The reason why people holds their capital stock in a wide range of
different types of capital assets with only a small part of it as
money is that they earn a better return in the form of interest,
dividends, and capital gains on other assets than they earn on their
money holdings.
The question is why anyone would hold money---cash in pocket and
deposits in non-interest bearing chequing accounts---at all?
If money is to be regarded as a part of one's capital stock,
it should earn a return that makes it worth holding.
Visualize a world without money. When you go to McDonalds
to buy lunch, what are you going to give in payment for your Big
Mac? At a wage rate of $10 per hour, an appropriate payment
might be to wash dishes for 20 minutes. But what if you are a
lawyer who earns $2000 per day in court? You could offer to defend
the owner of the franchise for 3 minutes on his forthcoming
impaired driving charge. But then, how is the owner of McDonalds
going to pay his staff---give them all the food they can eat?
Without money, all exchanges must take the form of barter.
And barter won't work unless there is a double coincidence
of wants. Each party to the exchange must want to buy what the
other party wants to sell.
A possible way to get around this problem would be to
establish a network of IOU's in the economy. When you buy a
hamburger at McDonalds, you sign an IOU sheet. When the owner
of the McDonalds franchise pays his employees he marks them down
as the receivers of IOU's. Then at the end of every month or
year, there could be an economy-wide IOU settlement in which
everyone's debt to everyone else is taken care of.
This scheme has some obvious difficulties. Apart from the
problem of maintaining records of every purchase and sale,
however small, there is the question of people's credit-worthiness.
What is to stop one from spending more than one's income?
It should now be clear from the above discussion that the basic
function of money is to save labor and other resources that
would otherwise have to be used up in making transactions. This
enables society to produce more consumption and investment goods
with its existing stock of human and physical capital. The return
from holding money to the person that holds it is the resources
that now can be used for productive employment and leisure rather
than for checking people's credit ratings, informing others of
his/her own credit rating, processing records, collecting bad
debts and looking for people to barter with.
So money represents an additional component of the
communities' capital stock. The return off this component is the
increase in the fraction of the output of the other types of
capital that can be used for consumption and investment as a
result of being able to use money to make exchange.
In order to make exchange, settle debts, and so forth, one
must have a unit of account. Money provides this. In Canada,
the monetary unit and unit of account is the dollar. Its
acceptability for this purpose is established by law. Dollars
are legal tender---that is, one must legally accept them
in exchange for goods and in the discharge of debts.
In situations where there is no legal tender, people
will adopt a monetary unit by convention. For example, in German
prisoner-of-war camps in World War II cigarettes were used as a
medium of exchange---one cigarette became one unit of money. In
nineteenth-century frontier gold-mining camps where paper money
was scarce, one oz. of gold often represented the monetary unit.
The total quantity of money in the Canadian economy is
the stock of dollars available for making transactions. What
counts as a dollar available for making exchange is often
difficult to define. Dollar bills and coin in pocket are
clearly part of the stock of money. Chequing account balances,
which can be transferred to other people in the payment of
accounts by cheque, are always treated as part of the stock of
money. Savings account balances, which can be withdrawn and
made available for use in transactions or simply transferred
into a chequing account by telephone, are also frequently
considered to be part of the money stock, but the conversion
costs make them less desirable as a means of payment than cash.
Some other assets, such as Canada Savings Bonds, are
easily convertible into money but more costly to convert than
savings account balances. Unused credit card limits can also be
viewed under some circumstances as a form of money because they
can be used in making some types of transactions as easily as
cheques, though never as easily as cash. Assets can be ranked
on a scale according to how easily they can be converted into a
quantity of cash that can be estimated in advance with some
precision. Assets that are less costly to convert into cash
than other assets are said to be more liquid.
Liquidity is thus the property of being cheaply convertible
into a defined amount of cash. Money in pocket is, of course,
the most liquid of all assets because it is cash. Chequing accounts
are the second most liquid of assets because they can be,
in effect, converted into cash by the writing of a cheque.
Savings and other non-chequable deposits have lesser liquidity
because one has to make a trip to the bank to cash them in.
One's house or car is a very illiquid asset because it takes
a considerable amount of time to sell an asset of this sort for
a price that is both reasonable and can be estimated with some
accuracy in advance.
It's time for a test. Have your own answers in mind before looking
at the ones provided.
Thus far in this lesson we have been defining capital very
broadly to include human skills, knowledge and technology as well
as buildings, machines, etc. One form of capital that has yet
to be mentioned is money. Yet it is the asset that is probably
most referred to in ordinary conversation---witness the statement
"Bill has a lot of money". What is really being
said here is that Bill has a lot of assets that he could
convert into money by selling them if he wanted to.