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Money in Market Clearing

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 MONEY IN MARKET CLEARING
By
Mohammad Gani
Economic Science Institute, Dhaka, Bangladesh.

Wheat

Boot Hat

Table

Abstract
Market clearing is the central issue in macroeconomics. Two centuries of debate on Say’s Law indicates that the
issue is not yet settled. This essay proposes that double coincidence is a necessary condition for market clearing, in
addition to the equality of demand and supply at equilibrium prices. However, the literature does not recognize
necessity of double coincidence. Jevons (1875) gave shape to the conventional wisdom on double coincidence. The
idea is that it is peculiar to barter, and that money overcomes this inconvenience. This is a fallacy. It prevents the
development of a theory of money as a necessary medium of indirect exchange. It hides the role of money in market
clearing. By recognizing double coincidence as a necessary condition for any trade, and the role of money in market
clearing, economics can become a much stronger and practically more useful science. Monetary reform can correct
the perverse circulation of money and prevent involuntary unemployment, undue instability, and excess debt.

Keywords: Market clearing, neutrality of money, double coincidence, unemployment, instability, debt.

JEL Classifications: B41, C67, C68, D46, D51, D71, D74, E41, E52, J64,

An earlier version was presented at the History of Economics Society Annual Meeting, June 25-28, 2004.
Victoria University, Toronto, Canada.
The authors thanks the many participants for useful comments and suggestions.
Special thanks are to Geoff Harcourt, Patrick Gunning and Sasan Fayazmanesh .

Please send criticisms, comments, and suggestions to ganiosman@hotmail.com

11.. Introduction
Market clearing requires that the buyer pays the seller. The payment must meet two necessary
conditions. First, the value of the payment must be equal to the value of the good. This is a more
general condition than the equality of demand and supply at equilibrium prices. It may be called
equivalence. The second condition is that the buyer must deliver a payment of a definite kind,
whether it is a real good or money, which the seller accepts. It is a necessary condition for any
trade, direct or indirect, immediate or intertemporal, regardless of whether money is used or not.
This second necessary condition may be called double coincidence.
Sadly, the literature does not recognize the necessity of double coincidence. So it fails to
see the role of money as a device to create an artificial double coincidence to meet this necessity
and thereby serve as an artificial means of payment in market clearing. It is a puzzle why formal
models do not recognize the role of money as a means of payment. Serving as a means of
payment is the essential function of money. It if does not serve as a means of payment, it cannot
be money. Yet all formal models treat money as either a numeraire (measure of value) or as a
bond (store of value), but never purely as a means of payment. Why has conventional wisdom
overlooked the essential function of money, and instead has been obsessed with non-essential
functions? A remark from Bertrand Russell may shed some light on this paradox. He said:

(1): “…....the point of philosophy is to start with something so simple as not to seem worth stating,
and to end with something so paradoxical that no one will believe it.” Russell (1918), page 53.

Apparently, the obvious fact that the buyer pays the seller was deemed ‘not worth
stating.’ The penalty of not stating the obvious has been tragic. The expenditure of much energy
to build monetary theory and macroeconomics did not produce compelling theorems about
money, as it was without a proper articulation of the role of money in market clearing. The key
issues are still being debated, and whether the market (especially for labor) clears is not yet
known with any confidence. Nor is anybody sure if money has effect on output or not.
If money is shown formally as a means of payment, then the inevitable conclusion is that
money is necessary to clear the market under indirect exchange. In a formal model with a means
of payment, price theory and monetary theory become two inseparable parts of the same theory
of payment. In that case, macro and microeconomics become inseparable, and the prevailing
micro and macroeconomics become obsolete One surprising conclusion is that the gravest
economic miseries of humanity, namely needless poverty, undue instability, and excess debt
arise from a perversion in the circulation of money such that market clearing is impeded. These
problems can be solved by reforming the monetary system.
William Jevons (1875) is the best architect of the conventional wisdom on double
coincidence. It is supposed that double coincidence is a peculiar inconvenience of barter, and that
money overcomes this. These erroneous Jevonian ideas became conventional wisdom and misled
the profession into fundamental error. The practical consequence of theoretical error has been the
persistence of needless unemployment, unjust transfer of wealth, and undue instability. For
further progress, economic theory must rethink the issue of market clearing and the role of
money in it. Economic policy must then be reformed to use the power of money properly for
growth, stability, and equity. Monetary reform can avoid the perversion in the circulation of
money, and thereby prevent involuntary unemployment, unjust transfer of wealth, and undue
instability.

Mohammad Gani (October 2004): Money in Market Clearing

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22.. Jevons on Double Coincidence
William Jevons may very well be the architect of the conventional wisdom on double
coincidence. Paradoxically, his book “Money and the Mechanism of Exchange” is not much
discussed in the literature on the history of thought, apparently because of the nature of success.
According to Russell (1902), the successful teacher makes himself redundant by making his
teaching a part of commonsense. Jevonian ideas have become commonsense.
Jevons provides a pretty exhaustive study of money, covering its functions, its history,
and the issues of currency, coinage, and banking. The book begins with barter and lists what are
termed inconveniences of barter. The next step shows that the use of money avoids these
inconveniences. This effectively stops any further examination of double coincidence.
Jevons is an excellent logician and that makes his arguments compelling. Where he falls
off the track, it is hard for his followers to get back on track. Let us see two aspects of his
analysis of double coincidence to see how he went off the track. The first is its inconvenience as
opposed to its improbability. The second is its presumed absence in monetized transaction.

2.1: Inconvenience versus improbability of double coincidence

The idea that barter is inconvenient compared to money is old. It is found in earlier
writings of Adam Smith (1776), J. B. Say (1803), J. S. Mill (1850) and Amasa Walker (1865).

(2): “But when the division of labour first began to take place, this power of exchanging must
frequently have been very much clogged and embarrassed in its operations. One man, we shall
suppose, has more of a certain commodity than he himself has occasion for, while another has
less. The former consequently would be glad to dispose of, and the latter to purchase, a part of this
superfluity. But if this latter should chance to have nothing that the former stands in need of, no
exchange can be made between them.” Smith (1776). Chapter 4, Para 2

(3): “…. What infinite confusion and difficulty must arise……..were everyone obliged to
exchange his own products specifically for those he may want; and were the whole of this process
carried on by a barter in kind. The hungry cutler must offer the baker his knives for bread;
perhaps, the baker has knives enough, but wants a coat; he is willing to purchase one of the tailor
with his bread; the tailor wants not bread, but butcher’s meat; and so on to infinity.”- J B Say
(1803): Book 1, Chapter 21, Section 1, Para 3.

(4): “The inconveniences of barter are so great, that without some more commodious means of
effecting exchanges, the division of employments could hardly have been carried to any
considerable extent.”-J S Mill (1848): Book 3, Chapter 7, Section 1, Para 3.

Jevons makes the statement clearer than earlier authors to articulate double coincidence:
(5): “The first difficulty in barter is to find two persons whose disposable possessions mutually
suit each other's wants. There may be many people wanting, and many possessing those things
wanted; but to allow of an act of barter, there must be a double coincidence, which will rarely
happen.” -W S Jevons (1875): Chapter I, Para 5.

(6): “We have seen that three inconveniences attach to the practice of simple barter, namely, the
improbability, of coincidence between persons wanting and persons possessing; the complexity of
exchanges, which are not made in terms of one single substance; and the need of some means of
dividing and distributing valuable articles. Money remedies these inconveniences, and thereby
performs two distinct functions of high importance, acting as— (1) A medium of exchange. (2) A
common measure of value.” - W S Jevons (1875): Chapter III, Para 1.

Mohammad Gani (October 2004): Money in Market Clearing

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 It is clear to Jevons that there is an ‘improbability of double coincidence between persons wanting
and persons possessing’. This apparently is the first inconvenience of barter. Who knows what might
happen if this short-lived logician lived long enough to revise his writings. Improbability is not
really inconvenience; but one may fall prey to heritage of using inarticulate words. Jevons
knows quite clearly that when barter is possible, which of course occurs rarely, it is gainful and
not inconvenient at all.
(7): “Exchange has been called the barter of the superfluous for the necessary, and this definition
will be correct if we state it as the barter of the comparatively superfluous for the comparatively
necessary”. -W S Jevons (1875): Chapter II, Para 1.

If exchange is the ‘the barter of the comparatively superfluous for the comparatively necessary’, then
double coincidence must mean that in an exchange, the seller of the first good regards it as
comparatively superfluous, that is, lower in utility compared to the payment (second good). In
short, it is gainful. Carl Menger holds the same view.

(8): “….. if command of a certain amount of A's goods were transferred to B and if command of a
certain amount of B's goods were transferred to A, the needs of both economizing individuals
could be better satisfied than would be the case in the absence of this reciprocal transfer.” Menger
(1871): Chapter 4, Section I, Para 4

The logical question must be asked: If exchange is gainful as it barters ‘the comparatively
superfluous for the comparatively necessary’, why is it regarded as inconvenient? We must conclude
that barter is improbable, but not inconvenient.
Double coincidence in kind is rare, but if it occurs, it is conveniently gainful. The danger
is that one may not see the fundamental distinction between barter and indirect exchange in
hence may not recognize that under indirect exchange, the absence of double coincidence in kind
is compensated by the presence of multiple coincidence in kind, and that if multiple coincidence
exists, it is possible to use money as a device to create artificial double coincidence.
As we study the literature, it becomes clear that the authors are confusing commodity
money with barter. For example, in the simplest case of indirect exchange, there are three real
goods. No tow of them have double coincidence and yet all three of hem together have triple
coincidence in the specific sense that each good has both an offer and an acceptance in its kind.
Thus suppose that a farmer first sells his food against a piece of cloth, and then sells the cloth to
buy medicine. It may appear as a two-stage barter, but it is not barter. The cloth here is used as
commodity money. Money is something which is bought without an intention to consume and
sold without having produced it. It is bought just to serve as an intermediate payment. The
critical point is that at each stage, there must be double coincidence. Thus at the first stage, there
is double coincidence between food and cloth, and at the second stage, there is double
coincidence between cloth and medicine. In a more advanced economy with fiat money, the
farmer sells food for money and then sells money for medicine, replacing commodity money
(cloth) with fiat money. But it is still the case that at the first stage, there is double coincidence
between food and money, and at the second stage, there is double coincidence between money
and medicine. It is not obvious that the job of money is to transfer claims and obligations on real
goods in an indirect exchange. If the farmer delivers food to the weaver, he has a claim on the
output of the weaver, but he wants to transfer this claim to obtain medicine from the aptekar. He
gives the cloth to the aptekar to get the medicine. Money is necessary to achieve this transfer.

Mohammad Gani (October 2004): Money in Market Clearing

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 In the absence of the distinction between direct and indirect exchange, one confuses
commodity money with barter and reaches the fallacious impression that double coincidence is
not necessary when money is used.
(9): “The earliest form of exchange must have consisted in giving what was not wanted directly
for that which was wanted. This simple traffic we call barter or truck, the French troc, and
distinguish it from sale and purchase in which one of the articles exchanged is intended to be held
only for a short time, until it is parted with in a second act of exchange. The object which thus
temporarily intervenes in sale and purchase is money. At first sight it might seem that the use of
money only doubles the trouble, by making two exchanges necessary where one was sufficient;
but a slight analysis of the difficulties inherent in simple barter shows that the balance of trouble
lies quite in the opposite direction. ” –W S Jevons (1875): Chapter I, Para 4.

The use of the term ‘inconvenience’ instead of ‘improbability’ makes it hard, and perhaps even
impossible to recognize that double coincidence must be present when money is used, although
this time, it is first between a real good and money, and then between money and another real
good. We could generalize Jevons by putting the word money and changing ‘rarely’ into
‘usually’ in his passage as follows: (Changes are in bold)

(5* generalized): There may be many people wanting money, and many possessing money; but to
allow of an act of barter between a real good and money, there must be a double coincidence,
which will usually happen.

2.2: Double Coincidence in Monetized Transactions

Once one thinks of how money overcomes the alleged inconvenience of barter, it requires a
difficult and perhaps impossible mental gymnastic to switch to the idea that double coincidence
must be present even when money is used. One apparently feels no need to show how money
itself changes hands, presumably because it is obvious. The literature is obsessed with the issue
of why people will accept (fiat) money, but quite forgetful of the issue of why they will spend it.
Perhaps it is presumed that people of course do not consume money, but spend it. Indeed, they
take it if and only if they believe that they can spend it. But this is incompatible with the idea of
money as a store of value, although most formal models of money are models of a store of value.
The Keynesian revolution and the rise of macroeconomics would be wholly unnecessary if the
issue of spending money (i.e., supply of money) was properly formalized earlier.
Having regarded double coincidence as an inconvenience instead of as a necessity, the
train of thought wanders off into an intractable territory because at this point, the connection
between money and exchange is forgotten. Even though everybody knows that money circulates,
somehow nobody feels a need to consider the circuit in which it circulates. The essential function
of money as a medium of exchange is dismissed as not worth stating. The distraction leads to
three lines of enquiry, all away from the essential function of money. First, the issue of how
money might have arisen endogenously from an earlier state of barter leads to the Austrian
theory of money. The second issue is the function of money as a numeraire or measure of value
or unit of account, leading to the quantity theory of money, monetarism, and Lucasian super-
neutrality of money. The third is the issue of money as a store of value, leading to the Keynesian
theory of money and subsequent developments. These are all off the track digressions that indeed
contradict the role of money as a means of payment. All three issues are still being debated.

Mohammad Gani (October 2004): Money in Market Clearing

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33.. Rediscovering the Obvious
Let us go back to the basic issue of money’s essential function as a medium of exchange to see
how the three sets of issues mentioned above are resolved. In this section, we consider some
basic elements for formalizing the issues. After that, we successively consider the evolution of
money, its role as a measure of value, and as a store of value.
Let us begin with the most obvious fact of exchange- the buyer pays the seller. From that,
we consider four mutually exclusive situations requiring four mutually exclusive types of
payments, money being one of the four. This taxonomy is of critical importance, because money
has been confused with all of them. Once we have categorized the four exchange scenarios, we
can identify the issues pertinent to money as a means of payment.
We may formally define an exchange as a set of real goods that pay for each other. The
most basic case involves just two real goods in a direct exchange or barter. Since each traded
good has two different agents associated with it, the first being the producer/seller and the second
being the consumer/buyer, let us use the letter x to denote a real good, its first subscript denote
the producer and the second subscript denote the consumer. Between agents j and k, the direct
exchange is x=(xjk, xkj).
A special form of direct exchange is an intertemporal barter between a current good and a
future good. Suppose a superscript denotes the period (0 for current, 1 for future). Then the
intertemporal exchange between (j, k) is denoted by x=(x0jk, x1kj). However, to balance payments
in each period, the borrower produces a bond f0 to give to the lender as current payment, which is
redeemed in the future period. Thus the bond splits the intertemporal barter into two exchanges:
x0=(x0jk, f0) in the current period; and x1=(f1, x1kj) in the future period, where f1 is f0 at the time of
redemption.
The bond is a store of value, and most models of money are models of bond. There is a
possible root of confusion between money and bond, because the use of money also splits the
exchange between two real goods. Suppose that j sells the real good to a customer c, and buys a
real good from a supplier s. Then the two real goods are x=(x0jc, x0sj). It is split into x0C=(x0jc, m0)
and x0S=(m0, x0sj). All goods and money belong to the current period unlike the bond. Money
involves a transport (transfer) of value, and not storage of value.
A degenerate form of exchange occurs when the buyer is identical to the seller j=k. In
that case, exchange degenerates into subsistence involving just one good which pays for itself. It
is interesting the much of prevailing economics is true only for this degenerate case. If genuine
payment is introduced, much of prevailing microeconomic theory breaks down.
Let us now consider indirect exchange. Walker (1865) wrote:

“For example, the farmer may wish to exchange wheat for a hat; but the hatter is already supplied:
what, then, will the hatter accept? A table. The farmer must then go to the cabinet-maker, and
offer his wheat for a table. But the cabinetmaker is supplied with wheat. He would, however,
accept a pair of boots. The farmer applies to the boot-maker, who happens to wish for wheat and
accepts the offer. With the boots the farmer gets the table, and with the table gets the hat which he
desired. In such a state of things, this was the only process by which exchanges could be effected;
circuitous, and expensive in time and labor, as it was. We might have supposed a far more difficult
case; but this is sufficient to illustrate the inconvenience of barter, or the direct exchange of
commodities. But there is still another difficulty, of scarcely less magnitude. When articles to be
exchanged became numerous, it would be found a very intricate matter to establish satisfactorily
the relative value of each.” Walker (1865): Book III, Part 2. Chapter 1, Page 121.

Mohammad Gani (October 2004): Money in Market Clearing

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 Walker’s stated aim is ‘to illustrate the inconvenience of barter’. He does not care to distinguish
between direct exchange, in which money is neither necessary nor possible, and indirect
exchange in which money is both necessary and possible, provided there is a complete circuit of
payments.
Walker misses the highly significant implications of his example, nine of which are listed
below. There is no sign that this example inspired later generations to study the implications. The
next known example of a complete indirect exchange appears in Wicksell (1905), but no
implications of indirect exchange are discussed. That is, there is no useful model of indirect
exchange known to this author. Mises (1949, Chapter 17) devotes a whole chapter to indirect
exchange, but without giving any formal clue to the need for a complete circuit. Marx (1859)
considers an incomplete circuit. But nobody explains precisely why money is used.
There are several things to learn from Walker’s example, even though Walker himself
does not teach us. The power of formal analysis is that if one considered money as a medium of
exchange, many issues would have been settled.

3.1 Distinction between Direct and Indirect Exchange

To distinguish indirect exchange from direct exchange, the first thing to note is that in an indirect
exchange, the first individual sells the real good to the second individual (customer) and buys the
intended real good from the third individual (supplier). Double coincidence can now be seen as
the condition under which the second individual is both the customer and the supplier.
Let us show Walker’s example with a graphical circuit. There are four real goods for each
of which demand is equal to supply. Walker’s discussion explicitly shows the direction of
movement of the goods. The opposite direction of movement of money is not implied, but may
be added without contradiction.
Wheat

Boot Hat

Table
Figure-1: Amasa Walker’s Payment Circuit

In the graph above, wheat pays for boot, which pays for table, which pays for hat, which
pays for wheat. The outer circle shows the direction of movement of goods. Money flows in the
opposite direction of the goods, as shown in the inner circle.
Let us consider the matter from the viewpoint of the farmer. We look at the upper part of
the graph. The farmer’s customer is the cobbler and the supplier is the hatter. When money is
used, as shown by the solid inner arrows, the farmer receives money from the cobbler and pays
the hatter with money, while he gives the wheat to the cobbler and gets the hat from the hatter. If
barter were possible, he would get the hat and pay with the wheat, and would neither receive
money nor give it.

Mohammad Gani (October 2004): Money in Market Clearing

Page 6 of 20
 Wheat Wheat

Boot Hat
Figure-2: The Customer and the Supplier Hat

The key distinction is that in direct exchange, the customer is also the supplier, but in indirect
exchange, the customer is not the supplier. The problem is to find out why the hatter would
accept money against a real good, namely, what would he get for his hat in real terms? Again,
where does the cobbler get the money from or what happens to his boots? These questions about
demand and supply of money at the micro level have not been answered by the literature. We
must find the answers.

3.2 Completeness of the Payment Circuit

The critical next step is to consider the circulation of money. We have so far presumed
that the farmer gets the money from his customer- the cobbler. But the cobbler himself had to
sell his good to get the money. In Walker’s example, the cobbler’s boots would be sold to the
carpenter. But the carpenter had to get the money from his customer- the hatter. And where
would the hatter get his money from? His customer is the farmer, who, as we have just seen,
does not have the money unless he gets it from the cobbler. The literature is unaware of this
problem, and hence it cannot deal with market clearing.
The quotation from Say suggests that he did not think much about completing the circuit.
In his example, the cutler wants bread, but the baker wants a coat, the tailor wants meat and so
on ad infinitum. This is an exaggeration to magnify the inconvenience of barter, and not an
analysis of indirect exchange and the use of money.
Marx (1859) took the issue of money seriously. He uses the term circuit to a single
agent’s action of selling a commodity C, getting and spending money M, and buying a
commodity C. As far as one individual is concerned, the sequence C-M-C (commodity-money-
commodity) and its obverse M-C-M (money-commodity-money) may look like a circuit. But it is
not a complete circuit. These incomplete circuits cannot tell us about the customer’s source of
money and the supplier’s destination of expense.
Why is it important to learn about the complete circuit? Unless the circuit is complete, no
trade can take place and no money can circulate. Suppose that the cobbler is absent in Walker’s
example. In that case, wheat lacks demand and the boot lacks supply. The farmer cannot sell (to
the missing customer) and consequently cannot buy. The carpenter cannot buy (from the missing
supplier) and hence has no reason to sell. Though the hat has demand and supply, and the hatter
has both a customer and a supplier, he is also disabled because his customer has no money and
his supplier has no reason to sell. Only when the cobbler joins the gang do we have demand and
supply for every good.
Supposing that demands and supplies exist for every good, it is still necessary that money
must be used as the means of payment. Thus suppose that the cobbler has no money, so he
cannot give it to the farmer, who in turn cannot give it to the hatter, who in turn cannot give it to
the carpenter, who in turn cannot give it to the cobbler. But if the cobbler has money, then the

Mohammad Gani (October 2004): Money in Market Clearing

Page 7 of 20
‘cannot’ becomes ‘can’ in the above example: Thus suppose that the cobbler has money, so he
can give it to the farmer, who in turn can give it to the hatter, who in turn can give it to the
carpenter, who in turn can give it to the cobbler. It is critical that the money must return to its
point of origin. It is just like an electrical circuit: unless it is complete, the electron cannot flow.

3.3 Impossibility of Barter and Necessity of Money

It must come as a shock that just when demand is equal to supply for every good under indirect
trade, no trade can occur unless money is used. The trouble in indirect exchange is that the
customer of the real good (the cobbler) has an obligation to deliver his own real good, not to his
supplier (the farmer) but to somebody else (the carpenter) on behalf of his supplier. Likewise, the
supplier of the real good (the hatter) has a right to receive a real good in payment, but not from
the customer, but from somebody else (the carpenter) on behalf of the customer. In the example,
the carpenter receives the boots on behalf of the farmer, and delivers the table, again on behalf of
the farmer, even though it is not at all transparent if we look only at the incomplete Figure-2.
The key is that there is a transfer problem: the obligation of the customer to deliver a real
good is transferred to the supplier, and the right of the supplier is transferred to the customer.
Money is the instrument to achieve this transfer. Without the use of money, this transfer is not
possible. In Figure-3, the customer’s real good (the boot) goes to the supplier of the hat through a
chain of transfer. Any break in the chain will stop the transfer and hence no trade will occur.
Wheat

Boot Hat
Table
Figure-3: The Transfer of Claims and Obligations

Despite the presence of demand and supply for each good, no barter is possible because
there is no double coincidence. Money creates an artificial double coincidence to solve the
problem. The farmer does not really want to consume money, and his demand for it is artificial.
He buys money pretending to prefer money to his real good. Next, he is not the producer of the
money, and yet he creates an artificial supply. He sells money to his supplier. This is true for any
money- be it commodity money or fiat money. In Walker’s thinking, the farmer would use the
boot and the table as commodity money in succession. But if fiat money was available at a
lower transaction cost, the farmer would use fiat money, taking it rather than the boot from the
cobbler, and giving the money rather than the table to the hatter.
The necessity of money as a means of payment should settle the issue of neutrality of
money. If money is a necessary means of payment, it cannot fail to affect the output that must be
traded against it. The key is that the lack of money cannot be overcome by resorting to barter,
because barter is impossible. Money is not a more convenient alternative to barter: these are
mutually exclusive means of payment. If barter is possible, money is impossible; and if money is
possible, barter is impossible.

Mohammad Gani (October 2004): Money in Market Clearing

Page 8 of 20
3.4 Interdependence of Demand
The payment circuit makes it graphically clear that the demand for each good depends on the
demands for every other good in the circuit. Thus the demand for the wheat depends on the
demand for the boots, which in turn depends on the demand for the table, which in turn depends
on the demand for the hat, which depends on the demand for wheat. In barter, the demand for
the first good is dependent on the demand for the second good.
The interdependence of demand is fatal to the most sophisticated piece of prevailing
microeconomic theory. The Walras-Arrow-Debreu general equilibrium model postulates a set of
independent demand functions. But if the demand functions are dependent, no solution is
possible with a simultaneous equations system. This is a major blow to prevailing
microeconomics in general and theory of value in particular. Luckily there is an easy escape. We
will briefly consider that in the last section.

3.5 Transmission Mechanism

The payment circuit shows that there is a mechanism to transmit the instability. If the farmer
fails to get money for wheat, he fails to demand the hat, and the hatter fails to demand the table,
and the carpenter fails to demand the boots. If there are n goods in the circuit, then the failure of
the ‘effective’ demand for one good disables the ‘effective’ demands for all other goods. There is
a multiplier effect, and this effect is the core of the theory of business cycle.
Let us imagine what might have happened if J B Say did not really suppose that the
cutler’s supply of knives was not met with demand for knives, especially as he has been credited
with the loose statement that supply creates its own demand. Suppose that in Say’s example, the
cutler wanted the bread, the baker wanted the coat, the tailor wanted the meat, but the butcher
wanted the knives. In other words, suppose he took Walker’s example. Then it would be
impossible for him to say that supply creates its own demand, because he would then be
compelled to recognize the need for money and the multiplier effect of not using money on the
demands. He would have come to the conclusion that the presence of demand and supply is only
half of market clearing. The other half is the use of money under indirect exchange. But he did
not think in this way. For two centuries, Say’s Law missed the issue.
The Keynesian revolution would be unnecessary if the payment circuit was recognized
earlier. Then it would be known that involuntary unemployment is inevitable unless money
transfers the claims and obligations on real output, namely, to clear the market. The magnitude of
the multiplier effect would also be easily measured by the length of the circuit.
In retrospect, the lack of the formal payment circuit meant that half of market clearing
was hidden from view. Let us now use the two distinct terms ‘ability to buy’ and ‘ability to pay’
so that we can reinterpret Keynes. When a prospective buyer has some real good ready to
deliver, and whose market value is equal to the value of intended purchase, the agent has the
ability to buy. The farmer has enough wheat to buy the hat. However, the ability to pay is a
different thing. It exists when the buyer has the right kind of payment as required by the seller.
The hat’s supplier does not accept wheat in payment for the hat, but requires the table, and the
farmer must somehow manage to deliver a table to the hatter. Unless he can get money, he
cannot achieve the transfer of his obligation to deliver a table to the hatter. The term effective
demand is not a good one, but the intent is to say that demand is not made effective until money
is used. We may say that the buyer must have both the ability to buy and the ability to pay. The
ability to buy must be converted into ability to pay by getting money for the good.

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 In the Keynesian argument, there is something wrong with the price either of labor or of
capital so that equilibrium is not reached. The distinction between ability to pay (correct price)
and the ability to buy (correct means of payment) shows that there is nothing wrong with price
behind unemployment. When cash does not move, goods do not move, and hence jobs are lost.

3.6 Multiple Coincidence

For a sharper presentation, we should clearly distinguish between the quantity and the kind of
payment. Let us reserve the terms demand and supply to refer to the quantities while the terms
acceptance and offer refer to the kinds. Then associated with the presence of demand and supply
of every good in a circuit, we need to add the condition that each one of the several good has
both offer and acceptance. This condition may be called multiple coincidence.
Let us clarify the terms offer, acceptance, and coincidence. These refer to the kind of the
good, not the quantity. The seller of a good accepts a payment while the buyer offers a payment.
Just as the consumer maximizes utility by choosing the quantity, the seller maximizes
utility by choosing the kind of payment. If there are several kinds of goods all available in
payment for the seller’s good, he chooses the one with the highest utility. Similarly, just as the
seller minimizes cost by choosing the quantity of output, the buyer minimizes his sacrifice by
choosing the kind of payment. Thus if the buyer has several kinds of goods each of which is
equally acceptable in payment to the seller, he chooses the one with the lowest utility to him.
When one good has both offer and acceptance, the condition is called single coincidence.
If the offer of the first good against the acceptance of the second good is matched by a reciprocal
acceptance of the first good against the offer of the second good, there is double coincidence.
When each of several goods has single coincidence, and it is possible to arrange them in a
payment circuit, then there is multiple coincidence. Indirect exchange requires multiple
coincidence. If and only if there is multiple coincide, it is possible to create artificial double
coincidence. Money cannot repair the lack of offer or acceptance. It creates artificial double
coincidence only if each good has both offer and acceptance.

3.7 Creation of Artificial Double Coincidence

Money creates an artificial double coincidence to achieve a transfer of real goods. In Walker’s
example, the farmer creates double coincidence artificially by first buying the boot with the
wheat, and then selling the boot to buy the table, and then selling the table to buy the hat. The
purchase of something without an intention to consume it is an artificial demand, just as the sale
of something without being its producer is an artificial supply. The farmer neither produces nor
consumes the boot, and yet he buys and sells it. He does this to achieve a transfer of goods.
The use of commodity money is generally mistaken for barter. We should note that an
outsider may not perceive that the farmer is really not bartering his wheat for the boots, but he is
trying to get the hat for the wheat. He is using the commodity to transfer the claims on real
output, in this case, literally. However, using commodity money imposes high transaction cost. If
a cheaper method is found, such as fiat money, the farmer would resort to using the fiat money.
Ultimately, double coincidence simply means that the buyer pays the seller. But of course
the payment must be both of the right quantity and of the right kind. The use of money is
designed to deliver the right kind of payment through a transfer of claims on real output. The
market of indirectly traded goods cannot clear unless this is done. The phenomenon of business
cycle cannot be understood until the market-clearing role of money is recognized clearly.

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3.8 Seigniorial Entrepreneurship
The creation of money requires seigniorial entrepreneurship. Walker’s farmer does not intend to
consume the boot, yet he buys it. If he were to consume the boot, he would suffer loss of utility.
This act is therefore not optimizing behavior. The act of buying something without an intention
to consume is an entrepreneurial one. It bears risk of loss, and also carries the prospect of pure
gains. The farmer bears the risk in the hope that he can get the hat he desires most to gain utility
This entrepreneurship of course requires the ability to manage payment by conducting a
transfer of claims and obligations. Echoing Menger, we may say that “if the individual (a) recognizes
the situation, and (b) has the power actually to perform the transfer of the goods’ then he can turn a
commodity into money or better yet, create fiat money out of thin air. The entrepreneurial
element in the creation of money is fundamental to a theory of money.

3.9 Excess Debt

A surprising revelation is that just when each individual has budget balance in real terms and
hence has no need to borrow, one of the agents must borrow money in the first instance. This
money debt is an excess debt. It is unavoidable, because a real good must be converted into
money before its owner can lay claim on the desired good in its exchange. We will later see that
fiat money must be issued by outsiders, and only as credit. If ordinary producers and consumers
could create money endogenously, there would be no occasion for excess debt or business cycle.
This has enormous practical significance to deal with the real problem of debt of
developing nations and of ordinary people. The circulation system must be reformed to match
the supply of money to the need for money, and to reduce burden of seigniorage fee for the use
of fiat money.
There is a need to reconsider the idea of money as a bond. If an ordinary person sells
something to get money, and then buys something with money, is he either a lender or a
borrower? And is he storing money or a good? How is money a store of value in this picture?

4. The Evolution of Money

Unless one recognizes how money creates artificial double coincidence by serving as a device to
transfer claims on real output, one cannot hope to study the emergence of money from a state of
its non-existence. One must see the essential job of managing the transfer of claims and the
entrepreneurship involved in performing this managerial action.
As we see it, the emergence of money is illustrated by Walker’s example of the
enterprising farmer. It is important to stress that the farmer is not behaving as an optimizer when
he undertakes to convert the boot and then the table into commodity money. An optimizer does
not buy what he does not consume, and he does not sell what he does not produce. An
entrepreneur buys what he does not consume, and sells what he does not produce. Their motives
and constraints are different. Without this distinction, creation of money cannot be understood.
The literature on the emergence of money overlooked the essential role of money as a
device to transfer claims on real output. Two major flaws in the prevailing literature on the
genesis of money are exposed by the notions of marketability and endogenous money. Both of
these notions overlook the seigneur’s role in the creation and issue of money as a tool.

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4.1 Marketability
The concept of marketability is a quest for the concept of acceptance. It is a matter of
kind. All traded goods must have demand and supply, and it is not likely to help if we try to think
of some goods as having an extra demand not for consumption but for the purpose of serving as a
medium of exchange. That begs the question: why would some good have additional demand as
a medium while other goods would not? The problem is vexed by the history of use of a wild
variety of real goods as commodity money.
If one saw a payment circuit, one would see that any good could serve as commodity
money depending on who the entrepreneur is. One paradoxical quality of the commodity money
is that it must neither be produced nor be consumed by the agent who intends to use it as money.
In Walker’s example, the cobbler could use the table and the hat as commodity money; but he
could use neither the wheat (he consumes) nor the boot (he produces) as money. The farmer
cannot use wheat or hat as money, but he can use the boot or the table.
The concept of marketability completely ignores the very creators of the market who
started indirect trade. Without traders, there would be little trade. So long as barter alone is
possible, there is no real market. Neighbors may engage in barter, but it is likely to remain a very
rare occurrence. Lending and borrowing would be a lot more frequent.
The emergence of organized trade must be supposed to begin with the emergence of
organized traders, and this occurs only for indirect exchange. This is a very different story than
the idea of spontaneous emergence of money without any organized effort to promote particular
goods as commodity-money. The spontaneous emergence story sounds as if individuals went
door-to-door in search of finding marketable goods. How did marketplaces, fairs, shops and
organized trade begin in that case? But if we suppose that some people took it upon themselves
to become merchants and thereby created the new institution of the market, it becomes simpler to
tell. Merchants have great need to select means of payment to minimize the cost of doing
business, and high stakes in developing a convenient medium of exchange. If we pursue this line
of inquiry, we are likely to tell a more coherent and historically more accurate story of the
evolution of money as a device to clear the payments.

4.2 Endogenous money

The idea of endogenous money risks missing the issue of medium of exchange altogether and
ending up with a bond (store of value). Ordinary people can certainly save, and they certainly
want to build up stores of value. But a store of value as such cannot become money, first because
a store is not spent, and secondly because the debtor’s liability cannot be transferred
The fundamental problem of money is the problem of managing the transfer of claims on
real output. This management cannot be done without managers. An external senior is able to
provide the management, but ordinary producers and consumers cannot. Thus suppose that the
producer of a generally acceptable good is able to buy anything with it. Then he is doing barter
with ease, a rather uncommon experience of course, but it is still barter. The buyers consume the
good and there is no question of it circulating. Again, a consumer just consumes the good and it
just cannot remain money, it cannot even remain a good: it simply vanishes.
How can money arise then? It must be issued by an outsider, and only as a loan. In
Walker’s example, the farmer may be said to lend his wheat. He gives it to the cobbler for boots,
then converts the boot into a table, and at last buys the hat with the table. The time that lapses
between his delivery of wheat and his receipt of the hat is the time he waits, as if he is lending

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his wheat. If he refuses to lend wheat in this sense, he cannot create money. To initiate the
transfer, somebody must take the first step of giving away something without immediate receipt
of the desired good. But that has nothing to do with storing value.
One possible way for a merchant to start commodity money is now easy to see. Suppose
that the farmer has a huge superfluity of wheat, which he cannot possibly consume. Let us
suppose that he wants to use this as his capital to run a business. What business is there? He
could lend wheat, and agree to take anything the debtors could give him in repayment. Suppose
we change Walker’s story by taking it back a few thousand years. The farmer lends wheat to the
cobbler, the carpenter, the smith, the potter, the hatter, the tailor, and other assorted producers.
And he receives all kinds of goods in repayment, because it is always easier for a debtor to
redeem his debt in his own produce than in the produce of somebody else.
Let us imagine that the cobbler is not exactly good at producing wheat, and hence tries to
pay back his debt in boots. The farmer does not need either the boot or the wheat, but he accepts
the boot. In course of time, the smith asks him if he would part with the boots for some iron
products, say nails. The farmer is now a merchant, and does not consume any of the goods he
buys. But he agrees to take nails in exchange for the boots, and puts the nails on sale. It is not
hard to see that by using wheat as a capital, he is able to collect an assortment of all kinds of
goods, and he wants to consume none of them. So he effectively buys and sells everything.
Anything that is bought to be sold again is commodity money. The farmer has a wide variety of
commodity money. But he has the largest stock in wheat, and it is best for him to turn wheat into
the common means of payment for anything he has. At the least, he may measure value in wheat.
Now suppose that the hatter does not need wheat, but needs the table. He comes to the
farmer-merchant. The farmer agrees to buy the hat, and offers to pay in wheat, with the promise
that he will take back the wheat for any good the hatter may wish to buy. Eventually, the hatter
buys the table with wheat. General acceptability has nothing to do with the wheat becoming the
common medium of exchange. The readiness of the lender to accept it in settlement of debt is the
first requisite and the readiness of the merchant to accept it in payment for anything is the
foremost requisite of it. And the early merchant could hardly begin a career as a merchant
without being a lender in the first place. The first and the foremost could mean the same thing:
accept payment or repayment in some chosen commodity.
The issue of lending is relevant. The presence of a lender is an important background to
assure the availability of the good that is to become money. Wheat would not become money just
because people would spontaneously suppose that everybody would more or less readily accept
wheat in exchange for any kind of good. Why? Wheat is also likely to be produced by almost
everybody. It would become money if the prominent lenders, acting as a single lender in the
extreme case, agreed to accept wheat in settlement of debt. In contrast, precious metals are not
generally available, and would hardly be generally acceptable to ordinary people. Ordinary
people were very unlikely to use gold and silver as ornaments, unless we forget that they did not
even wear much cloth a few thousand years ago. In short, metals could not become money
because everybody took them. The hand of the merchant must be seen behind its use as money.
Lending and borrowing is more likely than not to precede indirect trading. It is of course
an empirical issue and fresh research is needed to find out the role of merchants in the creation of
money vis-à-vis the occurrence of spontaneous emergence. If we remember that until about half
a millennium ago, the vast majority of people were peasants who strived to produce everything
they needed except artisanal goods, medicaments and minerals they just could not produce, the

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picture of the atomistic individuals spontaneously choosing one good over another would seem
less likely. Land was owned socially and administered by various forms of feudal politics. The
rise of commerce did not probably occur because of the prior atomistic ownership of land as the
principal factor of production, but the causation might go the other way. The rise of commerce
may have atomized agriculture by breaking down the power base of the feudal aristocracy. In
part, that is because the richer landlords would be lenders who ended up with repayments in
every sort of products and set up merchandising operations to dispose of the various receipts.
Though the state did not create money, its choice of the product to be accepted in payment of tax
certainly favored one over another commodity to become more widely used. If the king took
silver, so did his subjects. Deliberate promotion of one good over another as money is possible.
For the modern age, there is no question that fiat paper money is not endogenous. It is
exogenously supplied by the banking sector acting as a single body. This dramatically changes
the story of how money is supplied. The quantity theory of money apparently thinks of money as
a numeraire that people can assign without any trouble. Friedman’s vision of helicopter money
suggests that somehow people can simply increase their cash balances simultaneously in the
same proportion (Friedman 1969). The Lucasian vision of rational agents (Lucas 1972) also
appears to include the ability of the agents to change the stock of money at will. But if we allow
that money is supplied by an external supplier, and according to considerations of lending risk
based on some assessment of borrower trustworthiness and project feasibility, the story becomes
very different. In that case, cash balances do not suddenly change for everybody, but money
travels in a payment circuit so that’s some people have more cash earlier than others. The
external supplier is able to manipulate the cash constraint and the ordinary people can do nothing
about the constraints. If we consider the sequence of flow of cash in a circuit, and the effect it
has on the demands, supplies and prices as it circulates, the study of market clearing becomes
dramatically different. Business cycle theory, monetary theory, and macroeconomics cannot
remain the same if the concept of payment circuit is used.
Money is endogenous also in the Keynesian theory (Keynes 1936). Here, ordinary savers
are supposed to save money. The extremely complicated explanation of how the flow of money
is impeded by liquidity traps could be avoided if we supposed that external suppliers of money
may change the money supply abruptly according to their animal spirits.

5. Money as a Numeraire
When double coincidence is overlooked, one does not have a formal model to see money as a
medium of exchange. Then the digression is to think of money as a unit of account or numeraire.
Of course prices in a monetized economy are quoted in money. Theory of money ought to be a
part of theory of payment because money is a means of settling payments, but it becomes a part
of theory of price. The quantity theory of money is not really a theory of money at all, but it is a
theory of price. It is concerned with explaining the general price level.
Had there been a formal model of payment, one would have defined price as the quantity
of payment. Now, if the payment is in money and its supply increases without any increase in the
supply of real goods, then the price counted in money of course goes up by definition. The crux
of the problem is to find out how money supply could have increased or decreased without a
change in the supply of real output, but the quantity theory tradition did not consider the supply
of money as a means of payment at all. Supply without a supplier has no useful meaning.

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6. Money as a Store of Value
Let us quote Jevons on the use of money as a store of value.
(10): “It is worthy of inquiry whether money does not also serve a fourth distinct purpose—that of
embodying value in a convenient form for conveyance to distant places. Money, when acting as a
medium of exchange, circulates backwards and forwards near the same spot, and may sometimes
return to the same hands again and again. It subdivides and distributes property, and lubricates the
action of exchange. But at times a person needs to condense his property into the smallest
compass, so that he may hoard it away for a time, or carry it with him on a long journey, or
transmit it to a friend in a distant country. Something which is very valuable, although of little
bulk and weight, and which will be recognised as very valuable in every part of the world, is
necessary for this purpose. The current money of a country is perhaps more likely to fulfill these
conditions than anything else, although diamonds and other precious stones, and articles of
exceptional beauty and rarity, might occasionally be employed. ” –W S Jevons (1875): Chapter
III, Para 3.

It is interesting to note that Jevons applies his logical sharpness to see that serving as a
store of value is an incidental function of money, not its essential or first function as a medium of
exchange. Suppose that money does not serve as a means of payment. Can it then serve as a store
of value? The answer is obviously negative. But most models of money are models of a store of
value, and not of a medium of exchange at all. Even Baumol’s model of transaction demand for
money ends up with storing cash balances as stores of value (Baumol 1952). The key question of
why money is used in transactions in the first place is not discussed.
Let us distinguish between money and bonds as mutually exclusive means of payment.
First, in an indirect exchange, there is a problem of transferring current claims on current output,
and it has nothing to do with lending or borrowing as such. If the farmer pays the hatter with
money, he is neither a lender nor a borrower. He gives money as a device to enable the hatter to
get the table in exchange for the hat indirectly.
But intertemporal exchange is a completely different thing. Let us imagine that the farmer
and the hatter trust each other. They both try to keep a steady flow of consumption over time, but
their production is unsteady. At some points, the farmer has more wheat than he can use and is
glad to lend the excess to the hatter. At other times, the farmer has a smaller supply of wheat
than he needs, and the hatter procures wheat from somewhere and settles his debt to the farmer.
The essence is that lending and borrowing is a method of balancing the flow of production (Q)
with the flow of consumption (C). Time lapse is the essence here. But time lapse is not the issue
in indirect exchange.
C, Q
Wheat

C
Q

Boot Hat
Table Time

Figure-4: Money versus Bond

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 The distinction between bond and money is crucial for making progress in monetary
theory, business cycle theory, and macroeconomics. The first distinction is that a bond cannot
become a medium of exchange, but a medium of exchange can become a bond. The problem is
that a bond is essentially a barter, which excludes the use of a medium of exchange. This is
because the debtor cannot transfer his liability to somebody else. One who pays with the bond is
a debtor in the current period and has no real output to deliver, and hence cannot persuade
somebody else to deliver the compensation to the creditor on his behalf. But one who pays with
money has a real output to deliver in the current period, and can persuade his customer to
compensate his supplier on behalf of him. If the farmer pays the hatter with money, he is neither
a lender nor a borrower. The money enables the hatter to obtain the table delivered on behalf of
the farmer. This is not possible if the farmer issued a bond, having no wheat to deliver to the
cobbler. In short, the bond could not circulate as a means of payment. However, if a medium of
exchange is hoarded, it can be used later.
The theoretical issue for business cycle is to identify the source of the propagation of the
instability. The bond has no transmission mechanism associated with it, but money has. Suppose
that the lender fails to lend, so that his borrower fails to borrow. This of course keeps one lender
and one borrower unable to fulfill their lending and borrowing plans, but it cannot affect
anybody else. But money necessarily carries a transmission mechanism with it just because it is a
device to transfer claims on output. Let us use Walker’s example with a Keynesian twist to see
the transmission problem.
Suppose that Mr. Bagehot of Lombard Street is a lender of gold coins. Each period, he
lends one coin to the trusted nobleman Mr. Farmer, who buys a hat, and the hatter buys the table,
and the carpenter buys the boots, and the cobbler buys the wheat, and then Mr. Farmer returns
the coin to Mr. Bagehot, with a suitable interest in a sack of wheat. However, Mr. Bagehot has
seen some of his debtors fail recently, and is not optimistic about the future. He refuses to lend
the coin this time. No haggle on interest is enough to persuade him. Despite all demands and
supplies remaining as intact as before, all trades stop. It has nothing to do with saving and
investing or the distinction between consumer good and capital good. The same story holds if
Mr. Farmer refuses to borrow, because he does not care about buying the hat this period. The
disappearance of the demand for one good takes away the demand for all other goods in the
circuit through the interdependence of demands. It does not matter if the hat is a consumer good
or a capital good. In short, the propagation of instability is possible only under indirect exchange
as money carries the transmission mechanism. Instability cannot spread under barter or in
intertemporal lending and borrowing.

7. Concluding Comments
If we recognize that the buyer actually pays the seller, then we must agree that there is double
coincidence. If the seller wants money rather than the particular kind of good the buyer is able to
deliver, this is because the money is a device to enable the seller to get the kind of good he
wants. Unless money is used, indirect trade cannot take place.
The recognition of the role of money as a necessary instrument of market-clearing under
indirect exchange must change economic theory fundamentally. We will mention a few of the
changes in the theoretical outlook.

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7.1 Unified Economics
To find why and how money is both earned and spent, we must to look at the sales and purchases
at once for each household. This is most easily done with the input–output table. But this also
unifies micro and macroeconomics inseparably. If we describe the entire set of exchanges of real
goods of all n different kinds by an input-output table, then price theory and monetary theory
become essentially the same theory of payment in which the relations between the quantities of
traded goods appear as prices while the relation between the kinds of goods appear as means of
payment. Economic theory itself becomes a theory of trade, and there is just no need for a
separate theory of international trade or of international finance.

7.2 Involuntary Unemployment and Needless Poverty

The recognition of double coincidence as a necessary condition of trade in addition to the
equality of demand and supply at equilibrium prices offers a simple theory of involuntary
unemployment. Under indirect exchange money is necessary to permit market clearing. Even
when demand and supply is equal for every good in the payment circuit, no indirect trade can
occur unless money is used. Indirect trade covers perhaps no less than 95% of all trade.
Involuntary unemployment or real business cycle is impossible under subsistence or
barter, namely, when real goods suffice to serve as means of payment. If the employer can pay
the worker with the employer’s own output, which is really the output of the workers, there is no
reason for unemployment to occur. But if the employer cannot pay the worker with real output,
because the worker wants to consume other kinds of goods that the employer is unable to deliver,
then unemployment is inevitable unless the employer has money to enable the workers to get
what they want. Presence of demand and supply of labor at the correct wage is not enough to
ensure employment; the workers must also be paid in money.
Poverty is the result of involuntary unemployment. Let us distinguish poverty from
dependence, and inequality. If a person has no productive ability, he is dependent on the mercy
of others, especially the family, but he is not poor. If one wants to do work that nobody wants to
pay him to do, that person lacks a marketable skill and is not unemployed, but unemployable. If
he has lower productive ability compared to others, he is of course not as rich as the others; but
that is not poverty, but inevitable inequality. These cases of lack of ability and low productivity
are structural factors that must be remedied structurally by training the worker or equipping him,
or in case of dependence, supporting him with family or social support. True poverty is relative
to the potential income. It occurs if one has the productive ability but he cannot use it. This
happens if he is unable to get and use money to complete the transactions: he is involuntarily
unemployed despite the presence of demand and supply of labor. The inability to get money may
occur owing to the perversion in circulation of money, as discussed below.

7.3 Long and Short Circulation

The thick volumes on banking and multiple credit creation have ignored the sordid fact that very
large numbers of people are unable to get the proper amount of money and at the proper time.
Even in a world awash with fiat money, and plagued by inflation, unemployment is the result of
lack of necessary money. To see this, we must consider the circulation of money. A distinction
between short and long circulation will reveal the source of tragedy. A short circulation system,
unknown in practice except in case of commodity money, is the situation where one unit of

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money is used only once. In contrast, a long circulation regime uses the same money many
times. Long circulation spreads instability, short circulation does not.
To see the fundamental difference, let us take the Walker circuit. Suppose that the farmer
borrows a unit of fiat money (of the same value as the wheat, the hat, and the boots), and uses it
to buy the hat. He of course receives money from the cobbler in payment for the wheat, and as
soon as he gets the money from the cobbler, he repays the banker. It is long circulation if the
money goes from the bank to the farmer to the hatter to the carpenter to the cobbler to the farmer
to the bank. It will be short circulation if the money goes from the bank to the farmer to the
hatter to the bank. Excluding the bank, it is used just in one transaction, to pay for the hat, and
for nothing else.
Short circulation would work if and only if the banker issued one unit of money to every
agent in the circuit, and instructed them to use it just once. That is enforced by requiring that the
money be written as a single-use check, and the recipient must send the check to the banker.
The total supply of money would be exactly the same whether the circulation is short or
long. Under long circulation, 1 unit of money will be used n times, but under short circulation, n
units of money would be used 1 time each. Let us see how that short circulation destroys the
transmission mechanism to immunize the economy from unemployment and instability.
In Figure-5 below, the dashed inner circle shows long circulation. The farmer receives a
unit of money from the outside banker (shown in the center). This money goes to the hatter, the
carpenter, the cobbler, and then comes back to the farmer, when he returns it to the banker. In
contrast, there are 4 short circuits shown by the four inner triangles. In the first circuit, the farmer
receives one unit of money from the bank, and gives it to the hatter, who returns it to the bank.
The second circuit has the hatter borrowing one unit and giving it to the carpenter, who returns it
to the bank. The third circuit has the carpenter borrowing one unit, and giving it to the cobbler,
who returns it to the bank. Lastly, the cobbler gets one unit of money from the bank, gives it to
the farmer, who then gives it back to the bank. That is, the short circuit is a system of writing
checks that are used just once among buyers and sellers of real goods.

Farmer
Wheat

Cobbler Bank Hatter

Boot Hat

Carpenter
Table
Figure-5: Short and Long Circulation of Money

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 Short circulation immunizes the economy from the transmission mechanism. If every
producer gets fiat money directly from the bank, then the failure of one man to spend money
would not affect anybody else’s demand. This is because his supplier would not be dependent on
him for the money to buy his desired good, but would get money from the bank directly. His
supplier of course will be unable to sell the product, and hence remain indebted to the bank. But
others would not be affected. Under the long circulation regime, if the farmer fails to give the
money to the hatter, the hatter fails to buy the table, and the carpenter fails to buy the boots, and
the cobbler fails to buy the wheat. Under the short circulation, the carpenter, the cobbler and the
farmer would be able to sell their goods, and only the hatter will sit with unsold goods while the
farmer will sit with unspent money.
The biggest trouble with the existing long circulation regime is that the issuers of money
lend to 1 of n producers, and refuse to lend money to the other (n-1) producers. They regard
money as capital, and apply conditions appropriate to lending real capital. But money is not real
capital at all: it is fiat, and it ought to be fiat. The denial of money-loan is the true reason behind
the poverty of the great masses. This denial is not justified.
It is worth stating why a short circulation system does not require a test of credit-
worthiness. The system must ban bearer cash. Now, if there is no bearer cash, a borrower cannot
possibly run away with the checkbook. If he has any real good to sell, the proceeds must be
surrendered to the bank, and he cannot fail to repay the loan. If he fails to sell real goods, the
bank has good reason to take possession of the unsold goods and try to sell them, and put the
borrower through appropriate changes so that he learns to produce things that can be sold.
Incidentally, short circulation will reduce many petty crimes such as theft of cash, mugging for
cash, counterfeiting, money laundering, et cetera.
The experience of micro-credit should be reassessed as a peculiar manner of making
money available to people who are ordinarily denied by the banks. Empirical studies on payment
circuits can measure the effect of money on output and employment.
How much money is needed? The obvious answer is that he amount of money must be
exactly equal to the value of the indirectly traded output. The literature has no model to measure
the need of money. Economists are not sure what money is, and hence they use M1, M2, M3 and
M4 as alternative measures of how much money there is, without any mention of how much
money is needed. But it is easy to measure the need for money exactly. Walker’s example
involves the following matrix in which every real good has both demand and supply, and yet no
barter is possible. Unless money is used, all the output and employment must be aborted. The
cell where the zero is bold is the place where 1 unit of money must be used to pay for the real
good shown with 1 unit of value. Thus if the farmer wants to buy $1 of hat, he must sell $1 of
money to the hatter.
Wheat Hat Table Boot
Wheat 0 0 0 1
Hat 1 0 0 0
Table 0 1 0 0
Boot 0 0 1 0
We believe that a serious rethinking of economic theory of money is required to help us
learn how to overcome the problems of poverty and instability (Vij 2003). Gani (2003) offers an
exposition of a possible reconstruction of economics with money as a medium of exchange.
<<<THE END>>>

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