The great Scottish philosopher David Hume may have been the first to understand that the economics of money is closest to that of language.
Money is one of the most essential social conventions, the other two being language and law. Money is exchanged by humans to coordinate action, now and through time. It is difficult to imagine much human progress would have occurred in its absence.
Despite the obviously immense value of the monetary system, money has no private or physical value, although representations of money can be stored.
The closest economics comes to understanding the value of money is the idea of a ‘network externality’. To my knowledge, Hume is the first to identify this, although his terminology is somewhat archaic. The concept was popularised by the advent of telephony. A telephone’s usefulness depends on its use by others, something distinct to many other goods and services. The classic example is a fax machine. If I alone have a fax machine, it is worthless. If everyone has one, it is extremely useful.
A network externality is a very specific property, with important implications. I typical use three currencies: dollars, euros and pounds. Use of these monies helps me to achieve other things. But a private money would not have these properties. Even a private money with lower transaction costs would not have greater value than dollars or pounds. The value of a money is directly related to how many people use it. It’s value to an individual resides in its acceptance by others. There is a network of users and the value to any individual user is contingent on the use by a network of other users. The more users, the more useful. These properties may be partially true of many other things, but they are inherent properties of tools of communication and and coordination.
How do networks become established? This is important because people often confuse how a network is established with the properties of the externality. This is false. Once established, networks are extremely hard to break – that is why ‘better’ currencies face an uphill struggle. Typically the dominant network is established by the state.
The official currency is usually established by fiat and required for payment of taxes. But once established, it will thrive and prove resilient. There is usually a hierarchy of money and subsidiary, coexisting ‘quasi-monies’ – such as deposits and other private payment systems. The state usually continues to play a role, with inflation targets, deposit insurance and restrictions on private sector substitutes.
Money is very clearly a social asset. It is often a national asset, but its use spreads beyond national borders. The US dollar is an asset to many people globally. Is it possible to put a number on the value of this asset? Contrary to accounting convention, money has no meaningful ‘book value’. It should go without saying that this does not render it valueless. Theoretically we could pose the question like this: how much would a society commit to paying in order to obtain a monetary system?
The other way to see this value is to consider a privately-owned ‘quasi-money’: Visa. Visa earns a revenue off the ‘quasi-money’ it has created. It is a curious business. Monetary networks are stronger the greater the number of users, so requiring users to pay for usage creates a tension – ease of access strengthens the franchise, paying for access may open the door to competitors. Visa ‘wants’ you to use its language ‘for free’. So privately owned money must generate revenue tangentially – in this instance, by charging vendors or banks.
It should be clear that Visa (and MasterCard) trade at a huge multiples of book value. Book value is an accounting device to proxy market value. Market value is what markets believe things are actually worth. In theory it is a present value of future cash flows.
Valuing networks is curious because externalities by definition aren’t usually captured by private ownership – it would probably be more accurate to say that Visa owns the network over which money is used, rather than owning the money per se.
Either way, it is clear that Visa has immense value, the entire monetary system must have even greater value. This doesn’t show in the national accounts, which doesn’t measure the value-added of externalities which are not paid for or do not incur a cost to the government. This suggests that assets are often harder to measure than liabilities. No one even puts a value on our greatest social assets. It also suggests that the value created by the government’s ability to create money is not being measured. A social asset of huge value is nowhere to be found in book values, and the only market value which is measured is that of tangential profits in the banking sector. For the same reason, the perceived budget constraint facing western democracies is almost certainly a monstrous error of measurement – net debt is fair lower than you think.
Money and language have something else in common – they are unique phenomena.
A thought exeriment: what happens if you replace the word “money” in this blog with “language“?
After I originally wrote on this subject, the ever-rigorous and thought-provoking Nick Rowe sent me to an article he had written on the difference between an ‘externality’ and ‘strategic complementarity’. Where an externality means if you do something it affects me (pollution is the textbook example), a ‘strategic complement’ is when you doing something raises the marginal utility of me doing the same thing. It strikes me that both of these are properties of language and money. So I will use ‘network externality’ to capture both the externalities and strategic complements inherent in communication and coordination networks.