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 The Current Constitution of Money

Three Kinds of Money

In order to understand the possible implications of the introduction of CBDC,
it is useful to first look at the forms of money in our existing payment and banking system. In this system, we find three different kinds of money: physical cash (notes and coins), bank money on account and central bank reserve money. The interaction between these three kinds of money in the creation, circulation and destruction of money is described in great detail by a number of authors. Instead of reiterating these descriptions, we shall summarize the nature of existing money according to three questions:

What counts as this kind of money?
Who can use this kind of money? Where does this kind of money come from?

The first may be understood as the question of the ontology of aparticular form of money, the second as a question of accessibility, and the third as a question of supply.

As cash we count the legitimate paper notes and metal coins in circulation in the economy. This kind of money is accessible to all money users in the economy including private money users, commercial banks, central banks and governments. Cash is typically printed, minted and supplied by the central bank. In some cases such as UK and US only the printing of paper notes is undertaken by the central bank while the minting of coins is the prerogative of the treasury. Cash is supplied in response to demands from money users, who want to exchange their bank money for cash. This transaction is mediated by the commercial banks that purchase cash for central bank reserve money in order to accommodate the demand from money users.

As bank money on account we count electronically recorded deposit account liabilities on the ledgers of commercial banks. This bank deposit account money constitute assets for money users. Bank money is accessible to all money.


users in the economy in so far as they have a bank account. Bank money is supplied into the economy, when commercial banks credit the deposit accounts of money users. This typically happens as part of the extension of loans to borrowers. Money users thus exchange debt for bank money. Bank money may also be created as part of financial trading, when sellers of financial securities or cash happen to hold deposit accounts with the bank, which are then credited as payment of the bank's purchase of securities or cash. It is also possible for commercial banks to create bank money, when they make payments of salaries, goods purchases or dividends to employees, suppliers or shareholders, who happen to hold deposit accounts in the bank. When deposit account holders make debt repayments or interest payments to the bank, bank money is destroyed.


As central bank reserve money we count electronically recorded current account liabilities on the ledgers of central banks. This money is only accessible to money users that hold an account with the central bank. Central bank account holders typically only include commercial deposit banks, the treasury and foreign central banks. In some cases, certain non-bank financial institutions as well as employees of the central bank may also hold an account with the central bank and thus have access to central bank reserve money. Central bank reserve money is mainly supplied by being credited to commercial banks' current accounts as part of the purchase of governments bonds or certain other financial securities. Commercial banks may also borrow central bank reserve money from the central bank, which are then credited to their account. Such borrowing normally requires the commercial banks to post collateral in the form of financial
securities. Central banks also create reserve money, when they credit the government's account in the central bank as payment of dividends or in exchange for government bonds. Such direct monetization of government debt is, however, prohibited under the EU Lisbon Treaty (§26). It is also possible for the central bank to create new reserve money by crediting the accounts of foreign central banks in exchange for foreign currency reserve money.


Comparing these three kinds of money in terms of ontology, accessibility and supply, we can group them in three pairs each sharing a particular feature, which the third kind lacks:

• Bank money and central bank reserve money are both electronic, which cash is not.

• Cash and bank money are both universally accessible, which central bank reserve money is not.

• Cash and central bank reserve money are both supplied by the central bank, which bank money is not. 

This logic is illustrated in the Venn diagram below:

The features of existing money

We shall return to this diagram later.

Three Perspectives on Money

It may seem that with the description of our current money system as constituted by three different kinds of money, we have been jumping ahead of ourselves. Do we not need an initial definition of money before we proceed to describe, what counts as money? What about treasury bills and government bonds? What about money market instruments? What about Bitcoin? What about gold? Are these not also different kinds of money?


Discussions about the definition of money are usually raised through the question: What is money? And this question is usually settled through a listing of the three functions of money: medium of exchange, store of value, unit of account. This kind of textbook account of money, however, suffers from a confusion of two things. It answers the question of what money is by listing what money does. While the distinction between the three functions of money is indeed useful, this should not lead us to conclude that it has provided us with a definition of money. If we dig below the surface of textbook economics and explore the history of the discipline, we find that there is in fact no consensus on the definition of money. What we find instead is a number of different answers to the question: What is money. In another work, I have mapped out these answers and grouped them into three different theories or schools of thinking: the commodity theory, the state theory and the credit theory. While these different theories may be identified and personified in particular thinkers in the history of economics, they also constitute three ideal typical perspectives on money that coexist and compete in contemporary discourses on money. The distinction between these three different perspectives on money is relevant in the discussion of CBDC, as we can use it to group different kinds of concerns and interests regarding the design and implementation of this new kind of money. The three perspectives are summarized in the following:

The money user perspective

What would you answer a four year old child, who asked the questions: What is money? Even though money is used for a variety of purposes such as settlement of debts, comparison of value, payment of taxes, saving, speculation, etc. the arch typical image of money in action is probably the exchange of money for commodities in a store. Chances are, this is also the example that you would invoke in your answer to the child: Money is a thing that we use to buy milk, carrots, bread and other commodities at the supermarket. And to further illustrate the point, you might show the child a 100 kroner note and some coins and say: This is money?


The 'cash in the supermarket' example of money, puts to the fore the function of money as medium of exchange. This is the so-called commodity theory of money. The obvious reference point is Adam Smith's classical story about the butcher, the brewer and the baker, who overcome the 'clogged and embarrassed' operations of barter by adopting precious metals as means of exchange. The gist of the story is the explanation of how money emerges as one particular commodity, usually gold or silver, that is singled out as a generally accepted medium of exchange to perform the function of payment for all other commodities.


We shall refer to this as the money user perspective on money. The vantage point of the money user perspective is the private individual or company, for whom money is primarily a means to buy and sell commodities, services, capital, labour, etc. The money user is thus first and foremost concerned with the functioning of money as a medium of exchange: Which kinds of money can be used to make payments in the supermarket? How can I use my mobile phone to transfer money? Does my company have to accept payments in cash? What happens to people without a bank account, when more and more payment systems are digitalized? These concerns also include questions of security and privacy: Can my my bank account be hacked when I make payments over the internet? Can the government and others trace my use of money, when I make electronic payments? Can crime and illicit economic activities be inhibited through the abolition of cash? From the money user perspective the difference between cash and bank money is merely one of practical functionality. The former is physical and the latter is electronic. Since central bank reserve money is not available to the ordinary money user, this kind of money barely registers in this perspective.

The money manager perspective

What would we answer an eight year old child, who asked the question: What
is a bank? A simple answer would be that a bank is a place that keeps our money safe, so we don't have to worry about losing our money or being robbed. A bank is a place that stores money. If the child is smart, we might make our answer slightly more sophisticated by explaining how people with a lot of money put them into the bank, where people with less money may then go and borrow money. And if the child is very smart, we might tell the full story that today banks are the primary suppliers of money in the economy since the money that we use for our electronic payments are credits with commercial banks. This bank account credit money are borrowed into existence when money users take out new loans.


When we shift our perspective from the 'cash in the supermarket' to the 'debt
in the bank' image, we arrive at a very different understanding of money. We do not go to the bank in order to buy goods and services. We go there to get a loan or pay off our debts and interest. And while banks do of course use money to pay salaries to their employees and to buy different kinds of inventory, their defining characteristic is the capacity to issue liabilities that maintain a stable value over time and thus function as the supply of money in the economy. The value of contemporary bank account money is not 'stored' in commodities such as gold or other kinds of money such as cash or reserve money. The assets 'mirroring' the value of deposit liabilities on bank balance sheets largely consist of loans to different kinds of money users. In brief banks operate by storing value in the form of money backed by debt. This account of banks is elaborated in the so-called credit theory of money. Classic references in this theory include Joseph Schumpeter and the lesser known Alfred Mitchell-Innes but in recent years the theory has been picked up and developed to account for the contemporary economy. The theory conceives of money as a particular form of debt, which is universally accepted in payments in the economy due to the exceptional status of the debtor. In our economy today, commercial banks have this position as universally accepted exceptional debtors, which is why their liabilities are conceived as an exceptional store of value.


We refer to this as the money manager perspective on money. The vantage
point of this perspective is obviously the commercial bank but we may also include affiliated financial institutions such as the investment bank, the hedge fund, the pension fund, etc. that share the function of earning money by managing money. The money manager is primarily concerned about the ways that money functions as a store of value. The business model of a bank is to manage the interplay between money liabilities on the right hand side of the balance sheet and non-money assets on the left hand side. If bank liabilities lose their capacity as an exceptional store of value, banks will be the subject of different types of bank runs and they are eventually going to go out of business. The key to this business model is of course the earning of interests. Since bank liabilities are perceived as exceptional stores of value, money users accept to hold these at a relatively low rate of interest, while at the same time paying a higher interest rate on their loans to the bank.


The concerns of the money manager include questions such as: How do my
bank account money retain their capacity as superior stores of value relative to cash and central bank reserve money? How much can I expand the balance sheet
of my bank and thus the potential sources of income without jeopardizing the capacity of my liabilities as stores of value? How do I prevent the liabilities of other types of institutions to compete with the exceptional status of my liabilities as money? In the money manager perspective, the difference between different kinds of money is constituted by the fact that cash and central bank reserve money are non- or low-interest earning assets on the balance sheet of the bank, while bank account money are liabilities on the balance sheet where they emerge as counter items to loans, securities or other high- or medium-interest earning assets.

The money maker perspective

Now finally, what would we answer a twelve year old child asking the question: What is a krone? Again, we might begin with a simple answer: The krone is the currency of our country Denmark. If you go to another country such as for instance UK prices are listed in pounds and you have to pay in another kind of money. But perhaps the child insists and says: Yes, I know that, but I did not ask what is the krone, I asked what is a krone? By way of an answer, we might find a 1 krone coin in our wallet and point to it saying: This is a krone. Since we know this child to be very smart (he understood how banks create money already when he was eight) we might add: Why are you asking such a simple question? And now the child says: I heard someone on the news talking about the cashless society and I was wondering that if we no longer have physical notes and coins, how do we know what a krone is?

What is at stake in this question is the function of money as a unit of account.
Prices of commodities and services as well as outstanding debts within an economy are denominated in the currency of that economy. The currency thus functions as a numeraire allowing us to compare the value of different things and obligations by using a common monetary standard as bench mark. There are a number of different factors that determine, which currency counts as unit of account in an economy. Proponents of the so-called state theory of money point to the denomination of taxes as the most decisive factor. The classic reference for this theory is Georg Friedrich Knapp, who, among other things, served as a key inspiration for Keynes. The sovereign state has the power to determine the currency in which taxes and other debts to the state must be paid. It can also impose legal tender laws to extend this to the payment of other debts among citizens. This creates a constant and general demand for a particular kind of money in the economy, since most people will eventually need some of this money to pay their taxes and debts. The state then usually combines the power of taxation with a monopoly on money creation. It is then in a position to create the very same money that the citizens need in order to pay their taxes and debts. Once a particular currency is instituted as the general unit of account, this money automatically begins to function as a general medium of exchange and store of value in the economy.

The difference between the question:

'What is the krone?' and the question:
'What is a krone? is a difference between abstract and concrete unit of account. When we encounter prices denominated in kroner in the supermarket or debts denominated in kroner from the bank or the tax authorities, we encounter the krone as an abstract unit of account. But this function of money ultimately relies on the designation of a concrete unit of account. In order to price commodities, services and assets in terms of a currency, we need to know what is ultimately 'a Krone' or 'a Pound'. Among themselves money users may decide to use all kinds of things to settle payments. A car dealer may agree to accept two used cars in payment of one new car. A bank may agree to accept government bonds in payments of a debt. A farmer may pay his workers in produce and accommodation. But in order for the currency to function as a stable unit of account it has to legally designate some entity as the ultimate incarnation of money? The point here is not that money ultimately has to rely on gold or another commodity with intrinsic value. It is not even that money ultimately has to have a physical manifestation. There just has to be a final benchmark for the measurement of different prices. There has to be some entity, where exchange value and nominal value coincide by definition.


Our current money system relies on a monetary division of labour between the
commercial banks, the central bank and the treasury. The treasury has the sovereign power of taxation. It accepts payment of taxes in three different kinds of money: cash, bank money and central bank money. This means that all of these monies principally count as concrete units of account. Since central bank reserve money is only accessible to banks, this payment option is closed to all other money users. Furthermore, the payment of taxes in cash is in most modern economy quite inconvenient and cumbersome. This means that commercial bank account money is the dominant concrete unit of account.


The sovereign power of taxation exercised by the treasury is today used to
support the creation of money exercised by commercial banks. There are, however, a couple of caveats in this monetary order. Money users still have the right to convert their bank money into cash in effect forcing the banks to pay their debt to the money users in notes and coins. Banks also have the right to demand their mutual credits settled in central bank reserve money. The role of the central bank is to prevent either of these two things from happening. The policy mandate of financial stability translates into the responsibility to maintain parity between cash, bank money and central bank reserve money thus maintaining the issuance and circulation of bank money at its nominal value. The sovereign state in the form of the treasury and the central bank take responsibility for the maintenance of the abstract unit of account. In turn, the de facto control of the concrete units of account has been outsourced to the commercial banks.


We refer to this kind of questioning into the nature of money as unit of account as the money maker perspective. Even though the state as incarnated in the government, the treasury and the central bank seems to have relinquished much of its control of the making of money, these institutions still constitute the natural vantage point of the money maker perspective. In so far as these institutions are not only incarnations of the state but also the representatives of the people of the democratic state, the money maker perspective is also the perspective of the citizen. While concrete money units of account are unevenly distributed among the money users in the economy, the currency as such is (or at least should be) a public common of all citizens regardless of their individual wealth. Even the debtor (or perhaps especially the debtor), who owns less than no money, has a legitimate interest in the currency in which his debt is denominated.


The primary concern of the money maker perspective is the question of sovereignty: Who controls the creation of money in the economy? What are the conditions for sovereign monetary policy? How does monetary policy correspond with the interests of the democratic state? What are the relations and boundaries between monetary and fiscal policy? In the money maker perspective, the crucial difference between the three kinds of money is that cash and central bank reserves are subject to the state monopoly on money creation, while bank money is issued at the behest of a particular kind of private companies. Another important difference is that electronic bank money and central bank reserve money can be interest bearing, while physical cash is by definition interest free.