Money in the modern economy is just a special form of IOU, or in the language of economic accounts, a financial asset. Because financial assets are claims on someone else in the economy, they are also financial liabilities — one person’s financial asset is always someone else’s debt. If a I take out a mortgage, I acquire the obligation to pay my bank a sum of money over time — a liability — and the bank acquires the right to receive those payments — an asset of the same size. So the mortgage is a liability to me but an asset to the bank. Remember Robert Kiyosaki taught us that an asset puts money in your pocket while a liability takes money out of your pocket.
A debt is as good as the trustworthiness of the person who owes you. There is need for trust in financial transactions. Money in the modern economy is an IOU that everyone trusts. Because everyone trusts in money, they are happy to accept it in exchange for goods and services — it can become universally acceptable as the medium of exchange. Obviously no all IOUs are created equal.
It is useful to consider some of the different types of money that circulate in a modern economy — each type representing IOUs between different groups of people. For explanatory purposes the economy is split into three main groups: the central bank; the commercial banks; and consumers.
Many people do not realize that when we talk of money not all money is equal or equally available to all economic players. The types of money available in the economy are:
- Currency (banknotes and coin) — these are IOUs from the central bank, mostly to consumers in the economy. That is why the Zimbabwean Dollar notes would clearly state, “I promise to pay the bearer the sum of —, on demand.” Bank notes in reality are simply a promise by the Central bank to make a payment when needed. The USD notes will state that this note is legal tender to settle all debts both public and private.
- Bank deposits (these are your bank account balances)— They are IOUs from commercial banks to consumers. Many people mistakenly think that the money they deposit in their account actually stays there in a safe. They don’t realize that they actually surrender the money to the bank to use at it sees fit and in return are given a promise to pay them on demand. That is why when banks fail depositors lose money. The bank would not be in position to honour its debt obligation and extinguish its IOU. With this understanding the commonly spoken of issue that bankers used depositors money is exposed as interesting if not misleading.
- Central bank reserves– these are bank deposits for banks that are placed with Central bank. So they are IOUs from the Central bank to banks in the economy. We the consumers have no access to these.
From this description of the different kinds of money we could actually surmise that money as a concept is nothing more than a debt -an IOU from one player in the economy to another. Money is a financial asset to one player and a financial liability to another.
From these distinctions economists define two money concepts namely:
Broad money – is the amount of money circulating in the economy and available to consumers for transactions. This comprises of currency (bank notes and coins) and bank deposits).
Base money or ‘central bank money’, comprises IOUs from the central Bank and includes currency- bank notes and coins in circulation (an IOU to consumers) but also central bank reserves – bank deposits for banks held by the Central bank, (which are IOUs from the central bank to commercial banks.)
Put simply money can be conceptualised as a debt or IOU. Money is nothing more than a financial asset to one economic player and financial liability to another economic player.