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Modelling Money As Tokens Macquarie Graduate School of Management MGSM WORKING PAPERS IN MANAGEMENT Modelling Money as Tokens Andreas Furche, Capital Markets CRC, Sydney, Australia Ernestine M. A. Gross, Macquarie Graduate School of Management & Graham Wrightson University of Newcastle, Australia MGSM WP 2003-24 November 2003 Disclaimer Working papers are produced as a means of disseminating work in progress to the scholarly community, in Australia and abroad. They are not to be considered as the end products of research, but as a step towards publication in scholarly outlets. © Copyright: Andreas Furche*,Ernestine M. A. Gross**,Graham Wrightson*** * Capital Markets CRC, Sydney, Australia ** Macquarie University, NSW 2109, Australia *** University of Newcastle, Australia Research Office Macquarie Graduate School of Management Macquarie University Sydney NSW 2109 Australia Tel 612 9850 9016 Fax 612 9850 9942 Email [email protected] URL http://www.gsm.mq.edu.au/research Director of Research Professor John A. Mathews Manager, Research Office Ms Kelly Callaghan ISSN 1445-3029 Printed copy 1445-3037 Online copy MGSM WP 2003-24 Modelling Money as Tokens Correspondence to: Ernestine M. A. Gross Associate Professor in Management Macquarie Graduate School of Management Macquarie University Sydney NSW 2109 Australia Tel 612 9850 9924 (direct) Tel 612 9850 9016 (switch) Fax 612 9850 9019 Email [email protected] ii Modelling Money as Tokens Abstract The model presented in this paper provides a formalisation of the concept of money and the mechanics of its circulation in an economy. Any instance of money is modelled as a Money Token. The mechanics of the creation, transfer and redemption of money are modelled using a limited set of four defined Basic Transactions. In this model, money is any contract, which can be represented by a Money Token. This is shown to include, but is not limited to, various types of securities, fiat money, cash, and commodities. The definition of a Money Token builds upon Roy Radner’s (1972) formalisation of securities contracts. The concept of the defined set of Basic Transactions originates in computer based electronic money technology. In both origin and applications the model provides a bridge between theoretical models of economies, the applied economics areas of monetary economics, finance, and banking and computer based systems for storage and circulation of financial instruments. It has been developed as a tool for research or practical implementation. This paper discusses the model, developed as part of a PhD thesis (Furche, 2001), in the context of ongoing research work. iii Modelling Money as Tokens Introduction When the term ‘money’ is mentioned, everybody immediately seems to understand what is meant. Yet amongst experts on the subject, for example economists or bankers, the question ‘What is money?’ draws a variety of different answers that often contradict each other. When asked for a definition of the term, neither these experts nor the textbooks on the subject are able to provide anything more than a loose description of the roles that money may perform in society. However, there is no shortage of concerns and opinions about the stability of the international monetary and financial system, about inflation, and about monetary policy, all of which seem to presuppose a definition of ‘money’, which is precise enough to allow measurements and the description of money creation, circulation, and destruction. The lack of a precise, or mathematical, definition of money makes it difficult to deal with the subject in a structured and formalised way. This is a problem in a number of research areas dealing with the meaning and usage of money, as well as in applications in practice. The aim of the work presented here is to develop a definition of a concept of money, which is precise enough to be useful for two specific areas of research. The first area is electronic money research and the implementation of IT based financial systems. The second research area is economics; economic theory and the applied areas of monetary economics, banking, and finance. The model presented here draws on the methodology of both general equilibrium theory in economics and electronic money research, in order to provide an improved conceptualisation of money and its circulation. The approach taken in the development of the model deals with the history of descriptions of various forms of money and with the lack of a formal definition of money by providing a definition, which allows the characterisation of every ‘instance of money’. Each instance of money is modelled as a Money Token, a unique representation of a contractual arrangement between economic agents, which is shown to formally describe financial instruments that developed in the course of history, including debt contracts, equity shares, derivatives, fiat money (cash in today’s form), bank money and commodity money. A Money Token describes all distinct properties of each financial instrument in terms of a limited set of variables and a redemption rules function. Furthermore, the circulation of financial instruments within an economy is modelled, using a limited set of four Basic Transactions, which allow the precise description of the creation, transfer, and redemption of every financial instrument. The definition of a Money Token involves a generalisation of the concept of a security as found in general equilibrium models of sequence economies, particularly Radner (1972). It incorporates and makes precise parameters suggested in Douglas Gale’s (1982) discussions of fiat money as a special type of ‘paper asset’ in the context of sequence economies. It allows for an extension of Gale’s arguments on intertemporally incomplete markets to spacially incomplete markets (partially segmented markets; 1 Gross, 1988) where each nation state issue its own currency. Furthermore, types of security contracts are distinguishable by their respective redemption rules function. The structure of the model is directly linked to existing electronic money technology, so that the description of a financial system in the Model of Token Money can also serve as the basis for a computer-based implementation. This allows the model to be used as a tool in the design and implementation of computer based systems for financial transactions, as well as in the development of computer-based numerical methods of theoretical and applied research in economics. This paper contains some applications of the model in the specialist field within information technology (IT), which deals with the development and implementation of computerised banking and trading technology. We will refer to this specialist area in IT as ‘financial IT’. In this area the model can serve as a simple and effective basis for the design, implementation, and maintenance of computer-based systems for storage and trade of financial instruments, and the interconnection of such systems into networks. Here, the model provides a uniform and formalised description for the building blocks of any computer based banking or trading system, as well as the exact system properties. In an area where system development is very security sensitive, currently extremely expensive, and interoperability of heterogeneous systems is the recognised problem, a uniform, formalised approach, offered by the model, allows significant improvements in efficiency of development, and system security. This application of the model has the potential for substantial improvements in the development of financial IT systems, and it will be discussed in detail in a forthcoming paper. The model described in the present paper has been developed as part of a PhD thesis, titled The Model of Token Money (Furche, 2001). This paper provides a summary of this work. For more detail the reader is referred to the complete publication. Section 2 of this paper discusses briefly the difficulties in formalising a concept of money and the approach chosen here. In section 3 the Model of Token Money is introduced in a concise fashion. Section 4 contains some applications of the model, and section 5 contains the conclusion and discusses possible directions of further work based on the model. Both sections 4 and 5 are kept brief in the interest of limiting the size of this paper, and results of the application of the model presented here will be published separately in more detail. Formatted: Bullets and Numbering What is Money? When attempting to develop a formalised methodology for the description of money, one immediately faces the problem that the term ‘money’ itself is not clearly defined. On close inspection, the views on whether a particular item is money or not vary significantly between people considered to be experts in money related matters, as well as practitioners, which, on the subject of ‘money’, includes just about everybody. Textbooks on monetary economics generally deal with the matter by providing the so- called tripartite definition of money, which defines money as something that serves as 2 a unit of account, a store of value, and a medium of exchange (Jevons, 1875; Hicks, 1967; Issing, 1993; Jarchow, 1993; Dornbusch 1995). This definition is stated and the three functions of money described, usually in the earliest chapter, and it is then never used again for the remainder of the book. The main reason for this lack of later applications of this ‘definition’ is probably that in practice it is of little use. If it is in question whether a particular item constitutes money, the tripartite definition of money provides neither a necessary, nor a sufficient condition that could not be easily contested by questioning the ‘definitions’ of one of the three included functions of money. Finding a clear-cut definition of money is difficult because what money is, is to a good extent a subjective decision, driven by beliefs and opinions. Money is essentially what passes as money, i.e. ‘what is commonly accepted as payment for goods and services’ (Galbraith, 1995) and the discharge of debt contracts (Keynes, 1930).
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