Commodity Money vs Fiat Money

Commodity Money vs Fiat Money, A Unified View

Commodity money and fiat money are commonly viewed as two quite
different kinds of money. The transition from commodity to fiat money
occurred in the mid-20th century when the State ended the gold backing
of its notes. But are they really as different as most people think?
The following is abstracted from the analysis of the Swedish economist
Per Berglund to show how the two kinds of money actually fit into a
single framework, based on the State theory of money.

Money as a Claim on the State

When the State declares what kind of asset it accepts in payment of
taxes, it assumes a liability equal to the outstanding stock of those
assets. At the same time, the declaration creates financial claims on
the State by the holders of the assets. Those claims exist as tokens
known as money. The tokens may have a material value as in precious
metal coins, or may simply be paper certificates with no intrinsic
value. The former is referred to as commodity money, and the latter
as fiat money.

The Seigniorage Gap

The State sets the face value of the tokens, and accepts them in
payment of taxes at that value. The difference between the face value
and the material value of a token is normally positive, and known as
the seigniorage gap. A positive gap will exist only if the production
of the tokens is brought under State control and limited in quantity.
In the case of fiat money, the gap is large. In the case of commodity
money, the gap is small and may even be negative. A negative gap
means the token is more valuable as a commodity than it is as money.
If the gap becomes too negative, the public will hoard the tokens, or
it will convert them to their material use and thus end their role as
money.

The Material Value of Commodity Money

The material value of a token is a real asset without a corresponding
liability. An important question then is: who actually owns the real
asset? Surprisingly, we will see that it should be credited it to the
State. By agreeing to accept the tokens in payment of taxes, the
State automatically assumes a liability equal to their face value.
But if the State has a liability of that amount, then the bearer must
have a claim on the State of the same amount. However the bearer
cannot simultaneously have a claim on the State and the material use
of the real asset. That would clearly be double-counting.

Real versus Financial Assets

The claim on the State is inextricably tied to its token, e.g. the
coin. No records are kept of who owes what to whom, so there is only
one way of exercising the claim, and that is to surrender the coin.
If one melts the coin instead, the claim is gone, and so is the
State's liability. All that remains is a lump of metal whose material
value obviously belongs to the bearer. Melting thus transforms a
financial asset into a real asset from the bearer's point of view.
>From the State's point of view, melting cancels a financial liability
but also eliminates the prospect of recapturing the real asset.

Resolving the Accounting Dilemma

The logical way to reconcile the accounting then is to credit the
material value of the token to the State's balance ***, even though
the bearer has physical possession of the token. The State retains
title to its material value as long as the token exists as a liability
of the State. Keynes once defined the rupee, the Indian currency, as
a "note printed on silver" implying that the holder of the rupee
could either use it as money or as silver, but not both.

Melting then involves two things: (1) cancellation of the financial
asset-liability relation, and (2) transfer of the real asset from the
State's balance *** to the bearer's. The State loses the real asset
but also the liability. The bearer gains a real asset but loses the
financial claim. The net gain or loss depends on the size and sign of
the seigniorage gap between face value and material value.

William F Hummel
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