Government Bonds in a World of Moneyness

When you learn about the monetary system from the perspective of Monetary Realism you learn about a world with the concept of “moneyness” (see here for details).  The concept of “moneyness” helps us decipher how different financial assets fit into our traditional thinking of “money”.  It’s important to differentiate between the different types of financial instruments we utilize so we can better understand exactly how the monetary system is designed and operates.

“Money”, at its most basic form, is simply that which serves as the dominant medium of exchange.  In a world of “moneyness” lots of things can meet this definition, but some items apply more widely than others.  For instance, Bitcoin is a medium of exchange, but it has a low level of moneyness because it’s not very widely accepted as a means of payment.  Bank deposits, on the other hand, have a very high level of moneyness because they are so widely accepted as a means of payment.  You can buy almost anything these days if you have access to bank deposits.  I argue that, in our electronic age, bank deposits have usurped even cash in terms of moneyness.  Of course, there are lots of different instruments in the financial world that have money-like properties.  For instance, stock options are often used to pay employees, but you can’t buy much with your stock options.  You have to convert them into something with a higher level of moneyness like bank deposits.  So stock options don’t have a very high level of moneyness.

When we think of “money” it’s best to think of it as the medium of exchange.  But we must also understand that “money” is simply one type of financial asset that exists in a financial world with a plethora of financial instruments. In fact, our stock of financial assets is primarily made up of assets that aren’t of the highest moneyness.  Things like stocks, bonds and other assets comprise the vast majority of the financial instruments in our world.  We all want money to be able to spend in the present, but we also want to hold other financial instruments so we can plan and prepare for our future spending.  If we get too bogged down in the concept of “money” we can begin to think too narrowly about its impact on the overall economy.

More importantly, when we begin to think of all of these other types of financial instruments that comprise our financial world we have to consider why there are instruments with varying levels of moneyness in the first place.  For instance, when a corporation issues common stock they are giving the buyers of this stock a claim on future cash flows in exchange for money today.  The company is essentially trying to convince investors that they should give up their cash today so they can have more of it at a later date.  And in doing so, they have to convince someone that they should forego using their money today and instead hold onto an instrument that will potentially allow them to spend more in the future.  The investors have money they don’t need today.  The company has a cash flow machine they believe can generate higher future potential profits.  So there is a mutually beneficial financial arrangement that provides investors with an instrument of lower moneyness today with the hope that they can convert it into something more valuable with a higher level of moneyness in the future.

It’s important to understand the structure of this relationship, however.  Entities that need money must issue an instrument that convinces the buyers that they can utilize that instrument in the future to convert it into something in the future with a higher level of moneyness and greater purchasing power.  Otherwise, there is no point buying a financial instrument that is more risky than the cash or deposit they would otherwise hold.

And this brings us to a crucial point that John Carney of CNBC discussed today – are US government bonds “money”?  I would argue that US government bonds are an instrument with a high level of moneyness because they can be easily converted into something of higher moneyness (like deposits) and because they are backed by the taxing authority of the US government as well as a productive economy.  But they are not “money” in the same sense that bank deposits are because, as Scott Sumner notes, they aren’t a very useful medium of exchange for practical purposes.  And this brings us to an even more important point.  Our monetary system is designed so that the US government must obtain bank deposits.  In fact, it cannot spend if it cannot obtain these bank deposits and the US government cannot just force everyone to hold new bond issues or new currency issue (although I think such a scenario is incredibly unlikely).  And if the US government cannot convince the users of government bonds to hold these instruments (for whatever reason) then the government suffers a catastrophic demise as the collapse in its bonds would almost certainly coincide with a collapse in its currency.

This brings us to the most interesting point here.  The moneyness of different instruments can change!  And in fact, we find that in a hyperinflation or high inflation many instruments lose their moneyness.  In a hyperinflation something like gold and even common stock becomes a more viable form of money while government currency virtually dies.  So it’s important to understand that currency and US government bonds are instruments that are issued just like any other financial instrument and they serve a specific purpose under a specific institutional framework.   These instruments must find willing owners who want to hold onto these instruments with the expectation that their purchasing power will be maintained.  In the case of cash currency it is issued through the US banking system to facilitate the use of deposit accounts (mainly through ATM usage).  Currency in the form of reserves facilitates the use of deposits in the interbank system.  And US government bonds are issued because our government is structured in a manner that the Executive Branch cannot merely credit its own account and spend.  This is the result of very specific legal and institutional structures that are in place.  So, despite the fact that the US government is a currency issuer and a very powerful one at that, it is not exempted from the fact that it must always be able to find willing holders of the instruments that it issues to facilitate its cash management needs.  And under the current monetary design, US government bonds resemble something like corporate bonds much more than they resemble something like bank deposits.  Therefore, government bonds should best be thought of as financial instruments with a high level of moneyness, but a lower level of moneyness than something like bank deposits.