Wednesday, May 6, 2015

Paying by Promising to Pay

John Hicks writes in "A Suggestion for Simplifying the Theory of Money" (1935) about banks:

... the security of their promises to pay is accepted generally enough for it to be possible to make payments in those promises.

I find it hard to accept that payments can be made in promises to pay. It is illogical. Yet, this is how we view and talk about the economy. We consider payments made mainly in banks' promises to pay, although we do accept another way to make payments which we call barter.

Merriam-Webster defines barter (verb) as follows:

to exchange things (such as products or services) for other things instead of for money

In a barter system, payments are made in goods or services. Some people contrast bartering with the use of money as a medium of exchange and claim that a system where sellers acquire credits -- but not money -- which they can later use to buy goods or services is essentially a barter system. To me, this is too big a stretch from the classical definition of barter. For instance, Adam Smith, writing in Wealth of Nations (1776) of a situation where paper money would lose its value after the loss of the gold stock of a nation, says:

The usual instrument of commerce having lost its value, no exchanges could be made but either by barter or upon credit. (Book II, Chapter II) 

It is good to see that Smith, though often blamed for having suggested that money emerged from the difficulties (see Jevons' famous "double coincidence of wants") related to a barter system, does recognize credit as something which enables exchange, and which he separates from barter.

Here comes my main point. What we all must agree upon is that a seller who, in a transaction, extends credit doesn't receive a payment. From this it must follow that the buyer involved in the transaction doesn't make a payment.

If accepting a bank's, or anyone else's, promise to pay is not extending credit, then what is?

I, too, have grown up thinking that payments are made in money, that bank deposit transfers are money transfers, and so they constitute payments. But I'm ready to question all this if it helps me understand better how the economy works. Having now, for some time, entertained the thought that one cannot make payments in money *, I have come to believe strongly that it must be so. And not only that, but actually everything seems to make more sense when viewed through this "new lense". Although I have always considered myself a contrarian, I must admit that here I have exceeded myself.

* What I in the current post say about commercial bank deposits, I extend to central bank notes and deposits as they, too, are "promises to pay". See my earlier post for more information on this wider perspective.


  1. Peter, I think you're chasing your own tail.

    >"I find it hard to accept that payments can be made in promises to pay. It is illogical"

    Why is it illogical? If the payee is satisfied with how they've been paid, both parties are happy and the matter ends there for the moment.

    You could easily poke holes in the purity of "barter". One side to a barter exchange may receive a good or service that, for example, loses value over time faster than anticipated (e.g. milk goes sour, etc). So, immediately after the barter exchange they think themselves "paid", but come home and in two weeks they decide they've been cheated.

    Life gets so much easier if you just think in terms of creating and cancelling obligations, not goods and services.

  2. Welcome back, Sardonic! Good to hear from you.

    You're right. If both parties are happy, then the matter ends there for the moment. Once the seller receives cash or a deposit, the buyer doesn't owe the seller anything. There remains no (direct) obligations between the buyer and the seller. They are "settled".

    What is the problem then, you might ask?

    The seller ends up holding a claim against someone else. The transaction is settled between the two parties only because a third party is introduced. For all we know, the buyer might still have an obligation to someone else -- perhaps he took a loan to make the purchase. We know for sure that the seller has a claim, in form of cash or a deposit, against someone else.

    I'm not saying you haven't (personally) settled the transaction after you hand over cash to a seller. I'm saying that we should not call it a "payment", because the seller obviously receives only a promise to pay (why on earth would it be called a "promise" if it was settled?). Calling it a payment means adopting a commodity-view on "money", whether one is aware of it or not.

    Why do I insist on this? Because this thing called "money" is originally issued only when someone is not paying -- when he issues a promise to pay, an IOU, in order to buy something he needs or desires. So I need to turn the question around. Why not try to adopt this opposite view to paying? When we look at the world from a different angle, we come up with new ideas.

    Your example of "unsatisfactory barter" is a different thing. There we are not dealing with explicit promises to pay, like in the case of "money".

    I'm still working on a longer post where I try to sum up what I have said so far about money and "money". I hope it will clarify things. I think you've been right all along: this piecemeal approach is not enough.

    1. Your argument is muddled and confused. Money-cash is not a promise to pay anything, it is payment.

      The notion that "this thing called "money" is originally issued only when someone is not paying" is nothing more than nonsensical gibberish. Money used as payment, IS payment, transaction complete.

      You are not helping anyone understand anything, you don't even understand yourself.

    2. Dwain, how would you define 'payment' so that the definition applies both to "payments in money" (as you see it) and "payments in kind"?