Haute Lumière
Commerce · III.01 · MMXXVI · daylight
TEN CONCEPT BRIEFS · Chapter III.01 — What a Currency Is Made Of
One page each. A reader who reads only these ten pages has the chapter.
BRIEF 1 — The Four Functions
The idea. Money is not one thing. It is four jobs that happen, in most economies, to be performed by the same instrument.
- Unit of account — the ruler. What prices and contracts are written in.
- Medium of exchange — the thing handed over.
- Means of settlement — the act that makes a debt finally discharged.
- Store of value — what holds purchasing power across time.
Jevons set out the classic four in 1875. Keynes, opening A Treatise on Money in 1930, ranked them and put the unit of account first: money is whatever discharges a contract written in the money of account, so the account comes first and the money second.
Worked example. A Chilean mortgage is priced in Unidades de Fomento, paid in pesos, and the borrower's savings sit in a pension fund. Three instruments, three jobs, one household, and nobody finds it strange.
Why it matters. Once you can see the four separately you can design for one at a time. A currency that fails is almost never failing at all four. It is failing at one and dragging the others down with it.
You already know this because you have measured a room in metres, paid for the paint in pounds, and stored the value of the work in the house — and you did not confuse the tape measure with the money.
BRIEF 2 — The Unit of Account
The idea. The unit of account is a ruler, and rulers are useful in proportion to how boring they are.
It does not need to exist physically. It does not need to be held. It needs only to be published, agreed, and stable enough that two people signing a twenty-year contract mean the same thing by it.
Worked example — the Unidad de Fomento. Created by decree in Chile in January 1967 and published daily by the central bank, the UF exists only as a number. In 2024 one UF stood on the order of 37,000 pesos. A mortgage of 3,000 UF is settled at 3,000 × 37,000 = 111,000,000 pesos on the day. The borrower never touches a UF because there is nothing to touch.
Why it matters. Chile kept long contracts meaningful through decades of inflation that would otherwise have destroyed them, without abandoning the peso. The lesson is that you can fix the ruler without replacing the money — which is the cheapest monetary reform available to anybody.
You already know this because you have quoted a job in days rather than money, and both parties knew exactly what was meant.
BRIEF 3 — Means of Settlement, and Finality
The idea. Settlement is the moment a debt stops being a debt. It is different from exchange, and the difference is finality.
Handing over a cheque exchanges value. The debt is discharged when the cheque clears — and between those two moments somebody is carrying risk.
Worked example — Ireland, 1970. From 1 May to 17 November, 200 days, the Irish clearing banks were shut by a dispute. Uncleared cheques circulated, endorsed by each holder. The pound remained the unit of account. Settlement was suspended for six and a half months and the economy kept running on personal credit assessment, largely conducted by publicans.
Why it matters. It shows the binding constraint on a payment system is not machinery. It is information about who is good for it. Any settlement design that ignores where that information lives has misunderstood the problem.
You already know this because you have let a friend pay you back next week without a second thought, and refused the same terms to a stranger.
BRIEF 4 — The Store of Value
The idea. A store of value carries purchasing power forward. It is the only one of the four functions that rewards not using the money.
Worked example. Gold in a vault is a store of value that settles nothing and prices nothing. A government bond is a store of value with an explicit issuer. A woodland is a store of value that regenerates while you hold it — which is the only kind this volume is ultimately interested in.
The separation test. Ask of anything: does it price? does it settle? does it hold? Most instruments score one or two. Very few score three, and the ones that try usually do at least one of the jobs badly.
Why it matters. Saving is not the problem; unspecified saving is. A pound held as an idle balance is withdrawn from circulation and regenerates nothing. A pound in a dated claim on a regenerating stock is in circulation the moment it is subscribed. Same act, two designs, opposite effects.
You already know this because you keep your emergency fund somewhere different from your current account, for reasons you have never had to explain.
BRIEF 5 — The Credit Theory of Money
The idea. Money is not a commodity that happens to be used for exchange. It is a transferable record of obligation, and the token is a convenience laid over the record.
Alfred Mitchell-Innes, in the Banking Law Journal in 1913: credit and credit alone is money.
Worked example — Yap. The rai stones of the Caroline Islands, described by Furness in 1910 and revisited by Friedman in 1991, were up to about 3.6 metres across and were rarely moved when ownership changed. Ownership changed by public acknowledgement. One stone lost overboard in deep water continued to be owned and traded. The number of stones that had to move for ownership to change was zero. The stone was never the money; the island's memory was.
The English counterpart. Exchequer tallies — notched, split hazel sticks — recorded Crown debts from the twelfth century until 1826, roughly seven hundred years. They circulated because the Exchequer accepted them back in payment of tax.
Why it matters. If money is a record of obligation, the design question is never what shall we back it with. It is whose obligation, recorded how, accepted by whom.
You already know this because you have kept a running tally with a sibling for years without either of you writing anything down.
BRIEF 6 — Endogenous Money
The idea. The money supply is an outcome of lending decisions, not an input to them.
The strongest available source is the most conservative one. The Bank of England, Quarterly Bulletin 2014 Q1, McLeay, Radia and Thomas: whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money. And: rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
The composition. The same bulletin states that banknotes and coin are about 3 per cent of the money in the economy. Checked a second way against UK aggregates — £82 bn of notes and coin against £2,920 bn of M4ex — the currency share is 2.81 per cent and the deposit share 97.19 per cent. Two routes, 0.19 of a percentage point apart.
Why it matters. Ninety-seven per cent of the money you use is somebody's bank debt. The money supply and the debt stock are not two variables that happen to correlate. They are one variable seen from two sides of a ledger.
You already know this because nobody at your bank has ever gone to a vault when you asked for a loan.
BRIEF 7 — The Balance Sheet When a Bank Lends
The idea. Two entries, same size, opposite sides. Nothing moves.
the advance GBP 200,000
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ASSETS + loan to customer GBP 200,000
LIABILITIES + deposit in account GBP 200,000
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change in the bank's net worth GBP 0
change in broad money GBP 200,000What is actually constrained. Not reserves. Capital, and the price of funding. On a residential mortgage at a 35 per cent risk weight against a 10.5 per cent total capital requirement:
risk-weighted assets 200,000 x 0.35 GBP 70,000
capital required 70,000 x 0.105 GBP 7,350
money created per pound of capital 27.21 xAnd the drain. When the borrower pays a builder who banks elsewhere, 60 per cent of the deposit leaves and must be replaced at wholesale rates. Loan yield 5.40 per cent, wholesale funding 4.90 per cent, retained deposits paying 1.20 per cent: net interest of £3,960 in year one, a margin of 1.98 per cent.
Why it matters. The creation is free. The retention is not, and that is the real discipline on a bank.
You already know this because you have watched a firm run out of cash while its balance sheet was still profitable.
BRIEF 8 — Money Destruction
The idea. Repaying a loan does not return money to the bank. It deletes it.
The entries reverse. The loan asset is extinguished, the deposit liability is extinguished, and the broad money that existed a moment ago does not exist. No note is burned and no announcement is made.
Worked example. Against a UK deposit stock of £2,838 bn, a net paydown of 1 per cent in a single period removes:
2,838 bn x 1% = GBP 28.38 bn of broad moneyTwenty-eight billion pounds of medium of exchange gone, with every individual household having done the prudent thing.
Why it matters. It is the cleanest statement of the paradox of thrift available, and it is not a theory — it is double-entry bookkeeping. It also explains why credit contractions are so much worse than the arithmetic of defaults suggests: the money supply falls at the same time as the willingness to spend it.
You already know this because you have watched a downturn in which everyone was careful and things got worse anyway.
BRIEF 9 — Which Functions Conflict
The idea. Three of the four functions want stability and circulation. One wants appreciation and retention. That is the entire monetary argument.
A unit of account is useful in proportion to how boring it is. A medium of exchange is useful in proportion to how fast it moves. A standard of deferred payment is the unit extended through time and wants exactly what the unit wants.
The store of value wants the opposite, and here is the cost, priced:
unit appreciating in real terms 2 %/yr
term of the credit contract 30 yr
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(1.02) ^ 30 1.8114
real cost of the final payment vs the first 81.1 % moreA currency that holds value perfectly makes the last payment of a thirty-year mortgage cost 81.1 per cent more in real terms than the first.
Why it matters. A perfect store of value is an impossible unit of account for anybody who owes anything. Every long-dated credit system in history has either kept a mild positive drift in its unit or has periodically forgiven debts, and now you know why both practices exist.
You already know this because you have felt a fixed old debt become trivial after a decade of rising wages, and understood instinctively that somebody on the other side lost exactly what you gained.
BRIEF 10 — Demurrage, and What It Costs the Forest
The idea. A carrying cost on holding money makes it circulate. It also makes it impossible to save in, and long-lived regenerative capital is funded by saving.
Gesell proposed stamped scrip in 1916; Fisher wrote Stamp Scrip in 1933; Wörgl ran it in 1932 at one per cent a month.
demurrage 1 %/month
effective annual carry 1.01^12 - 1 12.6825 %/yrThe arithmetic that nobody quotes. Assemble £1,000,000 over twenty years for a woodland, a soil programme or a heat network:
annuity factor ((1 - 0.126825)^20 - 1) / -0.126825 7.3615
annual contribution required GBP 135,842 /yr
total contributed over twenty years GBP 2,716,840
the same fund in a zero-carry currency GBP 1,000,000
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penalty factor 2.717 xThe threshold. Solve for the demurrage rate at which the twenty-year penalty reaches 2×: 8.19 per cent a year, or 0.658 per cent a month. Below that, a patient investor absorbs it. Above it, nobody assembles twenty-year capital in that currency, and the economy becomes more dependent on bank credit, not less.
Why it matters. It is the honest negative of this whole volume and it points straight at the design answer: you do not fix hoarding by making saving expensive. You fix it by making saving specific — a dated claim on a stock that regenerates while you hold it.
You already know this because you have met someone who spends freely and someone who saves rigidly, and known perfectly well that the economy needs both.
All figures in these briefs are computed in lib/verify/III_01.py and printed by python3 lib/verify.py III.01, with inputs, units and sources. They are cited in the chapter's Works Cited.