What Is Money?

Money has been a part of human history for almost 3’000 years.

At the dawn of humanity, bartering was used in lieu of money to buy goods. As early man began to rear domestic livestock, one of the earliest forms of barter included cattle, sheep, as well as vegetables and grain.

The first known currency was created by King Alyattes in Lydia, now part of Turkey, in 600BC. The first coin ever minted features a roaring lion. Coins then evolved into bank notes around 1661 AD. The credit card was introduced in 1946 and since then, money’s history further developed into digitalization, instant iPhone payments or bitcoin, the world’s first decentralized crypto-currency.

Despite all digital possibilities and political efforts towards a cashless society (because cash is expensive to store or transport and a switch to digital transactions would ultimately pay off for many countries) the paper money in your wallet will be useful for quite some time to come.

And even if money is here for thousands of years and paper money became accepted as legal tender hundreds of years ago, I bet, you – as most of the people – still think of money in the bank and money in your wallet as the same thing. Rather than both being money, one (the bank deposit) is ‘Inside Money’, while the other (the bank note in your wallet) is ‘Outside Money’. These are not fungible and are instead like oil and water.

Inside Money

… is created inside the private sector, it includes bank deposits that exist as a result of the loan creation process. It is the dominant form of money in the modern economy and as the economy has become increasingly electronic it has taken on an increasingly prominent role in the modern economy.

Imagine that you go to your local bank for a loan. In granting the loan the bank creates a deposit in your account. This deposit is a liability on the bank’s balance sheet against which it holds an asset (a loan to you).

If you choose to transfer your (borrowed) deposit to another depositor of the same bank (let’s say, if you bought a car from me and I was also a customer of the same bank), the liability (eg, the deposit) never leaves the bank.

If you transfer my (borrowed) deposit to a depositor of another bank, your bank would need to settle the transfer – but the liability would never leave the banking system.

And so, Inside Money exists only on a bank ledger and can never take physical form. Inside Money is the short-dated liability of the banking system. Changes in bank lending practices do not change Outside Money.

Outside Money

… is created outside of the private sector. This includes cash notes, coins and bank reserves. Outside money – or government money – serves primarily to facilitate the existence of inside money. That is, the creation of outside money is almost entirely a facilitating feature to influence or stabilize inside money, the primary form of money in the economy.

It is like a government pays a civil servant. As the monetary sovereign they can do so by creating brand new Outside Money. The government then typically seeks to destroy an equal amount of Outside Money to offset this monetary expansion, and this process of money destruction is called monetary sterilization.

Your take-out for today: The private economy is considered as the ‘inside money’, government-issued money is called ‘outside money’.

Find out more about money by reading the Modern Money Mechanics booklet.

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Fed – Federal Reserve Bank, the central bank of the United States – controls the money supply.

Tsy – Treasury, manages Federal finances by collecting taxes and paying bills and by managing currency, government accounts and public debt.

Face Value – The dollar value written on the paper note or the coin, to distinguish it from the production cost of the note or coin.