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The Three Kinds of Money

The Three Kinds of Money

No. 7-8, Sep.-Dec. 2017 » Bridging News

Recent polemics linked to the fate of the so-called “2nd pension pillar” in Romania (the obligatory privately-run pension, as opposed to the optional private one) has brought to mind an older issue regarding the nature – public or private – of money. Since one of the questions raised by the mentioned discussion is just the nature of the money collected by the state and transferred automatically to the preferred obligatory private pension fund, I will underline some considerations in this article. 

What is money?

Public money is that money, no matter who is its owner, which is due, by law, to the state as government.

The term money must be conceptually understood only as an entity (no matter if physical or virtual) which is a universal means of exchange in economic transactions. These transactions concern goods and services, in last instance, although many intermediate phases could concern non-goods and non-services – for example, financial derivatives. No other independent functions/roles can be associated with money, although additional functions/roles can be derived from that of exchange (for example, the function of value storage). In the current monetary system, something is qualified as money by belief only (either that money is or is not covered/”backed” by something else – goods and services, gold, or other relatively stable economic entities of independent value). More than that, money is accepted as such if its transaction cost (different from the cost of transaction – this would be just the price) is the lowest possible or, equivalently, its liquidity is the greatest possible. It does not matter how we name or mark a particular currency – euro, dollar, leu etc. 

What is the criterion to classify the nature of money?

Herein, I will discuss only the features which define public money or, alternatively, private money. To this end, four questions will be answered:

  1. a) why is it important to establish the nature of money in this respect?
  2. b) which should be the most relevant criterion on which to decide the nature of money?
  3. c) how non-ambiguous is the selected criterion in its “decision”?
  4. d) what about the possible conflict between public money and private money?
  • the importance of clarifying the nature of money

The first requirement to clarify the nature of money is theoretical. For a very long time, the question of who has the right (not only legal, but also legitimate) to issue money as monetary base (i.e., as physical money) is debated without reaching a generally accepted answer. But establishing the boundary of the public money seems easier to do.

The second requirement of the nature of money addresses the economic policy (especially the two adjustment policies: monetary and fiscal). Indeed, in order to design the macroeconomic adjustment, the most operable variable, at least in the short term, is money. The two adjustment policies mentioned both use money, in some form or another. As a consequence, it is important to clarify the nature of different kinds of money, in order to put into place correct and legitimate economic policies.

  • the criterion to classify money based on its nature

Such a criterion must address, in my opinion, the most relevant economic feature in the free market economy: the property. However, the property must be viewed neither from the perspective of the producer of money, nor from the perspective of the holder of money, but from the perspective of the due destination of money. According to this, the issuer (or the holder) of money is not at all the owner of it (for example, the central bank is not the owner of the monetary base issued).

A holder of money is its owner only if that money is not required (either legally, or contractually) to be transferred to somebody else; in the contrary case, the owner of money is that somebody else who must receive, in a form or other, that money.

  • non-ambiguity of the classification

Based on the above considerations, it can be said that the public money is that money, no matter who is its owner, which is due, by law, to the state as government. In this instance, by government we understand the public sector only, not including the private domain of the state – for example, a state bank. So, the tax included in the gross wage is public money, as well as the VAT included in the price charged by the seller, although that money is owned by the worker or by the seller.

Private money is that money which is due, by contract, to someone other than the state, no matter the particular reason of such an obligation to transfer money.

Symmetrically, it can be said that the private money is that money which is due, by contract, to someone other than the state (i.e. government plus the private domain of the state), no matter the particular reason of such an obligation to transfer money. So, if some money is due to the state, based on contract, not on the law, that money is neither public, nor private.

From this, one obtains the logical necessity to accept a third kind of money: mixture money. By mixture money, we must understand that money which is due, based on contract, to the private domain of the state (that domain of the state which produces and delivers private goods and services through the market).

So, the nature of money is defined by the property right on it, granted either by law (when we have public money), or by contract (when we have either private money or mixture money). A synoptic view of such typology can be given like in the figure below. 

  • the “conflict” between law and contract

By contract, I will consider here the private contract only (the social contract between the state and its citizens is presumed be „translated” into laws). In such a context, what can be said when a law and a contract „governs” the same amount of money? For example, the salary level in the state sector is established by law, but, regarding that salary, a contract between the employee and the state also occurs. In my opinion, when a contract overlaps a law regarding the same money, the contract should prevail over the law. So, the salary of civil servants should be considered as private money. Of course, the part of that salary named tax on salary (more rigorously, on personal income) constitutes public money, as shown above. The reason to say this is the following: whenever a law establishes a monetary due towards the government without establishing a counterpart in exchange, the corresponding money constitutes public money. When the law establishes the salary in the budgetary sector, it establishes at the same time a required counterpart: the work in exchange of the salary, so this salary is private money. 

Back to the pension system 

By mixture money, we must understand that money which is due, based on contract, to the private domain of the state, which produces and delivers private goods and services through the market.

Applying such a reasoning to the second pension pillar governing mandatory private pensions with defined contributions, I would say the following: the submission of money to the fund in case is due by law (so, it is a legal obligation), so we have here public money. Although there is a contract between the depositor and the fund in order to invest (automatically or at the depositor’s order) the money which, in this way, may or may not bring some gains to the depositor, the contract does not concern the commitment to pay that newly gained money, but only the possibility to do that. As there is no mandatory counterpart here, one comes to the conclusion that the money involved is private.

 
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OEconomica No. 1, 2016