Monies – Joining Economic and Legal Perspectives

David Bholat, Jonathan Grant and Ryland Thomas.

The economist John Kenneth Galbraith once quipped that the answers economists give to the question “what is money?” are usually incoherent. So in this blog we turn to law for some answers. Debate about the nature of money has been renewed by recent financial crises and the rise of digital currencies (Ali et al 2014; Desan 2014; Ryan-Collins et al 2014; Martin 2013). This was the focus of a panel session at the Bank’s recent annual conference on Monetary and Financial Law, which brought together lawyers and economists to develop interdisciplinary perspectives on topics such as money. It prompted us to think more deeply about how law does and does not constitute ‘it.’

Common legal attributes of money

Anything can function as money. And many things have: cattle; cowry shells; even cigarettes.

But as Minsky once said, while “everyone can create money, the problem is to get it accepted.”

While in theory anything can be money, the reality is few things are. Monies produced by the Royal Mint and the Bank of England (BoE) are the ultimate means of payment, followed by private sector claims, in order of how immediate they provide for full convertibility into these.

Some economists argue that this hierarchy of money is the result of legal privileges, especially legal tender legislation (Smith 1936; Hayek 1976). However, legal tender legislation in the UK only applies to the settlement of debts. It doesn’t cover spot transactions— our daily buying and selling in the marketplace.

So if we want to explain why state issued tokens and claims, and promises of immediate conversion into them, are monies, legal tender laws seem less important than other legal attributes that make them trusted and give people comfort they can get someone else to accept them.

In the past, when gold and silver were monies, economists often explained this reality by reference to these metals’ physical attributes such as portability, uniformity and durability. Today these physical attributes of metal monies have legal analogues.

Think of a fiver. Three legal attributes make it money.

First, a fiver is portable because it is legally negotiable: it can be transferred to others without each time gaining consent from the BoE (the fiver’s issuer), and, once transferred, it’s free and clear of any claims being brought by those who previously possessed it provided it was taken in good faith (Geva 2011).

Second, fivers are uniform because they are fungible: each can substitute for another. This is because the rights and obligations they confer are the same.

Finally, durability means maintaining fixed nominal value through time. A rough legal equivalent of durability is an option for instant par redemption. State-backed monies such as fivers and promises of immediate conversion into them are monies probably because states retain the power to fix the nominal meaning of their unit of account and can choose to accept only claims denominated in that unit of account in discharge of tax obligations.


While all monies share hues of negotiability, fungibility, and instant par redemption, each type of money also has unique legal features. Ordinarily, these legal differences don’t matter because one type of money is easily convertible into another. Qualitative differences in the legal construction of monies appear, if at all, merely as quantitative differences in their rate of financial return. For example, in ordinary times, although term bank deposits accrue interest and BoE notes do not, they are treated by most people as equivalents. However, during financial crises, qualitative differences reassert themselves and, in the extreme, parity breaks down. In classic bank runs, for example, individuals seek to convert bank balances into cash because the difference between having a claim on a private counterparty that can go bust, versus a public counterparty like central banks that can operate even on negative capital, acquires greater salience.

Consequently legal differences between monies sometimes matter. So we note some below. Here our analysis chimes with research in sociology and behavioural economics showing that money is not singular but plural (Dodd 2014). However, while those studies focus on how money is imbued with different meanings by individuals once in circulation, for example, depending on its source (e.g. whether it’s from wages or inheritance), our point is that monies are plural from the start, in the nature of their legal construction.

Royal Mint coins

Sterling coins are manufactured by the Royal Mint Limited, a public limited company wholly owned by HM Treasury through the Royal Mint Trading Fund. Different denominations of coin are legal tender up to different thresholds. For example, 5p coins are legal tender for any amount not exceeding £5, while 50p coins are legal tender for any amount not exceeding £10. Royal Mint coins are unique among UK monies in that they are not the legal obligations of any counterparty, though they are treated as a liability of central government in the financial accounts of national income statistics.

BoE notes

Legally, notes represent debt obligations of the Bank. Originally they could be redeemed in gold. However, since 1931, the Bank no longer pays out gold against its notes. BoE notes were first issued in the seventeenth century but did not acquire legal tender status in England and Wales until 1833. They are not legal tender in Scotland or Northern Ireland.

BoE reserve accounts

BoE reserve accounts are debt obligations owed by the Bank to commercial banks and other Sterling Monetary Framework (SMF) participants. They are the largest liabilities on the Bank’s balance sheet and have been used by banks for settling their obligations with each other since at least the mid-19th century.

Scottish and Northern Ireland banknotes

Seven banks in Scotland and Northern Ireland issue their own notes which are these banks’ debt obligations. These notes are not legal tender even in Scotland and Northern Ireland. Rather, they circulate by convention, underscoring our thesis about the importance of other legal attributes besides legal tender legislation in conferring ‘money-ness.’ As a result of the Banking Act 2009, these notes are backed in full by a combination of Royal Mint coins, BoE notes and reserve account balances.

Accounts with banks and mutual organisations

Banks and mutual organisations offer current and other types of spendable accounts used for payments. On the one hand, these accounts are unsecured debt obligations of private organisations. On the other hand, many are backed up to certain limits by statutory guarantees. Today the value of transactions involving these accounts greatly exceeds the value of transactions involving legal tender. And growth in these accounts’ balances is mainly driven by additional loans that create equal and opposite accounting entries.

Further research

Economists and lawyers often approach the topic of money differently because they have different philosophies underpinning their professions. Economics is basically a branch of utilitarianism, meaning that the consequences of actions are the basis for judging their rightness or wrongness. Hence many problems in economics are about optimization and involve cost-benefit analysis. By contrast, law is derived from deontology, meaning some actions are intrinsically right or wrong according to normative rules. Hence legal decisions are typically justified by history and notions of justice.

These philosophical differences mean economists and lawyers often think about money differently. For example, many economists think money arose as a transaction cost reducing, utility enhancing device to overcome the absence of a double coincidence of wants that hampers barter, while many lawyers and institutionally minded economists think the origins of money is the state (Goodhart 1998). Economists mostly think of money as a medium of exchange (Kiyotaki and Wright 1989) because this function relates to trade and commerce, while law emphasises money as a means of payment (Proctor 2012): whether one party has discharged their obligation to another. In emphasising the settlement of obligations, law draws attention to money’s role in non-commercial transactions such as taxation and transfers. And while economists treat money mainly as an indicator or intermediate target for influencing real, macroeconomic variables, lawyers typically think about money in the context of individual cases and adhere to the doctrine of nominalism.

Despite these different points of emphasis, this blog has tried to show that understanding money requires joining legal with economic perspectives. For example, while for a long time lawyers saw bank deposits simply as loans, economists much earlier appreciated their wider bearing on inflation and output. However, if economists want to explain why certain claims like bank deposits are money, while others are not, they must look at their legal attributes and socio-legal history. Recent research on money by Bank staff has been informed by both law and economics (McLeay et al. 2014; Bholat 2013). Here are a couple paths on which further interdisciplinary research might advance:

  1. How is the money demand for a claim impacted by changes in its legal constitution, for example, after a major structural break like the conferring of legal tender status on BoE notes or abolition of their gold convertibility?
  2. Besides negotiability, fungibility and instant par redemption, what other legal features make claims suitable to be money?

David Bholat works in the Bank’s Advanced Analytics Division, Jonathan Grant works in the Bank’s Legal Directorate and Ryland Thomas works in the Bank’s Monetary Assessment and Strategy Division.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

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