Monetary System


Monetary standard = criterion or reference point guiding these social arrangements and constituting the ultimate asset combining the twin functions of standard of value and means of payment. 

Monetary systems (p.28)

  1. Independent standards
    • Fiat Money
  2. Single commodity based standards -->
    • goods/monetary unit=goods/standard commodity x standard commodity/monetary unit
    • big (unintended innovation) reducing the resource costs of commodity money was the use of fiduciary money to make the ratio of gold deposits/money much smaller.
      • Monometallism
      • Gold specie standard
      • Gold bullion standard
      • Gold exchange standard
      • Limping gold standard (half independent standard)
  3. Multi commodity based standards
    • Bimetallism
    • Symmetallism
    • Composite commodity reserve standard
  4. Currency standards
    • Exchange standard
    • Currency basket
    • Balance of payments standard (half index standard)
  5. Index standards
    • Tabular standard
    • Goods standard
    • Earnings standard
    • Labour standard


History of Monetary standards:

  1. Early antiquity - only commodity money with occasional credit transactions.
  2. Classic antiquity Europe to 18th - Metallic money, bills of exchange & money lenders
  3. France & Russia early 19th - Central Bank
  4. Medieval Italian cities 13th onwards - Deposit banks but no central and no paper money
  5. US to 1913 & Scotland first half of 19th - Multiple note-issuing and deposit banks
  6. Colonies at Independence - central bank, modern deposit banks, & money lenders
  7. Western Europe from mid-19th to WWI - Central Bank, deposit banks and other financial institutions
  8. USA from 1970s, Europe from 1980s - All modern financial institutions.

Monetary regimes (p.40)

  1. Gold standard 1879-1914
  2. Gold Exchange Standards 1925-31
  3. Bretton Woods 1945-68
  4. Dollar Standard 1968-71
  5. The 'Non-System 1972-
  6. ERM 1979-98
  7. EMU 1999-


  • Gold-standard brought a remarkable degree of exchange rate stability with arbitration keeping exchange rates around the gold standard (within the bands of transport costs).


  • 4 desirables are inconsistent : 1. fixed exchange rates 2. free trade, 3. monetary autonomy 4. free capital movements. At best only 3/4 can be achieved
    • Under gold-standard monetary autonomy was sacrificed.
    • Under gold-exchange standard in the interwar years fixed exchange rates were sacrificed.
    • Bretton Woods sacrificed freedom of capital flows
    • Fiat money sacrifices fixed exchange rates.




Financial sector:

  • Primary sector - monetary authorities (central government and central bank)
  • Secondary sector - banking system
  • Tertiary sector - non-bank financial intermediaries and the markets where debt instruments are traded


Money is:

  1. Unit of account
    • Avoid unnecessary calculations of one good barter price in terms of another.
    • Allows preferences
    • Transmit economic information
    • Unit of contract (only need to estimate the future value of one good)
  2. Means of payment
    • Simplifies economic transactions
    • Replaces bilateral trading with multilateral trading.
    • Money increases the number of similar transactions, increasing competition.
  3. Store of value - liquidity (over other assets)
    • Marketability
    • Predictability
    • Reversibility
    • Divisibility


  • Where exactly money ends and other alternative assets begin may not be essential for economic analysis, and not needed for the practice or the comprehension of monetary policy.
  • Is money supply exogenous (determined by a monetary authority) or endogenous (expanding and contracting in line with variations in the volume of credit provided by financial intermediaries)?
  • Price of money? Monetarists says inverse of the price level, a Keynesian/Central banker the interest rate. However, also need to consider domestic goods market and the foreign exchange market
  • Key question is the neutrality of money - Classical view is money was neutral, Monetarist view is that money can have temporary short-run effects (due to nominal rigidities or mistaken expectations). Keynesian is that real economy adjusts to interest rate (which is a monetary phenonenom)

Comparative Advantage

In 1817 David Ricardo invented comparative advantage which says that a poor country, which may be worse at producing every possible good than the rich country, can still make gains from trade. This is counter-intuitive because competitive advantage would suggest that if your friend, Lee Hsien Loong, is better than you at both mathematics and politics it would be best not to compete against him in either because you'll lose. What comparative advantage says is that even if a country is better than you in many things, how much better they are will vary, and they should focus on what they are relatively best at, and you in turn as the developing country should focus on what you are relatively least bad and and trade. So in the previous example, Lee Hsien Loong should go into politics and full-time and you mathematics and then trade.

Assassin's Mace


Let your plans be dark and impenetrable as night and when you move fall like a thunderbolt.
— Sun Tzu (孙子)

The Chinese version of David and Goliath involves the hero using an 'Assassin's Mace (杀手锏) which, despite being small and lightweight, could be used to surprise the enemy knocking him dead with a single blow to his Achilles' heel.


China is focusing a disproprortionate amount of its resources on asymmetric capabilities such as cyber attacks, anti-satellite weapons, electromagnetic pulse weapons, ground-launch missiles to combat America's superior long-range bombers, ground forces and nuclear armed ICBM's.



The concept of shi (势) is at the heart of Chinese strategy and translate to 'alignment of forces' that involves not only taking advantage of the natural circumstances but also creating circumstances that naturally lead to the outcome you want.

Crucially shi, requires not only reading shi before your opponent, but also actively deceiving them into complacency.


Mao cited China's fail to read shi in the 1950s and 60s, when the Soviets discovered China's plan to usurp the USSR's leadership in the Communist world, China lost opportunities to get FDI, trade opportunities, military technology, or political support.

Production function

Capital has five characteristics.

  1. It is productive.
  2. It is produced (investment requires opportunity cost of more consumption today)
  3. Its use is limited (rivalry)
  4. It can earn a return.
  5. It wears out (depreciates).

Production function

Assumptions - 

  • constant returns to scale (i.e. F(zK,zL)=zF(K,L)
  • diminishing marginal product (where MPK=f(k+1)-f(k)


Cobb-Douglas production function where

  • F(K,L)=AK^αL^(1-α)
    • y=Ak^α 
    • in the data α = 1/3
    • MPK=αAK^(α-1)L^(1-α)