Money (the medium of exchange) is an asset. But the demand for money is different from the demand for any other asset. Here is an (inadequate) parable that tries to explain why it is different.
A dozen kids are sitting in a circle around a campfire. They have cold hands. The parent has a bucket of hot yams. (They are magic yams that stay hot forever). Each kid has 2 hands and wants to hold exactly 2 yams. Trying to hold more than 2 hot yams would burn the kid. So a kid holding 3 yams would immediately pass one on to his neighbour, who will only accept it if he has an empty hand, or sees there's another kid with an empty hand.
With 12 kids times 2 hands each there is a demand to hold 24 hot yams. The parent hands out 24 yams and the kids pass them along until each kid is holding 2 yams. If the parent tried to hand out a 25th yam, no kid would accept it. Because any kid who accepted it would be unable to pass it on to another kid who wanted it. The stock of hot yams held by the kids is determined by whichever is less — the kids' demand or the parental supply.
Now let's change the story from yams to potatoes. Unlike yams, a hot potato will only burn you if you hold it longer than one minute. You can hold as many hot potatoes as you like, providing you don't hold any potato for longer than one minute. So the kids hold each potato for exactly one minute, then pass it on to the next kid in the circle.
What is the demand for hot potatoes? How many potatoes should the parent hand out? 12? 24? 36? 48? This question doesn't (yet) have an answer. The parent can hand out as many hot potatoes as she likes, and the kids will accept them, hold each potato for one minute, then pass it on to the next kid. The stock of potatoes held by the kids is determined by the parent's supply, and not by the kids' demand.
How would we need to change the story to make the demand for potatoes determinate?
Suppose the kids also supply and demand backscratches. You can only give a backscratch with your right hand, to the kid on the right. So you can only get a backscratch from the kid on your left. Suppose the rule is that the price of a one-minute backscratch is one potato (I'm assuming sticky prices). Potatoes circulate clockwise, and backscratches circulate counter-clockwise.
Let's start with a recession. There are only 6 potatoes in circulation, so 6 kids are producing backscratches, and 6 kids are consuming backscratches, at any point in time. You might say that the demand for potatoes is also 6, because that is the number of potatoes needed to pay for the backscratches that are being produced and consumed. But if the parent hands out a seventh potato, it will be willingly accepted, and be passed on once a minute, so now 7 kids are producing, and 7 kids consuming, a backscratch, at any point in time. If the parent hands out 12 potatoes, the recession ends, because each kid is now fully employed giving backscratches.
The stock of potatoes demanded equals the number of backscratches produced per minute. Because velocity of circulation is 1 per minute. But if the parent increases the supply of potatoes, the number of backscratches increases, and the demand for potatoes increases in proportion. The supply of potatoes creates its own demand.
What happens if the parent tries to hand out more than 12 hot potatoes? The kids will still accept them, because they can always pass them on to the next kid. But they won't get a backscratch in return. Because all the kids are already fully employed. If it weren't for the campfire taboo on changing prices, we would see the price of backscratches begin to rise.
Should we say that the kids demand a stock of potatoes equal to one minute's worth of nominal income from selling backscratches? Wouldn't it be better to say that the kids have a desired velocity of circulation of one per minute?
Money, as the medium of exchange, is like the hot potatoes in this parable. All other assets are like the hot yams.
Perhaps we should abolish "the demand for money", and speak about "desired velocity" instead. Or, better still, talk about the desired degree of synchronisation between payments and receipts.
Worthwhile Canadian Initiative 
Let’s say there are 12 potatoes. Next, the kids drop 3 of them on the ground to be used later. 3 other potatoes rot, and no more new potatoes can be grown (for now). What happens?
“The point is a certified check is one of the least convenient forms of money ever devised, yet it is sometimes the necessary form. Travelers checks are money. Casino chips are money. Bitcoins are money. Linden dollars are money… The list is endless.”
“Peter N: I see it differently. Compared to the total variety of different goods, which really is almost endless, the set of goods that are used as media of exchange is very very short. And within a given country, nearly all those money goods are convertible on demand at par into one of those money goods.”
“1) “convertible on demand” isn’t very well defined in practice. You need something like convertible to all holders with minimal friction. There are, after all, differences in when, where, how and to whom you have to make a demand for conversion, and you have to say what an acceptable fee for conversion is. There may also be minimum conversion amounts.”
I believe 1 to 1 convertibility matters.
Peter N and W. Peden, monetary base (currency plus central bank reseves) goes up. M4 goes down. What happens?
Too Much Fed,
That depends on the causes of the movements in the aggregates. For example, are people holding more base money because of a flight to safety or a rise in the desire to make cash transactions? Is M4 falling due a reduction in the demand for banking services or a constraint on banks increasing their balance sheets? Etc. etc.
The monetary base is important because of the influence it gives the central bank over some other things, but the vast majority of people’s liquid assets (in a modern economy) take the form of deposits and other liquid commercial bank/building society assets, so the monetary base has no direct relation to people’s expenditure decisions. For these reasons, I think there should be very little interest in what’s going on with the monetary base (at least as far as economic indication goes) and more interest in what’s going on with M4 and similar broad aggregates like Divisia M4, M4x, non-financial M4 and liquid assets outwith M4.
W. Peden, 1st paragraph:
What about debt defaults and debt repayments to banks and bank-like entities?
2nd paragraph:
Is that because the medium of account = currency plus demand deposits and not monetary base (currency plus central bank reserves)?
“What about debt defaults and debt repayments to banks and bank-like entities?”
Those are constraints on bank balance sheets, aren’t they?
“Is that because the medium of account = currency plus demand deposits and not monetary base (currency plus central bank reserves)?”
No, I’d say that the medium of account is currency plus close money substitutes. The medium of exchange could perhaps be said to be currency plus demand deposits, but whether my money is in a short-term time deposit or a demand deposit isn’t very important to my expenditure decisions. As Milton Friedman put it, the theory of money is a special topic in the theory of capital. Narrow aggregates are not special problems in the theory of capital, though as I said the monetayr base has some significance as the principal lever of monetary policy.
W Peden: “As Milton Friedman put it, the theory of money is a special topic in the theory of capital.”
That surprises me (not that I doubt you, and it’s probably just my bad memory). I would strongly disagree with MF on that, despite my monetarist/Friedmanite leanings. I can imagine a world with money and with no capital. And even if money were capital, or were related to capital, it is very different from other kinds of capital. I am trying to write a post saying that “the demand for money” should be abolished. Monetarism’s biggest mistake was to talk about “the demand for money”, as if it were just another asset, like a capital good. I think this is related to what you say MF said.
Nick,
Let’s talk about “quality money”. This is the financial asset that has the best combination of liquidity an value storage for use in the most common transactions of the niche in question. In most cases the premium for conversion to the quality money of another niche will be the lowest or very near the lowest for the niche being transferred from.
If it appears that some form of instrument other than the quality money of the niche is serving as quality money, this means that there is an economic subniche whose transaction favor it. If this subniche money is freely convertible to niche money a negligible cost this implies two things –
1) There is a barrier of entry to the subniche (which efficient market theory would seem to require.
2) If conversion is cheap enough and the advantage large enough, it may be possible to derive something very like rent by exploiting the differences (such as higher velocity or volume allowing small but lucrative rents). Also if the transaction volumes are high and the system is opaque, the niche market will supply cover for the extraction of much larger rents.
That’s my take, anyway. “Primary dealer” status with the Fed would seem to be a model for high volume low rent extraction.
Peter N:
1. There is a big barrier to entry with money. Like languages, or other networks, no individual wants to change to a better one unless other individuals change at the same time. But it helps if your new word processor is convertible on demand into MS Word.
2. You lost me.
Nick Rowe,
I’m sure Friedman would agree that money is different from other forms of capital, hence a “special topic”.
“I can imagine a world with money and with no capital.”
Intriguing. I look forward to the post!
W Peden: thanks, but I feel I’m running out of ideas nowadays. Brain not working.
Money is not just very different from other forms of capital, I’m not sure it is capital in any useful sense of the word. It would be as correct to say that money is a special topic in comparative economic systems!
W. Peden said: “The medium of exchange could perhaps be said to be currency plus demand deposits,”
OK.
And, “No, I’d say that the medium of account is currency plus close money substitutes.”
Why aren’t demand deposits a close “money” substitute so MOA = currency plus demand deposits?
Most demand deposits can be used just like currency to purchase goods/services and/or financial assets and are convertible 1 to 1. For example, I get a mortgage at a bank (emphasis) so that a new demand deposit (emphasis) and a new loan (emphasis) is created. I can now purchase the house with some kind of demand deposit transfer. I could also convert the demand deposit to currency and withdraw it to purchase the house. The builder would then take the currency and deposit it in a bank to get some kind of demand deposit that would probably pay interest. The demand deposit transfer is easier and probably safer.
“”What about debt defaults and debt repayments to banks and bank-like entities?”
Those are constraints on bank balance sheets, aren’t they?”
I’m going to say debt defaults are constraints on bank balance sheets. I’d say debt repayments are a reduction in the demand for banking services (by banking services, I mean currency denominated debt).
Nick,
The point of 1 is that if a group within a money niche has barriers to entry and special needs, they may develop a form of money that meets those needs. Since they are a subgroup, this money has to be easily convertible to the parent group money, but a sufficient economic advantage will give the new form of money an advantage within the subniche. This is a process of monetary speciation. A historical example would be letters of credit.
The point of 2 is that if the group gains a competitive advantage from the use of its new form of money, it can use this both to obtain fees and also, less obviously extract rents.
Too Much Fed,
“Why aren’t demand deposits a close “money” substitute so MOA = currency plus demand deposits?”
They do have a high degree of moneyness, but so do a lot of things. So it’s too incomplete a definition; a disequilibrium in M1 could be addressed quite comfortably by shuffling deposits from non-M1 M2 to demand deposits and/or currency.
W. Peden, for me demand deposits include things like savings accounts and money market accounts.
What about short-term time deposits?
How short-term?
Good question. The answer, I’m coming to think, is: “Don’t ask; use a Divisia approach to measuring moneyness”.