Standard of deferred payment and legal tender

Hey everyone,

So in the last couple videos, I was talking about various functions of money, and people usually list at least three different functions that it serves. The first is a medium of exchange; it's what we use to trade for goods. The second is that it's a store of value. If you keep your money around, it'll retain its value. The third is that it's a unit of value. We usually think of things in, you know, dollar terms or euro or peso or yen terms.

Some texts will actually add a fourth function of money onto this, which is that money is the standard of deferred payment. Standard of deferred payment—now what does this mean? What does deferred payment mean? Basically, it's any time that you receive something but only pay for it later, and the most common form of this is debt.

So let's say that you're over here and you want to borrow a thousand dollars. So you borrow one thousand dollars; maybe it's from some kind of institution like a bank. Maybe it's, let's say, it's a thousand dollar credit card loan. You receive it, and then some kind of time passes—maybe it's like the month before your credit card bill comes. Some time passes, and then after that, you repay that debt, and you'll repay it with money.

This is probably the most common, where you're receiving, you know, money to use for something, and then you pay it back. But there are other forms of deferred payment, like if you go to a restaurant, for example, where you receive your food before you pay your bill at the end. That would actually be a form of a deferred payment because you know you receive your food at the start of the evening, and then you eat it, and it's only at the end that you pay it.

Hopefully, your bill isn't a thousand dollars, but it is something where you're paying it at the end. Insofar as money is what we use to repay this, this is its fourth function. Now you might be able to see why some people think that this shouldn't count as an extra one because you could argue that this falls under the category of a medium of exchange.

You know, just in the same way that you use money to buy a chair or to buy legal services or to buy food, you're using money to pay your debt; it's just another one of those things that you're exchanging for. So why should this be separated? Well, one case that you could make for why this idea of a standard of deferred payment really does serve a different function than the others is that, at least in modern economies, there's somewhat of a legal backing to the idea of money serving this standard.

By that, I mean if you take on a debt in a country and there's some kind of legal obligation attached to that debt associated with the legal system of the country, tied into the law is the idea that you can pay back that debt with money.

If you've ever heard the term legal tender—legal tender, you might have heard of like dollar bills or coins and things like that being called legal tender. What this means is that "legal" indicates that there's some association with the system of law within a given country, and "tender" is kind of an old word for offer.

What this basically means is that if you take on a debt, like you know you borrow a thousand dollars from the bank or you eat food in a restaurant before you pay for it, as soon as you offer money—as soon as you offer something which is legal tender, so like dollar bills—that debt will no longer exist. The act of offering it alone will eliminate that debt.

As an example of why this has some bearing, consider the fact that it used to be the case that people would often take out loans in gold. For example, in the late 1800s, when a lot of railroads were being built and there was debt being raised to support the building of those, it would often be the case that one of the men building these railroads might borrow a large sum of money, but he would borrow it in the form of a lot of gold—some kind of gold. Then it was expected that he could pay this back, you know, in that same form; he could pay back the gold itself, you know, maybe plus interest.

This is why people would give him gold in the first place, and it might be, you know, maybe it's just a lot of people looking to invest the gold that they're holding and hoping that it returns some kind of interest.

Now let's think about what would happen if you tried to do this today, where if instead of, you know, back in the era, you were doing this today. So let's say you borrowed like one ounce of gold. It might be one ounce of gold, and say that corresponded today to one thousand dollars. If it was one thousand dollars for every ounce of gold, then let's say while you're holding on to it, you know, some time passes—you're investing it, maybe instead of building railroads, you're doing something more modern with it.

But let's say after enough time has passed, the gold has actually gone up in value; you know, maybe there's been inflation or maybe for whatever reason, the gold is now a higher price. Instead, let's say after the time it's now two thousand dollars—two thousand dollars for a single ounce of gold.

Now if you were to pay back exactly what you received, you would pay back one ounce of gold, maybe plus some interest, and nobody would have any reason to complain. However, legally you're allowed to pay back your debt in the form of the legal tender of the country. So for example, in the United States since your original loan was in the form of a thousand dollars, you could pay back instead of in gold, one thousand dollars—just U.S. dollars.

Just by offering that to the people who originally gave you the loan, the debt would be gone. But in effect, what this would mean is that you're paying back half an ounce of gold because after this time has passed, you know, the dollar has devalued relative to gold, and instead, a thousand dollars would only buy half an ounce of gold. You might imagine people would be kind of unhappy about that.

So the whole point here is that the standard of deferred payment actually has some legal clout to it. So what you could argue separates it from the other functions of money is this fact that the currency in most modern economies is actually tied up with the legal system of the associated country.

So with that, I will see you next video.