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A Slightly Broader View of Money

Clive Mphambela

The evolution of modern money as we know with all its desired characteristics of stability, transferability, credibility, liquidity, divisibility and so on has taken several years of iterative behaviour by economic agents. It however accepted that the narrow version of money that we dissected in our last installment needs to be broadened slightly for us to fully appreciate the characteristics of modern money.
As a brief re-cap money is any object or thing that functions well as a medium of exchange, a store of value, a unit of account and a standard of deferred payment amongst the most critical uses of money in modern society.
In this vein the definition of what economists technically call “narrow money” is expanded to include certain types of bank deposits with banks and financial institutions and as well as payment instruments such as travelers cheques. In this country we know of bearer cheques which later replaced bank notes for a number of years, but these were a form of travellers cheque were the requirement for the bearers signature had been waived by the issuing authority.
Therefore in addition to notes and coins (token money) in circulation in the economy, bank deposits also comprise money.
How do bank deposits become “money” in the economy? To answer this question requires us to go back a little bit to the origins of banking, when people used to “deposit” their gold or silver bullion with gold smiths. The smiths would issue the depositors with a receipt to signify and confirm the value of gold held by the depositor. Later people realized they could transfer the receipt from one holder to another as direct payment for goods and services. At the same time the gold smiths would keep a register or ledger with him as a record of each depositors value held. This record was essentially a primitive sort of bank account because when a receipt or claim of gold was redeemed, an equivalent amount was deducted from the clients holdings in the ledger. This is where modern banking terms of “deposit” and “withdrawal” came into being.
However, today, bank deposits constitute the most sophisticated form of money that we know. Just like in the olden days, where receipts signified the value of gold or silver held on ones behalf by the gold smith, bank deposits today represent the debt that the bank owes to its customers. This is because modern money is in fact a debt claim by the bearer on the issuer of such debt (normally the government through the currency issuing authority who, in most cases is the central bank).
A deposit is thus a record of the debt the banker has assumed by executing a transaction on behalf of his customer. The deposit can come into existence via a number of different transactions.
Firstly a customer may simply deposit notes and coins with the bank in exchange for which the banker will acknowledge his indebtedness by recording a credit to the customer’s account.
A deposit can also be created by the banker extending a loan to the customer with the banker acknowledging his debt to the customer in exchange for a customer entering into a loan agreement with the bank.
How and when do bank deposits become money?
However as noted earlier, for bank deposits to become acceptable as a form of money, they must satisfy the various qualities and characteristics of money that we espoused above, and in our discussion last week.
Bank deposits essentially become money if they can be used for payment of goods and services by transferring portions of the deposits to others via a number of instruments of payment. If one can write a cheque against his deposit for the credit of a third party, such a deposit qualifies as money. For this to happen, there a three pre-conditions. The payment instruments must be generally acceptable as a form of payment, there must be a reasonable degree of mutual confidence in the good faith and integrity of those that issue payment instruments such as cheques, electronic cards etc and thirdly and most importantly, there must be a high level of confidence that banks will be able to convert the deposits into legal tender ie notes and coins should the depositor so wish.
It is this third condition that makes bank deposits money as we know it. Just as gold receipts circulated in the full faith that when one wanted the actual gold they could go and redeem their receipts for their value in gold, modern bank deposits continue to be exchanged via various physical and electronic means between bank customers based on the full faith and confidence that the depositors will be able to get their notes and coins at any time should they so wish.
It is for this reason that banks, as a prudential measure, will hold within their vaults a sufficient quantity of notes and coins to meet this expectation of the banking public, without which, bank deposits would cease to be recognizable as money.
Clive Mphambela is a Banker. He writes in his capacity as Advocacy Officer for the Bankers Association of Zimbabwe. For your valuable comments and feedback related to this article, he can be reached on 04-744686, 0772206913, or clive@baz.org.zw.