Incompatibility of the functions of money

The first observation that is worth making about the nature of money is around the currently adopted functions. Money commonly functions as both a medium of exchange and a store of value.

A medium of exchange is a dynamic function. Money functions as a medium of exchange when it is in motion. Money in a wallet or in a bank vault is not functioning as a medium of exchange. It is only when it changes hands that it performs that function.

Store of value, on the other hand, is a static function. For the most part, the purpose of a store of value is to stand still.

So the dynamic characteristics of a medium of exchange and a store of value are essentially opposite. Is it necessary that the medium of exchange and store of value be performed by the same instrument? Why couldn’t corn be used as a medium of exchange and gold as a store of value?

The “original sin of money” is the decision to join together the two functions and perform them using one instrument. Silvio Gesell writes, “the power of money to effect exchanges, its technical quality from the mercantile standpoint, is in inverse proportion to its technical quality from the banking standpoint”.

Nature of goods & services

The second observation that can be made is about the exchange process and the nature of the goods and services that are being exchanged.

Most goods & services lose value with the passage of time. Milk goes bad, metal rusts and termites eat wood. Increasing entropy is a law of nature. The laws of nature can’t be changed to suit our preferences, so we must adapt ourselves around these laws.

A consequence of this fact, that nearly all forms of tangible wealth lose value with the passage of time, is that people who earn a living by producing goods & services are under constant pressure to sell their wares sooner rather than later. Generally, the longer they wait, the more they lose.

Imbalance of power due to hoardable money

Gold when used as money is the leading example of a material that exemplifies the store of value function.

Gold is one of the very few exceptions to the almost universal law of decay. The holder of money made of gold does not need to fear any loss due to this material. The possessor of gold money can often postpone their demand for goods or services whenever they’d like to do so.

The dynamics of the negotiations are fundamentally different than they would be in a non-monetary exchange where goods & services are exchanged for other goods & services. Now, one side of every transaction is subject to the pressure caused by the laws of nature, and the other side is immune from that pressure.

If holders of gold money don’t like the terms being offered by producers of goods & services, they can break off the negotiations and return home with their gold money. Their money will remain completely intact the next day, the next week and the next year. But on the other side, producers of goods & services suffer losses with every day that passes without concluding a successful transaction.

The introduction of gold money transforms a level playing field into an un-level one. Creating money that also includes the store of value function leads to the creation of an instrument that becomes the master of goods and services. Buyers can withdraw demand at a whim and at a moment's notice at no expense to themselves. Sellers providing their goods and services do not have this luxury.

Falling prices due to hoardable money

The problem that is created by adopting hoardable money is that it results in optional demand. Demand can be paused or delayed as long as the buyer wishes to do so when their money does not have any urgency for exchange due to a lack of decay.

If there is any reason for people to believe that prices might fall they can withdraw their intentions to exchange. This act of withdrawal puts sellers into a difficult position as they do not have the luxury of delaying the exchange. Sellers then become more inclined to reduce the price of their products or services to increase the amount of demand for people to exchange with them.

Most producers of goods & services have little to no ability to postpone their sale due to market conditions. Thus the flow of supply onto the market continues regardless of what happens to prices. But demand can postpone and withdraw at any time, and without penalty. As a result demand can shrink at any time there are expectations of falling prices.

Shrinking demand relative to stable supply can lead to falling prices. So expectations of falling prices cause falling prices to become a reality. And when prices do in fact begin to fall, this further increases the incentives for holders of money to postpone their purchases. This creates a self-reinforcing dynamic where falling prices cause prices to fall even more. And at the same time, the un-postponable processes of production of goods & services cause supply to pile up in the marketplace.

Saving reduces economic activity

Buying and selling become two separate actions under a monetary exchange process. Hoardable money results in demand that is optional. Buyers can decide to save their money instead of spending or investing it at no cost to themselves. Saving might add to individual wealth, but it also can be self-defeating and even be harmful for the exchange process and society more broadly.

The effect of not spending is it means there will be a reduction in demand for consumption below what it would have been if that money had been spent or invested and not been saved. The act of individual saving decreases the demand for consumption, which reduces employment and income.

For the act of saving to be truly productive it instead needs to be invested. Saving money does not help with generating a return or creating economic activity. Investing money is what leads to the productive usage of money for creating additional wealth.

It is natural for people to want to save what they have earned through labour and their investments. However money does not need to be the mechanism that people use to save. Money being used for saving is often counterproductive for economic activity. Everyone relies on the adopted medium of exchange to trade their goods and services for money.

The more that people save with money the less money there is available for facilitating exchange. People are able to save in many other assets that aren’t being used as a medium of exchange such as gold, silver, other precious metals, bonds, fine art, collectibles, jewellery or antiques.

The problem with the store of value property

Silvio Gesell argues that interest exists because we made the irrational decision to join a medium of exchange with a store of value. From Gesell’s perspective, doing so was a fundamental mistake, and interest is the consequence of that mistake.

We can draw an analogy between money and water to articulate the issue of the store of value property. Water can flow, and water can stand still. Flowing water represents money functioning as a medium of exchange. Still water represents money functioning as a store of value.

Let’s imagine that there is a stream with a community of people living on its banks. But this is no ordinary stream. This is a magic stream that enables people to transform the product of their labour into any other good or service that they want or need. The dairy farmer puts his milk into the stream and draws out of it bread, clothing, shelter, and everything else he and his family need in order to live. This magic is the division of labour.

The stream is a vital public resource, and the lives of everyone in the community depend on its flow.

Now let’s say that certain individuals choose to divert the flow of the stream in order to build private ponds. They do this so they will be sure to always have water in case the stream ever stops flowing. What would happen if everyone did this? Obviously it would jeopardise the continuous flow of the stream on which everyone’s survival depends. Furthermore, any time someone saw another person building a pond and diverting water into a private store, they would have an incentive to do likewise. And the more people who build ponds, the stronger is the incentive for others to build ponds too. And, due to the self-reinforcing dynamic of the incentives facing individuals to build ponds, the fear that motivated the construction of ponds in the first place becomes a self-fulfilling prophecy. Before long, everyone will obey the instinct of self-preservation and build a pond, and the collective consequences of doing so will be to bring about the circumstances against which the precaution of building ponds was meant to guard against.

If the flow of the stream was always continuous and reliable, people wouldn’t have to fear it ever running dry. But now, because of people taking precautions against that possibility, that has now made it a reality. Because of everyone guarding against the flow of the stream becoming unreliable, the flow of the stream has in fact become unreliable. To bring the analogy back to the subject of money, by making the decision to use money as a store of value, we have made it unreliable in terms of performing its primary, life-sustaining function as a medium of exchange. Gesell said “the power of money to effect exchanges, its technical quality from the mercantile standpoint, is in inverse proportion to its technical quality from the banking standpoint.”

Now, because of the inherent tension between money’s functions as medium of exchange and store of value, the flow of the stream becomes inconsistent. Sometimes too much water is diverted into ponds and the stream runs dry. And other times everyone decides to release their private stores of water all at once and the stream overflows its banks. Silvio Gesell tells us this is because the store of value function is an unnatural, incorrect use of money.

Hoardable money’s ability to extract tribute

Gesell’s great insight is that money is not a commodity. Money is a tool created by society in order to unlock the enormous wealth creating power of the division of labour system. So exchanging money for goods & services is not like any other exchange of commodities. And because we chose a form of money that is not subject to the same laws of nature and the same compulsion to circulate as the goods & services it is used to exchange, we have created a situation in which the blood of the economic organism extracts “tribute” whenever it facilitates exchange. So to investigate this concept of “tribute” more closely, Gesell writes:

“The present form of money acts as intermediary for the exchange of wares only on condition that it receives a tribute. If the market is a road for the exchange of wares, money is a toll-gate built across the road and opened only upon payment of the toll. The toll, profit, tribute, interest or whatever we choose to call it, is the condition upon which wares are exchanged. No tribute, no exchange. I wish to avoid any possibility of misunderstanding. I am not now speaking of commercial profit, of the payment which the merchant can and does demand for his work. What I speak of here is the profit which the possessor of money can demand from producers, because he can paralyse the exchange of wares by withholding his money. This profit has nothing in common with the merchant’s profit; it is a separate effect produced by money itself, a tribute which money is able to exact because, unlike all other wares, it is free from the material compulsion of being offered for sale… Wares must pay money a tribute because money is free; there is no other possibility. Without this tribute money will not be offered in exchange, and without money to effect exchanges no wares will reach their destination. If, for any reason, money cannot exact its accustomed tribute, there is a crisis; wares lie where they are and rot.”

According to Gesell, money should have been designed to make exchange as automatic, frictionless and efficient as possible. But because we misunderstood its appropriate functions, we designed a form of money that inhibits exchange and extracts value from it.

If we return to the metaphor of money as the blood of the economic organism, we designed a form of blood that does not flow of its own accord. Gesell states that the offer of goods & services for sale is not dependent on the will of their producers. They have to be offered for sale no matter what, and their physical nature punishes anyone who does not do so. But the nature of money does not compel it to circulate. As a result, a drug must be administered to force the blood to circulate. That drug is interest.