Before we set upon analyzing the financial system, we first need to define its place in public life as a whole.
The financial system determines who—when and on what terms—has the right to own and manage the wealth created by the economy. In other words, it is a set of rules by which people organize to produce goods and services and then share these products among themselves. These rules governing people’s lives are called social institutions.
Ownership and money are the two basic institutions of the economy. The economy is the part of social life that operates the terms “my” and “someone else’s” and offers a possibility to buy and sell, trading these categories’ places. Money is a tool used to redistribute ownership. That is, it is a carrier of economic power in a society. Economic power associated with money allows one not only to acquire material values, but also to manage people by paying for their services.
The fact that money is a social institution, rather than one of the real economy’s assets, is critical for understanding how the financial system works. By its nature, money is a social phenomenon—even when the role of money is played by goods (gold, kettles, furs, etc), they play this role through its recognition by the society as a means of payment, rather than through their consumer attributes. The main thing that makes these goods money is people’s agreement to regard them as such.
This agreement is not a legal concept. Undoubtedly, laws governing currency circulation may be adopted, but before that, money must gain a foothold as a social consensus in the society’s real life. The government can only codify rules that already exist and have been recognized by the society. This set of rules, as mentioned before, is a social institution.
From early childhood, we take these rules for granted, perceiving them as a very natural part of our lives, without even thinking that things could be different; this process is called socialization. Each individual goes through his or her daily routine without taking much trouble to think about his or her role in the larger social organism. However, if one looks at a society as a whole, there comes an impression that it lives by somebody’s design, that individual people are parts of a large mechanism moving like clockwork along the established patterns. This order adopted by their native environment is, for most people, as real as trees on the ground or the sky above.
However, we tend to perceive social institutions adopted by different social systems more critically, especially if they differ from the procedures existing in our own native environment. One of the advantages of economics is that it gives us a chance to look at our own society from outside, breaking many stereotypes.
Thus, let us take a look at one of the above-mentioned institutions, ownership rights. What does the word “own” mean in regard to property, for example, a car? Evidently, it is not the same as someone’s own hand or a leg or a kidney; however, we all unequivocally understand the meaning when we hear that a car belongs to somebody. The car belongs to somebody because both the owner and the people around believe that he has an exclusive right to own, dispose of, and use it. If other people decide to enter his car and leave, we will call them thieves. These are the rules. Being aware of the importance of these rules, society will prosecute the thieves in any ways possible in order to protect the legitimate owner’s fundamental rights.
To understand better that our rules and institutions are just our conventions, imagine a society where all things belong to everyone. A representative of such a society would be very surprised to see our behaviors. Why cannot a person in a hurry use a transport sitting idle in a parking lot? He needs it more than anyone else, including some “owner”! Why does anyone have to be hungry amid huge buildings with aisles and aisles of food just because he does not have some pieces of paper that would make this food “his”?
The ownership right involves not only the right to own and use but also the right to dispose of one’s property. One can voluntarily transfer his or her ownership to other people, receiving in exchange a value that he or she believes to be equivalent. Thus, a car owner may trade his or her ownership for anything—furniture, a land lot, or a service.
This ability of property to be used for acquisition of other property or services is called liquidity. The more wanted a property item, the higher its liquidity, that is, the greater the probability that other people will give something away or offer their labor in exchange for ownership of the item.
The higher liquidity, the more valuable it is due to its ability to grant its owner economic power in the society rather than due to the item’s consumer attributes. As soon as item ownership becomes more important than its consumer attributes, because of its high liquidity, we are talking about money.
Money is a universal tool generating ownership in a given society. Money is assertion of the right of ownership. If ownership means that the society has given us the right to own, use, and dispose of something, money gives us the right to choose what we want to own, use, and dispose of. Thus, if you know how to counterfeit currency notes, you can acquire ownership of any goods at your slightest pleasure—of course, until you get caught. In many countries, the penalty for counterfeiting is harsher than that for simple theft because counterfeiting constitutes a more profound threat to ownership. Here, it would be reasonable to clarify our definition of money as a social institution using counterfeiting as an example. Even if someone somehow gets ahold of a real printing machine from a mint and starts making currency notes that are absolutely identical to genuine money, these notes will not become real. The concept of modern paper money includes both the money’s physical form and the right of the central bank to issue it. Since this rule would be broken, the notes would not be real, despite their “typographic authenticity.”
Therefore, modern money is something that 1) usually has no use other than serving as a means of liquidity, and 2) is recognized and accepted by all society members.
As soon as something acquires these qualities, it becomes money. Conversely, as soon as money loses these qualities, it ceases being money.