Money Make The World Go Round: Review Of The Legal Concept of Money By Simon Gleeson
The Legal Concept of Money by Simon Gleeson exemplifies the high-class financial law literature I am constantly looking for. In-depth examination, classy legal writing style, and answers to crucial questions — all these you can find in that book.
Here I post my synopsis of this book.
Money is a social institution, not a legal institution
Gleeson observes that society can make anything money. Social norms and social behaviour determine what is money.
The legal doctrine of money determines only the consequences of being money (not the question of what is money).
Furthermore, the rules of legal tender determine what instruments the creditor is obliged to accept in payment of a pre-existing debt.
The moneyness = the idea of the medium of exchange
Gleeson argues that the conventional trifecta — money is a unit of account, a medium of exchange, and a store of value — is unhelpful as regards forms of money other than gold coins.
What constitutes money can be defined by observing what is actually used as a medium of exchange in the marketplace (“do people generally accept this as money?”).
Nothing is always money
As money is an institution, and institutions are in turn incidents of societies,Gleeson argues that there can be no arbitrary definition of money which is good for all societies at all times.
Money is a mechanism for discharge of debts due
The fundamental purpose of money is to discharge credit obligations, Gleeson observes.
Consequently, money is that whose delivery extinguishes an obligation.
The money is that which, when delivered, constitutes payment.
The more people accept a thing, the more money-like it is.
The fewer people accept a thing, the less money-like it is.
Money is memory
Money is a scorekeeping device intended to equalise transfers of value over time.
Kocherlakota explains this in more details in Money is Memory, Staff Report 218, Federal Reserve Bank of Minneapolis (1996).
Money is valuable because it is confidently expected to be accepted in complete discharge of obligations
From the debtor’s view, money is that which the creditor will accept in absolute discharge of credit obligation.
From the creditor’s view, money is that which the creditor confidently expect to be able to use immediately to procure whatever the creditor might otherwise have received.
Here is a quote on the related topic of money as a store of value:
[If] a debt is a store of value to the extent that it can immediately be converted into money at a point in the future, money is equally a store of value to the extent that it will already be money at that same point in the future. What makes money a store of value is the belief that it will have value at the time in the future when it is sought to release its value — or, put another way, if other things are potentially stores of value to the extent that they can be converted into money in the future, money is a store of value to the extent that it can be converted into other things in the future.
Modern money has extrinsic (not intrinsic) value
Modern money is work solely what you thing others will give it for you, Gleeson concludes.
Debt pre-dates money
Gleeson points out that the concept of money only makes sense in the light of the idea of a payment obligation which it may discharge — i.e. a debt.
Money pre-dates commerce
Money was initially created first to quantify and discharge tax liabilities.
Money is created by social acceptance
The more people there are who will accept a thing in payment, the more money-like that thing is.
It is true, Gleeson notes, that that physical money is generally (although not quite invariably) created by the act of a sovereign. However, more often than not the actual action of the sovereign was the creation of new mechanisms of exchange to facilitate the settlement of claims denominated in pre- existing socially determined units of account.
In addition, the fact that an instrument is a credit claim on a government is not of itself sufficient to make that instrument money.
Money exist(?)
Gleeson qualifies money as an existing intangible, but leaves the judgement about the “existence” of money to the society.
Take an example of bank money — i.e. intangible book-entry commercial bank money.
In the social context, namk money seems to be regarded as property, and is thought of as a “thing” which is “owned”. But in reality, currency in normal commercial banking use constitutes a claim on an intermediary for an imaginary* thing.
* Imaginary in the sense that, Gleeson states, nobody believes that the bank actually holds an amount if money equal to its liabilities, but every holder of those liabilities behaves as if that was the case.
So, does bank money exist?
Bank money is slightly less “real” than virtual currency
Both bank money and virtual currency are tokens representing accrued value, usually received in respect of value given, and held for the sole purpose of being transferred on, usually in respect of value received.
Based on that, people on the street, Gleeson observes, can justifiably regard bank money and virtual currency as “the same sort of thing”.
As to less “real”: The underlying virtual currency does “exist”, and is in fact “transferred” on the ledger. Contrarily, money held in a bank account is never transferred, but is created and destroyed by book entry.
Balance maintained with a bank = Balance maintained on a distributed ledger
Gleeson describes, the only difference between these two is the following.
The balance on a bank account is denominated in terms of units which are in turn designated by the government of a country as units in which it is prepared to transact.
The balance of a virtual currency is designated in units of its own devising.
Sovereign money has probably never formed the whole of the circulating payment media of any economy
At times of stress, private media have flourished to fill gaps resulting from a shortfall in the supply of sovereign money.
Do we need “real” sovereign money?
Gleeson believes, it is plausible to abolish the central bank and state-provided money, and rely exclusively on commercial banks to provide money to the economy — but it would be a bumpy road.
The capacity of the sovereign to create money at certain times may be essential: the endogenous money within the system may from time to time require supplementing through the creation and injection of exogenous money.
The state can create “money” by accepting it in payment
It is true if the state is the largest economic participant in the market.
Gresham’s law rules
Gleeson gives a brilliant description of the “lemon” problem which is an application of Gresham’s law to physical goods. Here is a quote:
Assume a car market contains ‘peaches’ — good cars — and ‘lemons’ — cars with some defects. Assume further that buyers cannot tell whether any particular car is a lemon. Buyers who buy peaches will keep them; buyers who buy lemons will seek to sell them on through dealers. As buyers realise that the proportion of lemons on the market is rising, the price they are prepared to pay for any car will fall. The lower the price falls, the greater the disincentive for owners of peaches to sell, and the higher the proportion of lemons on the market. However, as the proportion of lemons increases, buyers’ willingness to buy will diminish, and eventually the market will cease to operate at all.
Akerloff, The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism Quarterly Journal of Economics, Vol. 84, №3 (1970) at 488– 500.
Taxes make a money sovereign
Gleeson concludes that any entity with the power to raise taxes has the potential to create its own currency.
But there is a large number of entities which have taxation powers but do not issue their own currency (e.g. EU member states, Scottish and Welsh Assemblies in the UK).
Money and credit co-exist
This poses a challenge. Nosal and Rochteau explain:
one of the key challenges in monetary theory is to provide an explanation for the coexistence of money and credit. One reason why coexistence is a challenge is that the frictions that are needed to make money essential typically make credit infeasible, and environments where credit is feasible are ones where money is typically not essential.
Gleeson argues that the absence of money led to the continuing existence of such multiple credit obligations.
Money manages and reallocates credit risk
Gleeson observes, every creditor becomes, to some extent, an equity investor in the person to whom he has credit exposure, and the risk which lies at the base of any credit risk is not the risk that the creditor will not perform his obligation, but that he cannot.
The best way of mitigating credit exposure is payment, and consequently the best tool for mitigating the credit risk involved in the relationship is money.
Money is useful for the debtor
Gleeson notes, only payment of debts can purchase freedom of action.
Quote from Mitchell Innes:
The really important characteristic of a credit is not the right which it gives to “payment” of a debt, but the right that it confers on the holder to liberate himself from debt by its means.
Money is useful for the creditor
Money, Gleeson observes, is a credit risk allocation technique in its essence.
Note this quote:
In a money-free system, no transaction can take place where the resulting transaction would involve one person assuming a credit exposure to the other which exceeded their risk tolerance. At its best, this would result in an economy in which the maximum possible transaction volume was significantly lower than the total credit risk appetite of the participants in that economy.
Virtual currency can be a risk transfer mechanic
Provided that it is regarded as money.
[T]he function of transferring credit risk can only be performed by an instrument which extinguishes that risk — giving security from a debt is a different thing from extinguishing it. Transfer of an obligation can only be effected by an extinction of the obligation to the transferor obligor. However, if virtual currency is accepted by a creditor in extinction of the obligation due to him, then the risk concerned has been effectively transferred.
Money requires immortality
Gleeson notes, any token to function as a store of value needs a degree of permanence.
In comparison with physical money, bank money has little to no deterioration risk — assuming the continuation of the bank.
Virtual currency may provide even a higher level of comfort than traditional bank balances in view of that a distributed ledger is immortal.
Cental bank issued note vs government bond
Gleeson concludes, there is no necessary difference between the two in law — but, in the marketplace, there is.
The principal differences are:
- the government bond (sometimes) pays interest
- the government bond has a maturity date, prior to which it can only be converted into currency through sale to a third party, and
- the note is, but the bond is not, designated by law as legal tender.
But, Gleeson notes, all these differences are contestable, given that:
- short-term government paper generally does not carry a yield
- almost all government paper can be immediately exchanged for currency with the relevant central bank (albeit at a cost), and in the financial markets it is common to satisfy an obligation by transfer of high-quality government paper in settlement of obligations, and
- legal tender status is irrelevant to monetary status.
Central banknotes are not credit claims on the central bank
They function as tokens.
Gleeson illustrates:
If a customer went into the Bank of England, handed a £10 note over the counter and demanded payment, the bank would discharge its obligation by handing him the same £10 note back again. It seems relatively clear that if this is a credit obligation, it is a credit obligation of a unique kind. The better view is therefore that it is probably wrong to describe such instruments as credit instruments in any meaningful sense of the word.
A “promise to pay” by a central bank issuer does not give money value — the central bank has nothing to pay with except the thing that the claimant already has, Gleeson notes.
Virtual currency is not a credit claim
The holder of a virtual currency does not expect to incur further obligation to the virtual currency issuer.
A unit of a virtual currency is a freestanding thing which does not embody a credit claim on any other person.
Money, to be money, must be a risk-free asset
Gleeson points out that money can be used to produce a safe debt — along with the backing with the government’s taxing power or use of collateral. That safety is derived from social acceptance.
If value is simply what people will give for an asset, and the value of what they will give for it is exclusively determined (as it is with money) by their estimation of what they will get for it, then we rapidly create a self- reinforcing valuation mechanism, in which the consensus as to treatment of money as risk- free results in the money actually becoming risk- free.
However, take note of the paradox (which is painfully familiar to historians of sub-prime securitisation paper): a thing which circulates rapidly may be perceived by every one of its holders as low- risk despite the fact that the risk which it poses to them in aggregate is high- risk.
Is near-money* risk-free?
It depends on the likelihood that it cannot be either used as money or converted into money, Gleeson argues.
* Near-money is any instrument which can easily be exchanged with a high level of confidence for money. Such instruments are not money because they cannot be used to discharge debts directly. Example of near-money is foreign currencies.
Is virtual currency risk-free?
No, it is a currency risk — a risk that the currency will not be accepted at its assumed value by others.
Money, to be money, must be information-insensitive
Given that different assets can only be priced using a common metric, and money is that metric.
There is a hierarchy of paymasters
The central bank acts as a paymaster to commercial banks and payment service providers. (The central bank provides the money in two forms — notes and coins (commodity money), and deposits maintained with the central bank (these are together referred to as the “monetary base”).)
Those commercial banks and payment service providers act as paymasters to the rest of the economy.
Are banks the producers of money because of their credit creating function, or do they have their credit creating function because they are producers of money?
Gleeson argues, the answer is neither.
It is possible for an entity to be a producer of money without being a credit creator.
And it is possible for an entity to be a credit creator without being a producer of money.
However there is a convenience factor in performing the two functions within the same entity which seems to create a sort of commercial centripetal force, drawing the two together.
Plus keep in mind the payment service function banks perform.
The key point here is that the reason that we use commercial bank deposits as stores of value is that the only reason for holding money is to spend it, and the most efficient way of making a payment to another person in a modern economy is by instructing a bank to make that payment. Hence keeping money ‘in the bank’ is simply another name for having money prepositioned so that it can be spent as easily as possible. …[T]he utility of money rests entirely on the fact that it may be spent, and the opportunity (or desire) to spend it may arise, at an unpredictable time. If it must be kept somewhere, the rational place to keep it is in a situation where it may be disbursed with the smallest amount of effort — in other words, with a paymaster.
Does money creator (or paymaster) has to be a deposit-holder (i.e. a bank)?
Gleeson argues that deposit taking and payment service provision are not necessarily interlinked.
But they are generally encountered together.
Money on the bank account is not what it seems to be
Take your time to familiarize with the below quote:
[W]hen we ask what, in modern society, is meant by having ‘money’, the answer is having a claim on a financial institution…It is worth pausing to examine this situation in a little more detail. Although the balance on the customer’s account with his bank is denominated in money units, it is actually no such thing — there is no money anywhere which is actually owned by the customer. The only money involved in the process is owned by the bank. What the customer has is the right to instruct the bank to transfer money to someone else — in other words, what he has in law is no more than a right to give instructions to a person who is under a legal obligation to act on those instructions. This sounds odd, but only because we have the intellectual habit of conflating ownership and alienability. This conflation can be dissolved when considering money because of the fundamental nature of money. Money is unique in that it is of no use in itself, but its only purpose is to discharge obligations owed to others; consequently, the core characteristic which anything must have in order to be able to function as money is unrestricted transferability. It follows from this that ownership of money is an irrelevance — if I have the power to instruct a particular person to transfer a specified amount of money to another, it is irrelevant to me whether I am said to own it or whether he is said to own it, provided that my right to have it transferred is valid.
Principle of nominalism
The state has an absolute right to prescribe what at any given time is meant by its national currency (UK — “sterling”, Russia — “rouble”, EU — “euro”).
If I contract to sell you a new Fiat 500 in twelve months’ time, what I am contracting to sell you is whatever the Fiat company choses to market under that label at that time. In effect, what we have agreed between us is that the subject matter of the contract between us shall be defined by a third party, and the terms of that determination shall become part of the contract. Thus, if I contract to deliver sterling to you at a point in the future, and the UK government chooses to change its definition of sterling at some point prior to the obligation falling due, my obligation is to deliver whatever the UK government chooses to define as pounds simply because that is what the contract between us provided for. There is no special magic of monetary law involved. Equally, there is nothing difficult about the two of us contracting out of the UK government’s definition of a pound and substituting another of our own if that is what we wish to do. This practice used to be widespread in the era of high inflation, and this was the function of ‘gold clauses’* in contracts.
* Gold clause provides that an amount payable in a currency should be payable at the value in gold of that currency on the day of contracting. For example, if an obligation is for X pounds sterling, the clause might provide that on the payment date the obligation should be to whatever amount would worth in gold of X points at the contract date.
And one more quote:
To take a recent example, imagine a depositor holding a deposit of French francs with a US bank immediately prior to the creation of the euro. If the depositor were to go to the bank the day after the adoption of the euro and say ‘repay me my French francs’, the response he would get from the bank would be that the term of the agreement between them was that the bank should pay to the customer whatever ‘counted’ as a French franc, and if the government of France had proclaimed (as it had) that henceforth the franc was to become the euro, then the obligation of the depositholding bank was to repay euros, and only euros. The point is that although the claim may be a private claim between private parties, the claim is for the thing defined by the sovereign as such, and both parties effectively agree that the question of what is meant by the term ‘French franc’ is up to the French government to determine. It should be noted that there is no reason why the parties should not contract out of this arrangement, or indeed as between themselves define the term ‘French franc’ to mean anything they please at any time that they please. However, where two parties contract in the currency of a country, the assumption is that what they mean by that currency is what the government of the country says it means.
There is no legal definition of the term “money” at English law
English courts regard English money as money because English law tells them to.
They also regard foreign money as money — despite the absence of any law telling them so. But there is no definition which can be used to decide which foreign moneys are in fact money.
Anyway, legal certainty should support social consensus, but is a very poor tool with which to try and create that consensus.
Only sovereign currency is “money”?
There is no legal basis for this.
How free are the courts to recognise private intention as determinative of money status?
Gleeson argues that where the law confronts a body of activity which is conducted amongst a group on the basis of a common orthodoxy, the starting point should be to recognise and enforce that orthodoxy.
Moneys depend
Gleeson concludes that the answer to the question “should this be treated as money” is to ask how the parties to the contract intended it to be treated.
Nonetheless, parties to a contract may make what commercial terms they like, but must contract within the framework of the law.
Virtual currency is an investment?
If it is, a person dealing in it by way of business will be required to be an authorised firm, or to deal with or through an authorised firm. Regulatory customer protections must be applied. Plus the establishment of a venue on which it can be traded may require authorisation as constitution establishing a regulated exchange or trading venue.
Virtual currency is a security?
If it is, its offering may require a prospectus.
Virtual currency and deposit-taking
Gleeson discusses, holding money for another person constitutes deposit- taking, and since most virtual currency is held through service providers, the question of whether that service constitutes deposit- taking is an important one.
Virtual currency and payment systems
Further, Gleeson states, the operation of a payment system is itself a regulated activity, and a system whereby virtual currency units are employed to discharge payment obligations can in certain circumstances require the operator to be authorised as an operator of a payment system.
Disclaimer: This is my personal blog. This is neither a legal opinion nor a piece of legal advice. The opinions I express in this blog are mine, and do not reflect opinions of any third party, including employers. My blog is not an investment advice. I do not intend to malign or discriminate anyone. I reserve the right to rethink and amend the blog at any time, for any or no reason, without notice.
