These should be two of the easiest questions to answer in economics; after all, money is the one thing that we all use in an economy—surely we know what it is, and where it comes from?
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...Only one person ever really ever did—and no, it wasn’t Ayn Rand. It was Augusto Graziani, an Italian Professor of Economics, who died early last year. He understood what money is because he posed and correctly answered a simple question: how does a monetary economy differ from one in which trade occurs by barter?
This ruled out gold being money, since gold is a commodity that anyone can produce for themselves with a bit of mining (and a lot of luck). So even though gold is really special and incredibly rare, it is in the end, a commodity: an economy using gold for trade is really a barter economy, not a monetary one.
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This gave Graziani three basic conditions that had to be met for something to be called “money”:
a) money has to be a token currency (otherwise it would give rise to barter and not to monetary exchanges);
b) money has to be accepted as a means of final settlement of the transaction (otherwise it would be credit and not money);
c) money must not grant privileges of seignorage to any agent making a payment.
Graziani saw only one way to satisfy those three conditions:
The only way to satisfy those three conditions is to have payments made by means of promises of a third agent, the typical third agent being nowadays a bank.
So money is fundamentally the promise of a bank to its customer, and a monetary payment is the transfer of that promise from one customer to another.