Notice the IOU

Suppose you decide to trade your IOU to Jane for the pound of sugar, rather than handing it back to me… if Jane agrees, you get your pound of sugar…

but the debt is NOT extinguished; now Jane holds it, and I will have to give Jane the pound of sugar if she presents me with my IOU.

The IOU served as medium of exchange; but NOT as extinguisher of debt. IOU plays (fake) monetary role, but is not money as it cannot extinguish debt.

Not only that; suppose I do not use the pound of sugar I borrowed, but instead lend it to Joe; in turn, Joe gives me an IOU for a pound of sugar… and magically, one pound of real sugar now has two IOU’s against it. Who would have thought! One pound of sugar, two IOU’s claiming the same pound of sugar. This process can proliferate with no end in sight; Joe could lend out the sugar again, etc… Endless IOU’s ‘backed’ by the same pound of sugar.

If you come to claim your pound of sugar, that I no longer hold, I cannot give you your sugar. Joe now has it; all I have is another IOU. Would you exchange the IOU that I gave you for the IOU Joe gave me? Mere exchange of debt notes… We start to see how real stuff is categorically different form IOU’s; debt notes masquerading as money cannot extinguish debt; they can only change the holder of the debt.

But it gets better, not just for silly debt like a pound of sugar IOU, but for debt in the real world. Let’s look at two companies; call them Co. ‘A’ and Co. ‘B’. Company ‘A’ makes grommets… and Company B buys grommets in order to incorporate them into its own product line of widgets. ‘A’ sells a hundred grommets to ‘B’; then on ‘A’s books, in Accounts Receivable, an entry is created for ‘one hundred grommets sold to ‘B’ for 100 monetary units, payable in 30 days’.

Similarly, in ‘B’s books, in Accounts Payable, an entry is created for ‘one hundred grommets bought from ‘A’ for 100 monetary units, payable in 30 days’. So far, nothing unusual; in 30 days, ‘B’ pays ‘A’, and the accounts are settled… the IOU is redeemed. Notice the IOU (for 100 grommets) is an asset on ‘A’s books, but a liability on ‘B’s book… just like the IOU pound of sugar. These IOU’s are two faced, assets and liabilities at the same time, depending on point of view.