6. Contracts in a monetary economy

By: Andrea Terzi

When real values transfer by contract

Social systems organized within a system of property rights and a hierarchy relationship between the state and the people provide the setting for a powerful stream of contractual (legally enforceable) transactions. These provide by far the most important (yet not unique) platform for giving and receiving values in modern economies.

The real values transferred by contract include the property rights on newly produced as well as secondhand goods; the property rights on legal entities (such as business companies); the right to receive a provision of services; the right to use other people’s property; and the right to use others’ labor services.

Such rights result in the acquisition of products in the form of owned goods (to be used up more or less quickly) or services (to be consumed as they are performed). Products are acquired for either final or intermediate use. Final products include all the goods and services that people expect will contribute to their standard of living (consumer products) as well as all the capital goods that serve as means of production of other products (capital goods). Intermediate products are not for final use and are consumed as input in the production of final products.

When transferred, products change ownership at a value quantified in the contract.  This can be either a contract for forward delivery, when the supplier agrees to make a good or a service available at some future point in time, or a contract for spot delivery, when the supplier agrees to sell a service or a stored good for immediate delivery.

Contractual settlement in a monetary economy

Any act of giving or receiving may either be final or entail further economic consequences, depending on whether the transfer process ends with that action or opens a relationship to be settled in the future. Within a hierarchy system, any act of giving is a final, unilateral transfer enforced by an accepted rule. Within a gift-with-reciprocity system, no act of giving is ever final, and an action of reciprocity is expected to follow, yet with no enforcement. Within a contractual obligation system, each party remains debtor to the other (and each is creditor to the other) until payment and delivery are settled.

While the time of real value delivery and the time of payment need not be the same, payment is considered settled when the party delivering real value (creditor) has no further claims and the party receiving real value (debtor) has no further liabilities. Except when traders have specifically agreed on different settlement terms, a monetary claim (or credit) on the sovereign state provides the ultimate means of payment. Until payment is settled and the liability discharged, one party remains liable to the other, and the latter owns a credit claim from the former.

Payment or real-value delivery may not be settled within the terms set in the contract by mutual agreement or because one party defaults from the obligation, in which case the other party may request action from the judicial system.

Financial contracts

When the payee agrees to concede more time for settlement and payment is delayed, one party owns the right to receive and the other party owes the liability to deliver monetary claims or a sequence of cash flows at some future dates.

The same right can become the object of a financial contract (with no transfer of real values) when a party delivers monetary claims to another party in exchange for the right to receive monetary claims in the future. The ownership of such right (called a financial asset) has consequences that are similar to those of the ownership of a capital good in that both entail future cash flows, and yet they are different: while a financial claim includes a description of the cash flows and the specific entity promising the payment, property of a real asset is expected to generate cash flows as a result of future contracts yet to be concluded.

Next module: Nominal and real value: The legacies of Smith and Keynes
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