We have seen that is a broad, multi-dimensional concept. Throughout history, societies around the globe have experimented with different monetary settings and parameters, which have given rise to a rich landscape of, sometimes exotic, monetary systems, instruments and customs.

Within a given monetary system, may be represented in multiple ways (both physical and virtual), issued in the form of different instruments (e.g. banknotes, coins, digital currency), by different institutions (public and private) and available to either the general public () or select groups ().

In theory, any asset – tangible or financial – could fulfil the role of , under the condition that it would be widely accepted as a within a specific economic area. In practice, there are only a few financial , issued by different institutions, that meet that condition, as we will explore in greater depth in this chapter.

Before diving deeper into the monetary system that exists today, it is important to understand the core societal beliefs about . These beliefs can be distilled into two opposing viewpoints: ‘metallism’ (money should be tied to a tangible commodity) and ‘chartalism’ (money is fundamentally a creation of the State).

Depending on which viewpoint is adopted, monetary systems tend to be built on one of three types of . This serves as the ultimate , occupying the highest position in the monetary hierarchy. There are three main types of :

• : This typically comprises physical objects with relatively uniform characteristics (being fungible or easy to exchange for others of the same type and value) that function as for physical exchanges. While they may have intrinsic or utilitarian value, their monetary character stems from general acceptance as representing underlying relationships. Examples include gold or silver coins, seashells and other items. Cryptocurrencies like Bitcoin are difficult to categorise but could be deemed synthetic forms of due to factors like the absence of a formal issuer and a predetermined supply. 

• : This form of holds little or no on its own. Instead, it represents a claim on an underlying commodity that supports the stated value. is generally exchangeable on demand at a fixed rate for the underlying commodity at an authorised facility, such as a central bank branch. Examples include gold-backed paper , like the USD under the Bretton Woods II system.

• Fiat : Fiat lacks and derives its worth from government decree. The ’s value is primarily supported by the power and of the government, which is rooted in its taxation and legislative authority. The modern financial system operates on legal trust, representing an entirely -based system that requires double-entry bookkeeping.

In essence, regardless of the material a is made from, it fundamentally serves as a symbol.

As discussed above, is a special type of , or , which has undergone a making it a transferable and generally accepted instrument for repaying any .

Together, the State and banks are the primary entities in charge of and ensuring trust in the monetary system is maintained.

The role of the State in credit conversion

The State, as the sovereign authority, has the power to levy taxes and demand payments in a specific form. Additionally, the State boasts extensive connections, similar to a major hub in a network, as it receives many payments from different members of society. Its recognised authority, coupled with legal powers, often holds ideological or even spiritual significance. Hence, the of the State enjoy a level of that private issuers cannot attain, given the State’s extensive reach and acknowledged authority.

It is important to note, that the State and ‘society’ are distinct entities, and their interests may diverge over time.  

The role of banks in credit conversion

The primary role of commercial banks and revolves around . By extending loans, they transform individual held by households or companies into bank , also known as bank , often in exchange for a fee. This conversion process can occur in various ways, including discounting drafts or bills of exchange, as well as through recurring interest payments on loans. An important macroeconomic role of banks is their use of of risk-taking private sector agents for lending in order to foster economic growth and dynamically respond to changes in demand.

To the average consumer and business, the various forms of (i.e. , bank deposits and e-money) circulating in a modern monetary system may appear the same. Yet, a closer look reveals a diverse landscape of institutions issuing different forms of , each with unique characteristics.

Generally, the forms of can be divided into two broad categories:

• : characterised by its counterparty risk-free nature, it serves as the ultimate medium for . This form of is typically issued by authorised entities, with banks and other regulated providers taking a prominent role. Public fiat-based takes two primary forms:

  • : including physical and potentially retail central bank digital currencies (CBDCs)

  • : represented by reserves and possibly wholesale CBDCs.

• : claims on banks or other financial institutions. It usually takes the form of deposits in commercial banks. It is created when banks extend loans.

The quantity and forms of in circulation largely hinge on how different issuers manage their . The demand and supply of versus varies depending on economic conditions.

• In times of crisis, the private sector’s contract, prompting central banks to step in and substitute with through IOU exchanges. During crises, as confidence erodes, short-term IOUs lose their status as and instead become risky investments, leading to a standstill in markets. This prompts a revaluation of and , with far-reaching consequences, including cascading failures across the entire financial system and economy. In these moments, the central bank, acting as the State’s agent, emerges as the pivotal institution capable of restoring confidence by offering emergency aid to eligible financial institutions.

• During economic upswings, the private sector’s expand, leading to an abundance of liquid and an uptick in circulation, resulting in an expansion of the supply. During these times, the private sector experiences growth and prosperity, which leads to an increase in the overall value of held by individuals and businesses, as well as a rise in their financial resources. As a result, there is a surplus of available in the market, making it easier for businesses and individuals to borrow . This increase in available , in turn, boosts the circulation of within the economy. Such periods are characterised by increased levels of investment and consumer spending, and a generally buoyant economic environment.

Tracking the supply might seem simple. However, as we have already discussed, in modern developed economies there are various forms of that are all intertwined and linked in some way. 

Central banks use monetary aggregates, denoted by the various ‘M’ measures (e.g. M0, M1, M2, M3), to represent the supply. However, adding complexity to the challenge of identifying which instruments truly constitute not all central banks across the globe calculate these monetary aggregates in the same way. For reference, use the links to see how the European Central Bank (ECB) and the United States Federal Reserve (Fed) calculate these aggregates.

Apart from the lack of uniformity, lags in data reporting also make it difficult to get a true estimate of the supply in real time. As central banks need to collect and analyse data from multiple sources, such as banks and other financial institutions, any delays in reporting will make accurately calculating these metrics difficult.

Moreover, as we venture into the realm of wholesale markets, the array of exotic financial instruments further compounds the measurement challenge. Simply put, tracking the supply is far from straightforward.

How can we not notice the fact that not all is created equally, and that there are significant qualitative differences between and issued forms of ? That’s where the comes in.

A fundamental premise of a unified monetary system is the ability to exchange, or convert, its various monetary instruments at . This means that a $1 banknote is worth the same as a $1 bank balance of a current account: there is no difference in price. The legal and regulatory powers of the State play a crucial role in ensuring the so-called singleness of through an institutional structure that may be referred to as the .

The is a multi-tiered institutional arrangement based on the public–private partnership between authorised (i.e. the central bank and private agents of the State) that fulfil specific roles. These roles include:

• ensuring the singleness of the currency: allowing for seamless circulation of different monies trading at

• preventing liquidity crises: central banks being able to offer emergency assistance to banks when there is a loss of confidence in the system, by replacing parts of their with rather than

• regulating the money supply: monitoring and controlling the amount of in circulation through monetary policy – by setting reference interest rates and, in some cases, imposing bank reserve requirements

• fostering the payment and settlement system’s safety and efficiency: promoting a safe, efficient and accessible system for transaction in their respective currencies.

The system is built on an exchange relationship between commercial banks, the central bank and the State.

On the one hand, banks are granted the privilege of ( creation via a legally granted ‘monopoly’ (licensed agents of the State). The State also backs them (and indirectly depositors) by guaranteeing deposits through insurance up to a specific amount as well as being, through the central bank, a provider of liquidity and lender of last resort (including running discount window and open market operations). In exchange, commercial banks and money market funds are subject to robust regulatory and supervisory frameworks, including rules on capital and liquidity, to minimise the risk of failure and avoid imposing losses on depositors and upsetting the stability of the financial system as a whole.

The combination of these measures increases the credibility of the banks’ promises and mitigates any perceived differences in the credibility of these promises between different banks. Ultimately, they ensure the individual liabilities of banks circulate at par value (standardised and to some extent fungible) and are perceived by depositors as ‘good money’ (Dan Awrey (2020) Bad Money).

Due to these arrangements, commercial bank is a quasi-. This gives commercial banks a comparative advantage for the issuance of when compared to any other institution.

As we conclude this chapter, it is crucial to acknowledge that all monetary instruments that are within the can be considered perfect substitutes. This is not by virtue of their underlying material, or because they are convertible on-demand into , but primarily because they are accepted as means of payment at State pay offices to fulfil one’s tax and other obligations.

Outside the perimeter of the , instruments must compete to be generally accepted. This is the case for non-regulated monetary instruments, which include most stablecoins. They offer different levels of customer protection, due to idiosyncratic terms of services, and individual , among other factors.

In the following chapter we will explore how the representations of have evolved over time and how their representation affects their function.