. This is accomplished through credit and the use of reliable money substitutes. Keep in mind that the continuous pool of money collected in bank reserves as a result of using money substitutes is, in essence, a pool of real savings. It is also worth pointing out that when the banking system has fully capitalized on this additional source of savings, the total amount of money in bank reserves remains unchanged, all else equal. This observation indicates that the banking system has exploited these additional savings with the existing supply of actual money. The banking strategy thus enhances the efficiency of this existing supply and uses it more effectively. Consequently, the additional expenditures resulting from putting this pool of money to work can be accommodated by the greater efficiency in its use. It does not require any additional new money, as demonstrated by the MCT dynamics.

To help explain, the daily trades conducted with bank money inevitably result in a reallocation of resources. While this reallocation is an ongoing process, it is conceptually helpful and theoretically valid to consider it a daily single event. This singular event can be represented by the clearing process, in which trades are finally settled at the end of the day. Hence, each daily clearing event signifies a new reallocation of resources. Consequently, each clearing event can be seen as just one iteration in a continuous series of such iterations.

The success of this ongoing series of iterations relies heavily on effective management of daily reallocations to ensure overall profitability. When banks issue bank-money accounts, such as demand deposit accounts, to borrowers, they transfer potential claims on available but underutilized resources to those who can make better use of them. This process inherently involves credit and creates debt obligations. To maintain a viable financial strategy and prevent banks from going bankrupt, these debt obligations must be met to a large extent. Consequently, the ongoing reallocation of resources must be profitable not only for the bank but also for its community.

In a competitive, free market, these daily iterations can be expected to be profitable for the community as a whole, ensuring the economy continues to improve. This expectation is grounded on the principle of mutual gains in trade, where both parties expect to benefit; otherwise, they would choose not to trade. Thus, each iteration represents a new allocation of resources aimed at benefiting all parties involved, promoting economic growth and prosperity. However, when a favorable outcome does not occur—often due to unforeseen anomalies—the market's equilibrating forces swiftly work to restore profitability, provided these are not impeded.

As explained earlier, another remarkable consequence of using money substitutes is that it enables banks to exploit an additional source of elusive savings. The traditional theoretical framework misses this beneficial effect by treating bank money as real money. This phenomenon is shown by the stable pool of actual money that banks obtain from offering a desirable substitute for money. Instead of loaning this money directly to borrowers, banks provide borrowers with a bank-money account, allowing them to withdraw from this pool of savings as needed. As a result, the money is indirectly loaned out, as it tends to be redistributed among banks' competitors.

The lending to borrowers in this case is based on actual savings; that is, the money loaned from reserves represents a claim on previously produced value that has yet to be exercised. This previously produced value can be understood as resources that remain available, potentially for investment purposes. Hence, the expenditures made from these added accounts align with the value of the resources available for such spending.

The extent to which banks can add these extra balances in bank money to borrowers is constrained by a reasonable expected supply of these savings. This supply of such savings, on the other hand, is determined by banks' ability and competitive efforts to harness it by offering desirable money substitutes that people prefer to hold or use in lieu of physical currency. According to the profit-maximizing principle in economics, banks and financial institutions strive to capitalize on profit opportunities by converting savings into investments. They do this while maintaining a balance between profitability and safety. These ambitions ensure that all available savings are used responsibly unless hindered by external factors.

Given the extension of credit, resulting from the bank money strategy, this series now includes borrowers' expenditures resulting from banks' credit extension. As a result, the reallocation of resources represented by these clearing events involves the effective utilization of previously underutilized resources, thanks to the bank-money strategy. While expenditures may have risen as a result of these additional balances, they align with market fundamentals, as these investment expenditures reflect actual value being saved within the economy. These investments are likely to improve economic conditions over time.

The framework above, which depicts a continuous series of ever-expanding clearing events, can be considered alongside the dynamics of MCT. Given these dynamics, the banking system strives to make the most resourceful use of the limited supply of money that exists outside the system. A credit device is used instead of money. This dramatically reduces reliance on a given supply by using a credit device to replace money. These credit devices allow the banking system to take full advantage of efficient clearing systems, as they are collected and settled at the end of the day. This efficiency in the use of money enables the community to achieve its full economic potential with the existing supply, even as these daily clearing events continue to expand.

As long as transactions are made with bank money, the strategy continues to capture elusive savings while minimizing reliance on physical currency. From the framework discussed above, extending credit to borrowers, as shown by the expansion of bank money balances, represents a financial strategy in which actual money, representing real savings, is loaned out. Putting this unspent money to work does not constitute the creation of money.

This bank-money strategy can be understood as a method of capturing and lending base money while significantly conserving its use. In this context, banks are essentially loaning out other people's money, which is their defining role, and there is no ambiguity in what money is in this defining role. Furthermore, their ability to supply their financial alternatives is strictly limited by the real savings or capital they can attract. Therefore, it is a misconception to refer to banks as money-making machines. There is nothing magical in these financial activities; these are merely rational responses to the fundamentals of the market. Just as the MCT model, which uses chips as money, cannot be misinterpreted as a system that creates chips, the banking strategy of using money substitutes should not be confused with an arrangement that creates or multiplies money.

The extent to which banks can leverage the savings generated by marketing an appealing alternative to money is remarkable. Even before the advent of computerized bookkeeping, banks were able to leverage 95% or more of this additional capital into productive community investments. Maintaining a reserve ratio of 5% or less was considered sufficiently safe, provided there was a suitable mix of interest-earning assets to support it. Historically, this ratio has proven effective, except during catastrophic events, such as a great depression, when free convertibility becomes challenging and may even be uninsurable.

As mentioned earlier, the concept of economizing money can conceivably be pushed to an extreme (or mathematically taken to the limit), resulting in a reserve ratio at or near zero percent. In this scenario, only money substitutes are utilized in transactions, which is what is meant by a "cashless society." While little to no physical currency is used, this does not imply that real money disappears, as it is essential for anchoring bank money. Although this idea is conceivable in theory, it is implausible in reality due to natural constraints that strictly limit the extent to which real money, i.e., base money, can be economized.

In a free market, which is naturally competitive, banks take careful measures to manage the inherent risks associated with banking, particularly when dealing with freely convertible money substitutes. In the contemporary theoretical framework that emphasizes spending levels as a key factor in economic well-being, these precautionary measures are often viewed unfavorably as obstacles to extending additional credit, thereby dampening spending levels.

However, this so-called "friction" plays a crucial role in curbing reckless behavior and in achieving important objectives, such as maintaining adequate reserves and capital. While policies aimed at stimulating spending often seek to reduce this "friction"—such as government bailouts, deposit insurance, and “Fed puts”—they can dangerously undermine its positive impact. Notably, by weakening these natural safeguards against imprudent behavior, such policies promote the enactment of additional heavy-handed regulations to address the negative influences on bank management behavior.

This innovative means of loaning out garnered savings is often cryptically described as putting “idle” money to work. Still, this description misrepresents a critical property of money: money's role as a store of value. For one reason, in a market society, every cent of the entire supply of actual money is owned by some group or individual, whether it is possessed or consigned to others. It is wrongheaded to think that any of it is “idle” and not working at any given time. Money is always working, even if it is “hoarded.” As von Mises (1949, p. 402) pointed out long ago, “Hoarded money is still money and it serves in the hoards the same purposes which it serves in cash holdings called normal.” when cash or income is converted into bank money, it becomes integrated into a strategic arrangement that allows banks to capture and utilize an additional source of savings, as previously explained. It is in this sense that real money, which reflects stored value or savings, is put to work.

Finally, the convenient cash-out-at-will feature of bank money is undoubtedly a fruitful inducement to augment the demand for the bank product. However, similar to any business model that offers an “all-you-can-eat” option, it exposes the bank to the risk of an undue “binge” on cash, leading to potential financial challenges for the bank. Any "all-you-can-eat" feature is likely supported by evidence that the risk of excessive bingeing is minimal. Though this risk was small, prudent banking in earlier times included “option clauses” that provided temporary relief in rare cases of “undue bingeing.” Although such precautionary "clauses" are reasonable, they have long been outlawed (see Dowd, 1996, ch. 3). Nevertheless, these earlier limitations on convertibility further illustrate the distinction between bank money and base money.

An unrestricted cash-out-at-will feature clearly influences the level of liquidity risk and the time duration of funds acquired by issuing bank money, especially when compared to other banking products with withdrawal limitations, such as savings accounts and time deposits. However, these considerations are primarily contractual and managerial issues, and they do not change the fundamental purpose of all these products, which can be stated as loaning out other people's money.

The arrangement of bank money is a crucial aspect of a bank's role as a financial intermediary. Nevertheless, the time duration of the savings collected through this arrangement falls within a broad spectrum of bank liabilities with varying time frames. To remain competitive and viable, prudent bank management aligns the duration of its liabilities with that of its assets. This approach helps address liquidity and interest rate risks, maintaining a balance between safety and profitability.

The Requisite of Profitability

In both facilitating and financing trade, the concept of bank money is fundamentally based on credit. As a result, its viability and existence rely on the profitability of using bank money. It must be generally advantageous for both the bank's community and the bank itself. If this profitability is not achieved, the demand for the bank's money substitute may decline, leading to reduced reserves and potentially resulting in “bank failure.”

This requirement for profitability highlights the distinction between actual money and its fiduciary substitutes. Unprofitable situations, like an economic recession, do not threaten the stability of actual money. In fact, such conditions are likely to increase the demand for real money compared to bank money.

To illustrate, the requirement for profitability also applies to a gambling house’s casino chip strategy. If using chips as a substitute for cash was not generally profitable for the house, the result would be that cashing out would exceed cashing in. This disparity would deplete cash reserves and ultimately lead to “house failure.” However, the case for gambling casinos is different, as profitability is virtually guaranteed; the odds are deliberately designed to favor the house. Certain activities, such as “card counting,” are even internally monitored because they can negatively impact profitability.

Moreover, the cash reserves generated from the chip strategy must be carefully managed. For example, if a casino were to recklessly “invest” significant amounts of its cash reserves in the “wheel” of a neighboring casino, it’s highly likely that these squandered reserves would contribute to “house failure” as well.

Regarding the viability of the chip strategy, the frequency with which chips change hands, or their “velocity,” is irrelevant as long as the strategy remains profitable for the house. While it is true that gambling is generally a losing proposition for the patrons, the demand for the house's cash substitute remains strong as long as customers are satisfied with the house’s offerings. If they are not satisfied, they can easily choose to go to a competitor or refrain from gambling altogether.

Banks, unlike casinos, cannot manipulate the odds in their favor. They primarily rely on thorough due diligence and liens to enhance the profitability of their banking strategies. Similar to casinos, banks may impose contractual restrictions on certain activities or behaviors that could negatively impact their profits. However, unlike the zero-sum nature of gambling—where either the house or the gambler wins at the other's expense—the bank-money strategy operates differently. As mentioned earlier, bank lending practices are designed as a win-win-win proposition for the depositor, borrower, and bank.

Banks have a vested interest in the overall financial well-being of their customers. A financially healthy customer base creates a stronger demand for their money substitutes, resulting in a larger pool of savings or capital for the bank to leverage. As long as the demand for bank money remains sufficiently strong and profitable, this strategy remains viable.

Like the casino-chip strategy, the turnover rate of bank money is of little concern when it comes to profitability. In a market society where individual rights are protected, this "churning" or market activity tends to be profitable or wealth-creating, given the natural inclination to profit from one's actions.

The requirement for profitability is closely linked to the daily clearing and settlement event at the clearinghouse, which is a significant financial development resulting from the introduction of bank money. This daily event offers a comprehensive snapshot of how that day's trading activity affects the well-being of the bank's community. It can be viewed as a daily "temperature check" on the overall health of the strategy. This daily "health check" uncovers any issues that may need attention. As long as the strategy's overall health remains strong, its future prospects remain bright. However, if issues arise, there is a risk of bank failure. Additionally, since this event primarily involves bookkeeping adjustments, it requires less actual cash, as suggested by the concurrent trading model (MCT).

For emphasis, the viability of a bank-money “gathering strategy” necessarily hinges on the attributes of credit, such as trust and confidence. Any consignment of cash or income to a bank for a deposit depends on the utmost confidence that it will be safeguarded or managed appropriately. Since bank products that perform as a medium of exchange are indeed credit instruments, any such bank products that are not trusted or creditworthy would, of course, be unacceptable or discounted in a free market as a means of payment. Furthermore, credit manifests in the time between purchase and clearing, even if this duration is brief. This aspect is absent with cash or currency payments (given the assurance that the cash or currency is authentic).

Cash payments have a distinct feature known as “finality.” This means that once a cash payment is made, no further debt obligations arise or remain. In contrast, transactions made with bank money carry some level of liability until they are cashed out or cleared because bank money is inherently a claim on base money. The creation and stability of bank money heavily depend on a culture of integrity and trust. Adam Smith acknowledged long ago that this cultural aspect is essential for a functioning free-market economy. Without it, bank money would be nearly impossible, forcing the community to rely on cash payments or barter instead.

Part 2: The Impetus Behind the “Modern View”

The Endogenous Nature of Money and Its Fiduciary Substitutes

The supply of bank money plays a crucial role in enhancing the bank's primary function as a financial intermediary, connecting savings with investments. According to the classical view, the provision of bank products that attract savings or capital for lending aligns with the economic principles of a free market, similar to other industries. In economic terms, these optimal supply levels are known as endogenous variables, meaning they are determined within the system as a result of various factors. Typically, these equilibrium levels are regarded as optimal and beneficial for overall welfare, given the prevailing conditions at any particular time.

On the other hand, causal agents are understood to be the ever-changing external factors, which include concepts such as wants, resources, and technology. In a free market, aside from changes in these external factors—like unexpected fluctuations in the supply of base money and innovations in banking—the supply of money and its substitutes are merely effects. As a result, they do not have any causal influence on economic conditions beyond what has already been accounted for. In other words, all else being equal, the production levels of these banking products in a free market reflect the current conditions and tend to move towards optimal levels.

The modern perspective critiques the classical view by arguing that the free market frequently fails to provide a stable and welfare-enhancing medium of exchange. It links recessions and recurrent financial instability to an ineffective money supply. Unlike the classical view, the modern perspective highlights the crucial role of the money supply in influencing economic conditions through spending levels. Consequently, this framework advocates for centralized control of the money supply.

Notably, economics is indebted to recent developments in monetary theory proposed by the “free-banking view,” as mentioned earlier. Again, this school of thought emerged after the enigmatic 1970s episode of stagflation in addition to F. A. Hayek’s (1977) pivotal work that addressed such phenomena. This immense body of work in both monetary theory and history has spurred a profound change in how to think about money and banking phenomena (it is unreasonable to cite all the literature here but begin with Selgin, 1988; White, 1989; Dowd, 1996; Glasner, 1989). In many respects, the interpretive framework of the free-banking view substantiates and greatly amplifies the classical view.

Again, similar to the classical view, the free-banking view holds that a free and competitive issuance of what is referred to here as bank money rationally complies with the equilibrating forces of the market to establish an “optimal,” welfare-enhancing level, thereby avoiding adverse monetary disturbances such as inflation or recessions. Also, in opposition to the modern view, its extensive and in-depth historical analysis has shown that most, if not all, of the past episodes of financial instability, including the depth of the Great Depression, have resulted from misguided policies or legal restrictions.

As a result of these momentous developments in monetary theory, it is now acknowledged that the classical view had an elevated grasp of monetary theory compared to what was initially thought (see Glasner, 1989). But more importantly, this interpretive framework supports the view that the free-market supply of bank money is an endogenous variable; that is, the supply of bank money is derived from economic conditions as an effect and not a cause.

As previously explicated, the endogenous nature of the supply of bank money reflects a business of collecting and loaning out savings. All bank deposits, including demand deposits, are just one of three major sources of savings or capital for banks. The other two are borrowings and equity, which is the contribution made by owners. In the grand scheme of banking operations, a bank’s total investment portfolio, including infrastructure and overhead, is strictly limited by its ability to secure these three sources of liabilities. The totality of these liabilities is assumed to be invested in assets expected to maximize the rate of return on owners’ equity with a minimum amount of risk. For that matter, the same objectives apply to all financial intermediaries in general.

Regardless of which of these three sources above is used to garner savings or capital, the financial venture of banks does not depict a business of creating or multiplying money but one of leveraging these various sources of savings or capital into investments. That is the nature of a financial institution. Thus, in addition to the marginally profitable service of a convenient means of payment, the innovative bank money secures another source of capital in this endeavor. As noted, this beneficial service of financial intermediation using a credit instrument as a money substitute explains why the classical view characterized the issuance of bank money as credit and not as money. Again, in his recent working paper, Selgin (2024, p. 7) emphasizes the importance of viewing banks as financial intermediaries:

“The Intermediary theory maintains, in contrast, that ordinary banks’ lending capacity is generally constrained by their need to tap into real savings—savings that they are unable to create, either individually or collectively, out of thin air…Rather than being a matter of semantics, the disagreement between them is substantive. It is a disagreement concerning what real resources banks do or do not require in order to make loans, and make them profitably. It is substantive, and it is also important, for as I hope will become clear, whether or not banks are intermediaries has important implications for both monetary and bank regulatory policy.”

The endogenous nature of bank money in both its price and quantity supplied makes it clear that these variables of bank money are strictly tied to that of base money; that is, its price and quantity supplied, outside any legal force, are derived from those of base money as a result of well-understood market forces. Thus, the processes entailed in the price and quantity supplied of bank money are, in fact, much like those of a financial derivative linked to an underlying asset. The underlying asset here is the entity that identifies as actual money (or base money). Again, the redeemability-on-demand feature of bank money is an inextricable part of the process that links its price to that of (base) money through arbitrage. Nonetheless, the modern view posits that this inextricable process must entail exchanging actual money in trade. This theoretically imposed requirement, in turn, compels the modern view to characterize the “house money of banks” as actual money and not credit.

The “Real Side” of Money

The Presuppositions of the Modern View

It is understandable why the modern view equates bank money to actual money, given its presuppositions and theoretical foundations. Notably, it is wedded to the venerable old “Quantity Theory of Money” (QTM), which emerged as early as the 16th century. Its basic idea is influenced by a common observation that economic activity correlates well with spending levels. For sure, economic activity is typically higher when spending levels are higher, and conversely, it tends to be depressed when spending levels are low. Given this positive correlation, spending levels are postulated to be the primary “driving force” in the level of economic activity or output. Since spending involves the use of money in some fashion, the money supply is perceived to play a predominant role in the level of economic activity. The presumption behind this emphasis on spending is that money changes hands whenever trades occur. Hence, the modern view considers it practical for theoretical reasons to adopt the idea that a payment utilizing bank money is equivalent to a payment made with cash or base money.

Indeed, the thesis of this view was popular in the early days of economics when it was asserted that a "general glut of goods" or what is referred to as an economic recession, was caused by "too little money." This popular view was, of course, famously rebutted by the classical view, which argued that it was unlikely that "too little money" was the cause of a "general glut" in the context of a free and robust banking industry, which will always generate a sufficient supply of a means of payment when it is rational to do so. This will be expounded on later in the discussion on the presuppositions of the classical view.

It is worth mentioning that this ever-popular theory, which posits that spending is a dominant factor or "driving force" in the level of economic conditions or wealth creation, turns the classical theory on its head, regarding theoretical aspects of cause and effect. Despite the common observation that spending levels and economic activity correlate well, "correlation does not imply causation," as it is commonly said.

Notably, the conventional theory holds that the impact of spending on economic conditions is equally effective, regardless of the purpose of the spending. Even government spending is ranked equally. In contrast to the classical view, consumption spending is therefore viewed favorably and highlighted, since it is calculated to make up the vast majority of total spending. Since saving is seen as the absence of spending and as a "leakage" from the total spending levels, it is conversely viewed apprehensively as an “ever-present danger” to economic well-being. Moreover, exports are viewed favorably, while the classical view contends that the real gains in foreign trade for a country lie in its imports due to its focus on the allocation of resources and the value received relative to the value given up.

As an appendage of QTM, the modern view embraces the famous Fisher “Equation of Exchange” or (M)(V) = (P)(T), where

(M) is the money supply,

(V) is the number of times money changes hands,

(P) is the average price level, and

(T) is the number of transactions.

The Equation itself is understood to be merely a concession in accounting that total spending [or (M)(V)] necessarily equals what is spent on total output [or (P)(T)]. Thus, the tautological nature of the “Equation” adds little to economic understanding, absent a theory on cause and effect. The tautological aspect of the equation is clearly manifested when only base money, e.g., commodity money, exists and bank money is absent. For example, in the model of concurrent trading with only three vendors, total spending [i.e., (M)(V)] equals the total “chip” value spent on the three goods [or (P)(T) = (1)(3)], regardless of whether it was three chips changing hands once [(3)(1) = (1)(3)] or one chip changing hands 3 times [(1)(3) = (1)(3)]. For sure, the theoretical challenge here is in determining what ultimately causes what in this arrangement. However, if the vendors decide that they do not want anything from others, the market obviously comes to a halt.

However, with the advent of bank money, the variables (M) and (V) in the "Equation" are no longer straightforward. For one thing, the turnover rate of money, i.e., velocity (V), is not even data that can be observed and analyzed. Its level has to be imputed from what is determined for the other variables in the "Equation." This makes the findings circular and self-inducing. Thus, the "Equation" loses a lot of its relevance.

From a classical perspective, in comparison, the variable (M) in this famous equation denotes base money. Consequently, the variable (V) necessarily reflects the economizing effect achieved by using money substitutes, as demonstrated earlier. Again, this economizing effect inherently requires credit, and the supply of these substitutes is necessarily the result of the financial operations involved in extending credit, thereby leveraging the actual savings that ensue from this economization in the use of base money, as explained earlier.

These financial operations are nonetheless closely linked to base money by the relentless forces of arbitrage. Thus, from a classical perspective, the price and supply of both base money and bank money in a free market are the effect of the equilibrating forces of the market. To be precise, the market-driven supply of a medium of exchange, broadly speaking and including both base money and bank money, is considered an endogenous variable, being derived from the natural forces of the market. Thereby, the product (M)x(V), or total expenditures, is the effect of economic conditions and not the cause or "driving force" of such conditions. The natural forces of the market are understood to be ultimately driven by the wants and aspirations of its participants.

Understanding the distinction between endogenous and exogenous aspects of the market is crucial for grasping the relationship between cause and effect within a specific theoretical framework. For instance, the classical perspective recognizes that exogenous factors can influence the levels of either (M) or (V) beyond what is deemed endogenous in the market. These exogenous factors are all encompassed under the concepts of "Wants, Resources, and Technology." A significant, unexpected gold discovery, for instance, is considered an exogenous change in "resources," and this would impact the level of (M). The advent and advancements in financial innovations, such as bank money, are understood to be an exogenous change in "technology." These changes are likely to have a favorable effect on the level of (V). Centralized monetary policy and banking legislation are external factors that can significantly change the levels of both (base) money supply (M) and velocity (economization) of money (V). These external changes can greatly affect economic conditions, either positively or negatively. However, the market has demonstrated a strong ability to adapt to such changes without relying on government intervention. More will be said about this later.

With that said, the famous “Equation” nonetheless comports well with the QTM playscript of the modern view, where the level of "spending" plays a critical causal role in the level of total output and prices. Again, total spending [or (M)(V)] is interpreted to be the primary “driving force” in the money value of total output [or (P)(T)]. Thus, from this quantity-theoretic framework, the “Equation” fosters the notion that virtually every transaction entails the exchange of actual money. Again, this assumption helps make the theory plausible.

The classical theoretical framework, where the exchange of money is bypassed in a vast number of transactions through financial arrangements, using various credible substitutes for money, does not align with the modern view that relies on a QTM framework. Furthermore, the “Equation” accentuates what is already ingrained in the modern view: the notion that the “money supply” can be treated as an arbitrary or external causal agent rather than an optimizing endogenous variable shaped by market dynamics. It is important to note that these "external forces" are typically viewed as being disconnected from the welfare-enhancing processes of the market.

The presupposition that spending in itself drives economic activity understandably leads to the belief that the economic maladies of recessions or inflation stem from suboptimal spending levels, specifically nonoptimal combinations of money (M) and its velocity (V). Consequently, these nonoptimal spending levels are mostly blamed on “adverse monetary disturbances” of either “too little” or “too much money” that can arise in a free market economy. This cause-and-effect framework indeed promotes a policy agenda of centralized control. To address or prevent such issues, centralized government supervision and control over the money supply is thought to be necessary to maintain appropriate levels of the money supply (M).

To govern money, however, the monetary authorities must identify what monetary aggregates qualify as candidates for (M) to control. Since most spending is conducted with credit devices or money substitutes, it makes sense that monetary aggregates that resemble or come close to resembling a “generally accepted medium of exchange” (GAMOE) qualify as candidates. GAMOE, again, is the essential attribute or genus of the broader concept of a medium of exchange. This identification approach, therefore, classifies money substitutes as money. The modern view thus dropped the differentia from the definition of money that distinguishes it from its fiduciary substitutes to make it work for the theory. It is worth mentioning that this manner of identifying entities and the method of nomenclature lean on the dubious philosophical approach of nominalism. This approach focuses on identifying entities based primarily on their resemblance to the essential attribute as described in the definition, while dismissing other relevant attributes or properties. Disregarding pertinent nonessential attributes can, of course, result in misrepresenting entities and their function.

As noted, scrubbing the differentia was to square the facts of reality with the QTM interpretive framework of the modern view, where money (M) is presumed to be exchanged in virtually every transaction (T) of the “Equation.” Identifying money substitutes as money is thus necessary to make this presumption reasonable. Therefore, an entity resembling GAMOE qualifies as money (M). For instance, although bank checks are credit instruments and are technically classified as “orders to pay” (base) money, demand deposits still qualify as money because check payments are viewed as equivalent to cash payments. In this case, the reasoning behind this perception is that the fiduciary aspects of these payments are irrelevant, as checks are regarded as being backed by actual money.

Initially, the monetary authorities sought to control and optimize (M) to achieve the desirable economic goals of price stability and low unemployment. For decades, this objective led to an earnest but futile effort to find the right (M) to control. By the 1990s, these search and control efforts were abandoned and replaced with determined efforts to control and optimize interest rates. Despite this required shift in policy, the modern view, which is now accepted as uncontestable conventional wisdom, still embraces the monopoly-issuance of currency and strict centralized control of the "money supply."

The Presuppositions of the Classical View

The classical view, on the other hand, supported a free and robust banking system, which was indeed experienced in the early days of economics. Given the existence of a competitive banking system, the classical view, for example, decidedly rejected the ever-popular “too little money” theory as the cause of recessions. In the famous economic passage known as Say’s Law, where the “too little money” theory was disputed, J. B. Say remarks that “merchants know well enough how to find substitutes for the product serving as a medium of exchange or money” (1880/1971 p. 134). To repeat, the terminology and monetary theory of the classical view is clarified by David Glasner (1989, p. 63):

“In [Say’s] usage, only coin or specie was actual money; banknotes and other credit instruments that performed as a medium of exchange he called money-substitutes. But semantic differences do not alter his basic point that a competitive banking system would never allow an unsatisfied demand for money to turn into a general oversupply of all real goods.”

The most significant presupposition of the classical view that helps explain the quoted proposition above and why the classical view often clashes with the modern perspective is referred to as the “primacy of production premise” (PPP). [See Salsman, 2021, pp. 115-168, for an in-depth description of PPP.] This premise stems from the recognition that for value to be consumed, it must first be created–that practically everything we consume must be produced, that “not much grows on trees.” A key implication of the PPP is the assumption that once value is consumed, it is gone forever. This point is inferred in the phrase "eating your seed corn." The significance of this implication is not diminished by pinheaded objections that some values like state parks can be enjoyed without being consumed, which demonstrates a misunderstanding of what is meant by consumption in economics. The distinction between the economic concepts of consuming, saving, and investing is the difference between burning a tank of fuel to take the family to the beach or foregoing the trip and using the gas to grow the corn crop instead.

The classical view considers PPP axiomatic for economics, which is described as the science of wealth creation. It is axiomatic in that it does not need to be proved; it holds regardless. The recognition of PPP leads to a fundamentally different approach to economics compared to the modern view, which is heavily influenced by the philosophical approach of "positivism." Adherence to PPP leads the classical perspective toward an emphasis on market processes that are intent on optimizing the responsible management of scarce resources, rather than the preoccupation with spending or demand.

Again, in the classical view, the willingness and ability to spend are a given in a free economy when value is produced. “Spending is easy when value exists,” as William Hutt exhorted in defense of the classical view. The cardinal virtue of the straightforward recognition of PPP is that it helps expose illogical conclusions and theoretical contradictions. Consequently, the convoluted ideas of mercantilism were rejected in the classical era. While PPP may seem commonsensical, it is not always honored in economic thought. The source of conflicting theories on cause and effect can often be traced back to the extent of commitment to PPP.

Furthermore, the concepts of “wealth creation” and “optimality” are understood in the broader sense of maximizing personal happiness or satisfaction rather than in some narrow material sense. The “God-given” or natural right to the pursuit of happiness of individuals constituted the “ends” or, in Aristotelian terms, the “prime mover” in economics. Whereas the accessible resources at any given time, including labor and know-how, constituted the “means” or, in Aristotelian terms, the “material cause.”

Accordingly, commodity money and its fiduciary substitutes were understood to be an integral part of the means in the pursuit of those ends. As depicted by the famous “Invisible Hand” metaphor, the “ends” in this case are generally best served by freely trading producers wholly reliant on their faculties and capital. The classical view on “wealth creation” no doubt complemented the developing political thought at the time that a free society is morally superior to a centrally controlled or enslaved society.

In alignment with the presupposition of PPP, the "classical" concept of demand is fundamentally different from that of the modern perspective. The classical idea of demand necessarily infers the production and supply of value for trade or exchange. Therefore, the supply of goods is what constitutes the demand for non-competing goods. In short, demand does not ensue from hungry mouths (wants) but from happy hands (production).

Hence, the so-called “driver” in the classical interpretive framework is the “production of value,” which is the genesis of demand. As Salsman notes, "What drives a robust economy is not 'consumers' per se but savers, investors, innovators, and producers." In contrast, the contemporary view has evolved to where the market is divided into two separate and disconnected factors of supply and demand, which is commonly illustrated by two intersecting lines. This helps explain why the modern view stresses the importance of spending levels, particularly spending on consumption, in stark contrast to the classical view.

In the classical view, “spending” sits in the back seat as an effect. For that matter, the desire to spend is only limited by “wants,” and "wants" are correctly and axiomatically stated in economics as being “unlimited.” Thus, in the context of a competitive and robust banking system, the only constraint on spending is the supply of value that initially creates the ability (or income) to trade value for value in the first place. Once again, the implications of PPP play a decisive role in dispelling convoluted theories that suggest "demand" can be created from nothing, such as the idea that “printing money” or government spending augments demand.

Moreover, a severed link or “leakage” between savings and investments would suggest that a viable profit opportunity has been left unexploited. This contradicts the inviolable profit-maximizing principle in economics. Leaving a profit opportunity unexploited is hard to even imagine in a free and robust economy. Regardless of how produced value is saved, an unimpeded profit-maximizing market will find a way to exploit it if rationally possible. Even a quirky bent to “hoard” money (or its substitutes) and not to “cash out” on the implied created value of these claims only means more existing value in terms of assessable resources for others to exploit. The unusual preference of never “cashing out” money on the implied created value certainly does not warrant a dire “warning” or disapproval from economists. “In the field of monetary policies too there is no such thing as a scientific ought” (von Mises, 1949, p. 422).

The industry responsible for the production of a medium of exchange, including the production of (base) money (e.g., mining and coinage) and the production of fiduciary substitutes (i.e., the issuance of bank money), is an integral part of the whole economy. It is just as “real” as any other industrial production line. Most importantly, the total supply of such products is endogenously determined; that is, the supply of commodity money plus its fiduciary substitutes is subject to the relentless Laws of economics. And, as in other production lines, such forces are understood to supply a welfare-enhancing optimal level in the context of a competitive and unimpeded market. Outside of some unusual major autonomous event, any “adverse monetary disturbances” were considered unlikely, if not implausible. In such an event, for instance, a gold discovery or the advent of a financial innovation, the market's equilibrating forces engage immediately in establishing a new welfare-enhancing equilibrium. This is achieved as expeditiously as possible, given the “means.”

The classical view presents a unified and general theory of wealth creation, wherein the supply and demand for a means of payment are fully integrated within the system. One of the most significant insights in science is that a welfare-enhancing equilibrium incorporates and reflects a completely integrated combination of knowledge and judgments from every individual who freely participates in the system. The underlying understanding of this insight is that everything relies on the sanctity of private property rights and the freedom of contract. This also relates to the supply of a medium of exchange. In other words, the optimal levels of nearly all products, including the medium of exchange, are determined internally by the market. As such, a free and competitive market was not bifurcated into a market-behaving “real side” and then an unruly “money side” that requires control.

The classical perspective on classifying base money as actual money led to one of the most salient principles in economics: the "purchasing power parity principle." This principle states that a unit of the market-driven commodity recognized as money will flow to where it holds the highest value. As a result, a unit of money maintains the same value (or parity) everywhere within its universal sphere, due to the relentless forces of arbitrage. In this case, a unit of money represents an objective measure of its purchasing power, based on the collective knowledge of all market participants. The distinction between money and its fiduciary substitutes clarifies this principle; without this distinction, the principle becomes murkier.

The bifurcated view of the economy between the “real side” and the “money side” can partly be attributed to the methodology of the classical view that punctuated the “real side” and treated the “money side” as less relevant, given the efficiency of a free and competitive banking system, where producers can generally find a way to trade their goods. In time, the money side was seen as merely a tool for "keeping score" and keeping the "machine well oiled." The unflattering “veil of money” metaphor describing the classical view of the "money side" suggested its view had virtually dismissed the issue of adverse monetary disturbances.

By the turn of the 20th century, the "money side" was merely viewed as raw material that the central authorities could manage and control to ensure optimality in what is considered “real” in the economy (e.g., low unemployment and stable prices). The respect for the inviolable sanctity of private property rights and contractual freedom in the production of a medium of exchange was practically ignored. Consequently, a long-desired political agenda of monopolizing the issuance of currency and instituting a fiat standard was accomplished.

In a very “real” sense, the free-market production and supply of both money and its fiduciary substitutes potentially create enormous utility and value for the community. Notably, however, the two entities, base money and bank money, depict two different “animals” in the economic kingdom. As is well understood, the two entities differ in both attributes and function. For certain, their value and quantity supplied are determined by distinctly different market phenomena. They may appear to live in symbiosis with one another, but the life and value of base money, or what is actual money, do not depend on the existence of bank money. It can and has lived without bank money. The same cannot be said about the bank money. It is strictly dependent on the existence of money; its life and value are indeed "derived" from it.

Prospecting for Money

As shown and explained in this paper, the story of the significant advancements made by the advent of “bank money” is best told from a classical perspective, where the IOUs that perform like money are recognized as credible substitutes for the entity that serves as money. The concurrent trading model, MCT, patently demonstrates that the mechanics of using a money substitute manifest a financial strategy that greatly economizes on the use of money. Like clay chips in a casino, these financial instruments are not money in themselves but functional substitutes that reduce the need to use actual money. Indeed, the supply and demand for (base) money can be reduced to just a small fraction of what would otherwise be required for trade.

The financial innovation of using a stand-in for money that can be "gathered" and reconciled "at the end of the day" takes advantage of innovative settlement mechanisms that promote even greater levels of efficiency in making trades. Advancements in technology are constantly improving the efficiency of these settlement mechanisms. These features alone create enormous benefits in terms of costs and convenience. Notably, however, the innovation of bank money led to a new way of tapping into a previously hard-to-reach source of additional savings for investment. This has indeed accelerated economic growth where such innovations are applied.

As a result of investing the savings that accrue from using bank money, the money reserves of banks represent just a fraction of the balances held in terms of money substitutes. This aspect of a bank's portfolio does not reflect a "money-multiplier effect," as depicted by the traditional view. Despite the on-demand feature and particular liquidity risk, the financial operation using bank money resembles savings accounts and time deposits, where money is loaned out rather than generated. The business of loaning out other people's money is purely financial and banked on the attributes of credit, namely trust and confidence. Using bank money thus greatly facilitates both trade and finance by utilizing outside money more effectively. Hence, money is not created under these arrangements.

As noted in the paper, the modern and classical views clash on theory and policy due to different presuppositions that underpin their respective theories. As a result, the contemporary view posits that the money supply is a primary causal factor or "driving force" in economic outcomes via spending levels. This view was popular even in pre-classical times. The mechanistic framework of this view presumes that transactions necessarily entail the physical exchange of money. Thus, it is expedient to include money substitutes in the money supply to make the theory plausible.

Since this quantity-theoretic framework assumes that transactions must entail the physical exchange of money, the number of transactions is constrained by the existing money supply (M) and its turnover rate (V). The product of these two monetary factors, (M)(V), is considered an independent development from the market's equilibrating forces. Consequently, it can be misaligned with what is optimal, leading to either too little or too much "money." Clearly, this interpretive framework is devoted to the idea of monopolizing currency issuance and maintaining centralized control over the money supply.

In contrast, the classical view regards spending levels as an effect, meaning that spending levels respond rationally to the market's reaction to anticipated real economic factors. The "money supply," or, more precisely, the supply of a medium of exchange, adjusts accordingly to reflect actual conditions due to the market's equilibrating forces. Given that the issuance of money substitutes is entirely a financial operation, their supply is strictly limited by the amount of real savings that can be mobilized through these activities. On the other hand, where value exists, there is no reason to think that a competitive financial system will not exploit all profit opportunities to meet the demand for a medium of exchange. That is, the equilibrating forces of a free and competitive banking system tend to produce an adequate supply of a medium of exchange but not a dollar more.

Thus, the classical view considers it unlikely that undesirable outcomes, such as inflation or recessions, are caused by monetary problems arising from a free and competitive issuance of currency, as well as a variety of other substitutes for money. Contrary to the conventional view, the classical view argues that such economic maladies are more likely the result of misguided policies that are destructive to value or wealth creation. The remedy, in this case, involves addressing such destructive policies. When property rights are clearly defined and enforced, and the market's beneficial forces are not misguided by political motives, the coordinating forces of the market tend to achieve financial stability and effectively tackle challenges such as inflation and recessions.

While this paper does not delve deeply into monetary theory, economics is indebted to the monumental contributions made by the Free Banking School of Thought in both theoretical advancements and historical analysis. Several of these excellent works are referenced below for further enlightenment. These developments represent a transformative shift in monetary theory. The Free Banking School reinforces and amplifies the classical perspective on the advantages of a free and competitive banking system. As such, the free-banking view aligns with the classical view and strongly advocates for a free and decentralized issuance of currency. Currency in the form of private banknotes would be another consideration for bank money.

The theoretical framework of the free-banking view is essential in fully grasping how the equilibrating forces of the market tend to drive the supply of bank money to optimal levels, helping avoid or mitigate inflation and recessions. The free-banking view understandably adheres to the existing terminology used for monetary entities, although it recognizes that bank money is tethered to base money. Additionally, it aligns with the Intermediary Theory, which holds that banks do not create money out of thin air nor conjure up savings out of nothing, in line with the propositions outlined in this paper. Given that banks are understood not to create money, the proposition in this paper is that this understanding implies money is the monetary entity that exists independently of banks.

As explicated in this paper, a key inference from the straightforward recognition that bank money is a money substitute is that base money is what identifies as real money. The existence and usefulness of bank money outside the force of law depend on the trust that it can be converted to base money if and when desired. Additionally, the value and supply of bank money are inextricably linked to and derived from that of base money. Base money is at the heart of economic affairs. It serves as a fundamental measure of value in trade and financial affairs. As a reliable anchor in financial matters, it plays a crucial role in effectively coordinating global market activities. The coordination of these activities is pivotal in the allocation of resources throughout the world and through time.

When base money was a market-driven commodity under the gold standard, its value and supply were endogenously determined, meaning that its value and supply were the effects of market-driven actions. Such actions are driven by the collective knowledge and decisions of all market participants. The processes are about as democratic as these can be. Furthermore, these processes proved mostly reliable and stabilizing when not unduly regulated and property rights are clearly defined and enforced. An evaluation of these processes certainly has economic implications, but even more so, it holds ethical and political concerns. In a free society, the moral question of whether real money is market-driven or fiat-driven is profoundly significant. These critical issues are addressed by Professor Judy Shelton (2024, p. 35) in her most recent publication and summarized below:

The magnificent mechanism of free-market interactions, so compatible with our belief in individual freedom and economic liberty, should cause us to question why we permit central banks to distort the signaling mechanism that so efficiently conveys value. It goes against founding values and common sense to utilize central planning to tweak the validity of the money unit – deliberately making it more plentiful (through monetary stimulus), or less available (through restrictive interest rates) to alter economic outcomes in pursuit of government-directed objectives.… Substituting the perspicacity of designated monetary authorities, for the shared acumen of hundreds of millions of people carrying out voluntary transactions to facilitate their daily needs and future dreams is akin to selecting the path to serfdom.

In summary, it is worthwhile to prospect for a commodity or combination of goods that could potentially serve as money in a free-market economy. As previously noted, money was the monetary use of gold or specie under a gold standard in earlier times. The gold standard possessed the paramount property of being independent or greatly shielded from bank manipulation and political influence. Granted, the integrity of such a system relies on a culture of honoring and protecting property rights, preferably on a global scale. The establishment of the Federal Reserve System (the U.S. Central Bank) in 1913 defied this culture. However, it was sold to the public as a “system” that could yield the paramount property of being independent of political and banking influence. Given the perpetual debasement of the currency and the dismal record of financial stability since its inception, confidence in central banks or a fiat-driven monetary system has been severely shaken.

The shattered confidence in central banks was a primary impetus in the development of Bitcoin. Being an “internet money,” its unassailable property of independence, plus its lightning-speed efficiency, make Bitcoin one of the most promising prospects for money ever “mined” by the market. Its unique digital signature provides secure authentication and ownership, and the “decentralization” of its supply and holdings is an invaluable attribute in establishing a truly independent and reliable money supply. For sure, its supply is strictly limited and structurally impervious to almost any attempt to encroach on its independence. Given a free and competitive banking industry, the optimizing supply of freely convertible bank money mutes any arguments of an insufficient supply of a medium of exchange. Nonetheless, Bitcoin presently lacks the necessary properties of “general acceptance” and “unit of account” to serve as a possible candidate for money, although this situation can certainly change.

On the other hand, the gold standard has already demonstrated its value as a form of sound money, particularly when property rights are respected and enforced by governments. Additionally, its supply is adequate and sufficiently responsive to changes in demand, taking into account both its production and its interchangeability with nonmonetary uses. Coupled with the innovation of bank money, this ensures that there is an optimal response to any demand for a medium of exchange where value is recognized.

Moreover, there is something noticeably special about a tangible asset with the characteristics of gold. Born and dispersed throughout the universe from the wedlock of supernova stars, this precious substance is impervious to the elements and will stick with us forever. Its atomic number, 79, allows for precise authentication and makes it impossible to counterfeit, even in the most sophisticated laboratories. These attributes establish the basis for a sound financial system when one is desired.

With that said, the gold standard may rise above other competing standards for a financial system. However, regardless of what the market eventually favors among competing options, it warrants a “judgment-free zone” in economics.

No matter whether money consists of gold, Bitcoin, or some other market-driven good, a “cashless society” is certainly plausible where nearly all payments are made digitally, biometrically, or with some other alternative substitute for money. An entire life could conceivably be spent without ever encountering the entity, money. Even so, the relentless forces of arbitrage due to unimpeded convertibility will keep the value of all the various forms of "bank money" strictly tied to that of money.

References:

Ammous, Saifedean, 2018, “The Bitcoin Standard”: The Bitcoin Standard- Wiley

Kevin Dowd, 1996, "Laissez-faire Banking": Laissez-Faire Banking by Kevin Dowd - Routledge(Routledge).

Irving Fisher, 1911, "The Purchasing Power of Money": The Purchasing Power of Money

Milton Friedman, 1969, "The Optimum Quantity of Money and Other Essays": The Optimum Quantity of Money

John Fullarton, 1845, "On the Regulation of Currencies": On the Regulation of Currencies

David Glasner, 1989, "Free Banking and Monetary Reform": Free Banking and Monetary Reform - Cambridge University Press

F. A. Hayek, 1977, "Denationalisation of Money": Denationalisation of Money - Institute of Economic Affairs

W. S. Jevons, 1875, "Money and the Mechanism of Exchange": Money and the Mechanism of Exchange - Archive.org

B. J. Moore, 1988, "Horizontalists and Verticalists": Horizontalists and Verticalists - Cambridge University Press

Ludwig von Mises, 1949, "Human Action": Human Action - Mises Institute

Frederic S. Mishkin, 2019, "The Economics of Money, Banking, and Financial Markets (12th Edition)": The Economics of Money, Banking, and Financial Markets - Pearson

Dale K. Osborne, 1985, "What is Money Today": What is Money Today - Dallas Fed (Archive)

Richard W. Salsman, 2021, "Where Have All the Capitalists Gone?": Where Have All the Capitalists Gone? - AIER

J. B. Say, 1880, "A Treatise on Political Economy (4th Edition)": A Treatise on Political Economy - Archive

George Selgin, 1988, "The Theory of Free Banking": The Theory of Free Banking - Mises Institute

George Selgin, 2024, "Banks are Intermediaries of Loanable Funds": This reference is a working paper, and it may not yet be publicly available online. You can check for it on the Cato Institute’s website or research publication portals.

Shelton, Judy, 2024, “Good as Gold”: Good as Gold - Independent Institute

L. H. White, 1984, "Free Banking in Britain: Theory, Experience and Debate": Free Banking in Britain - Cambridge University Press

L. H. White, 1989, "Competition and Currency": Competition and Currency - NYU Press

McCallieBot