Our current monetary system is a complex network of institutions, policies and practices that enable the circulation and exchange of money. At its core, the monetary system is designed to ensure enough money is in circulation to facilitate economic transactions while keeping the value of money stable over time. To better understand our system, we can illustrate its functioning with the example of Pokémon cards.
What is money?
Money is defined as a medium that fulfills at least three conditions:
1. Medium of exchange. Instead of bartering chicken against wheelbarrows, we can use the money for intermediation, which reduces friction and facilitates trade.
2. Store of value. Money should not be perishable. Ice cream would be a terrible store of value. Same for air since air is abundant. Gold is a good store of value.
3. Unit of account. A collector of classic cars might boast about the number of vehicles he owns, but it might not mean much to a farmer who measures his wealth in acres of land. However, most can relate to the value of things expressed in dollars.
Before the advent of paper money, people used gold coins as a medium of exchange. Unlike paper money, which is just ink on paper, a gold coin has tangible value and is easily understood. However, carrying around heavy coins was inconvenient and risky. The introduction of paper money was a game-changer as it provided a lightweight and convenient alternative to gold coins. In 1971, the gold standard was abandoned, and paper money became detached from its physical backing. Today, money is merely a social construct, and its value is based on our collective agreement. Despite being intangible, it is a powerful tool that enables trade and economic growth.
The rise of electronic banking has brought about the concept of digital money, which takes the abstraction of money to a whole new level. While we traditionally associate money with its physical representation as cash, the truth is that most of the money exists purely in digital form, represented by strings of zeros and ones stored on computer servers. In fact, only a tiny fraction of the money supply in the United States is in the form of physical cash, with estimates suggesting that only around 1-2% is available domestically. The sheer scale of digital money is staggering, with the total amount outstanding in the US amounting to a staggering $93 trillion, compared to just $2.3 trillion in physical cash circulation.
Pokémon Theory of Money
To illustrate how our monetary system works, let’s use an analogy with Pokémon cards. Pokémon trading cards were first introduced in 1996 in Japan and have since been sold more than 43 billion times worldwide. Let’s assume all Pokémon cards are equally common and different designs equally distributed. While the production cost of each card is just a few cents, they are sold to the public for $1, much like how our paper currency is printed at a very low cost but has a much higher face value. These cards have almost zero material value, being made of cardboard and ink, just like our dollar bills. In this analogy, the company that produces the Pokémon cards represents the central bank, whose role is to serve the public by supplying currency. The central bank manages the production of cards so that the market isn’t flooded with them, which would cause the value of each card to plummet. Instead, they aim to produce enough cards for new players to accumulate, while maintaining the overall value of each card.
Pokémon exist in the digital world, too. Players can collect Pokémon through an electronic game by either finding them by chance or completing in-game tasks. Motivated by the game’s popularity, certain private companies have entered into a license agreement with the CPC (“Central Pokémon Company”) to produce digital Pokémon. These companies function like commercial banks, creating only digital representations of the Pokémon. However, players can still exchange their digital Pokémon for real cards if they wish. Private banks hold a certain stash of physical cards in their vaults for this purpose.
Some players wish to borrow digital Pokémon for business purposes. The creation of those Pokémon happens via double-entry in the bank’s books – as an asset and a liability. The bank records Pokémon on loan to the customer as an asset. Simultaneously, the bank records the same Pokémon as a liability since it was also credited to the customer’s online wallet. The customer can now either exchange his Pokémon into a real card or send it from his account to other players in digital form.
Private banks create additional digital Pokémon out of “thin air” with a…
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