Every good university course in corporate finance, from undergraduate to MBA to PhD, starts with the Modigliani-Miller Theorem.
That famous formulation says that if there are no taxes and transaction costs, if cash flows are given, and if information is symmetric, a firm’s value doesn’t depend on how it is financed. In other words, the mixture of debt and equity is irrelevant.
Put differently, money doesn’t matter.
The reason corporate finance courses begin with this isn’t because we believe the theorem is true in the real world. It’s because the assumptions are incredibly useful for understanding why capital structure matters. This structures the course around taxes, transaction costs, cash flows and information. It’s a great teaching tool.
But with the changing landscape of digital payments, the rise of cryptocurrencies, and the emergence of officially sanctioned central bank digital currencies (CBDCs), this approach is rapidly becoming out of date. Money now matters a lot.
In the first millennium BCE, the total size of the world economy barely grew – from $182 billion to $210 billion. In the next 500 years, it only doubled. But it took off. Between 1700 and 1820, world output went from $640 billion to $1.2 trillion. Today it’s more than 100 times that.
This exponential rise in economic progress since the mid-18th century is usually explained by technological progress – exemplified by the Industrial Revolution – which radically changed how much we could produce.
That explanation isn’t wrong, but it’s incomplete. Economic activity relies on two things: production and trade. Technological advances make it possible to improve living standards, but the ability to trade with one another and specialise in the use of our talents helps turn that possibility into a reality.
So it’s not surprising that money arrived early in human civilisation. The shekel – about one-third of an ounce of silver – became standard currency in Mesopotamia nearly 5,000 years ago. The first coins were minted in the 5th or 6th century BCE, and coins evolved into paper banknotes in the Ming Dynasty in 1375.
And then nothing really changed until 2008, when Steve Jobs, in a final act of genius, launched the smartphone. To paraphrase Jobs himself when he introduced the iPod, a smartphone is “an entire bank, in your pocket”, allowing digital payments with standard fiat currencies to become dramatically more common. In many parts of the world, digital payment volumes outstrip cash.
Also in 2008, the idea for world’s first decentralised currency, a “cryptocurrency” called Bitcoin, was announced in a seemingly obscure white paper. Suddenly, a single clever idea by the still unknown Satoshi Nakamoto ended government monopolies on money and ushered in the age of decentralised digital finance.
The nature of money has fundamentally changed. It has changed how consumers and business interact. It has changed how banks operate. And as CBDCs become a reality, it will change the landscape of international finance.
Hence, it’s now time to change how we teach finance at university. We can no longer think of money as a background phenomenon – a simple lubricant – while focusing on the “real” economic machinery of cash flows, taxes and information.
The fact that Facebook, with Libra (then Diem), came breathtakingly close to establishing a private digital currency that could easily have rivalled the currencies of major economies underscores that we are witnessing a global battle for the control of money. China’s roll-out of its digital e-CNY currency represents the first genuine threat to the US dollar’s status as the global reserve currency since the Second World War.
Economists find it challenging to talk about power. This is partly because we don’t have good mathematical models of it, and partly because it reminds us of Marx. Instead, we tend to focus on efficiency.
But when it comes to money in the 21st century, both power and efficiency are centre stage. Our students can’t think sensibly about what exchanges are possible without thinking about how those exchanges are made.
So we instructors must broaden our outlook, and take money more seriously. The good news is that in doing so we will make finance much more interesting and much more relevant for our students.
Richard Holden is professor of economics at UNSW Sydney and president of the Academy of the Social Sciences in Australia. Prior to that, he was on the faculty at the University of Chicago and the Massachusetts Institute of Technology. His new book, Money for the 21st Century, is published by University of California Press.
