Economics (4) Money

Money has been in use for thousands of years. A large majority of humans seem to be able to function with it. In the realm of psychology, it is referred to as a “secondary reinforcement”, and studies have shown that other animals, especially other apes, can deal with it. Despite all that, I am left with the view that few people actually understand what money is or why it functions as it does. A simple litmus test is to ask “is money a thing of value (worth)?”. True understanding shows that money is not inherently valuable.

The adoption of money, that is to say its use in commerce, did not spread quickly, nor was its evolution without rude surprises for its adherents. As I said earlier, the true need was for some improvement in efficiency and reliability in balancing exchanges of surpluses, or rather tracking the outstanding debts that arose from inequalities in those exchanges. The essential properties needed were as follows:

  • Scaleability — able to represent amounts of value owed from small to large
  • Granularity — able to represent amounts to arbitrary precision
  • Stability — able to retain its identity (the amount owed) over a sufficiently long time
  • Recognizability — able to not only be recognized by party to whom the debt was owed, but also by the party who owed that debt

An extra bonus for any system that permits such accounting to service exchanges between every pair of parties with surpluses to exchange.  This extension would impact all of the essential properties.  Getting such a system accepted by a sufficient portion of the population requires a long period of acclimation, with the system needing to evolve over generations of players.

Initially, a party learning to use money is unwilling to accept a lessor item in exchange.  Thus, the initial design of money must preserve the illusion that the tokens of money actually embody the worth imagined.  Numerous extreme events have shown over and over again that no material can have sufficient value to impart to the tokens the needed value without the value of the material being largely due to its role in producing those tokens (coins).  In the more general case, any commodity backing a currency is more valuable as the backing than it can possibly be in all other roles combined.  Yet, the illusion, or rather the delusion, of pieces of money having inherent value seems to be a requirement of the initial bootstrapping of monetary systems.

A functioning system of money permits exchanges of surpluses to be distributed over

  • multiple parties
  • multiple locations
  • multiple times

The system rewards its participants by

  • vastly increasing the opportunity to trade away a surplus before it loses its value
  • vastly increasing the opportunity to correct shortfalls in needed products
  • better matching
  • allowing much greater amounts of specialization
  • facilitating opportunities for diverse investing
  • reducing waste or loss via missed opportunities

Those rewards together with the enhanced efficiencies over the long term outweigh the increased risks from counterfeit currency, theft (it too benefits from the efficiency), or simple loss of tokens.

Modern currency is a fiat currency; it has value only in that the powers-that-be dictate that it has value. It seems to be a house of cards, but it cannot fall down because the agencies responsible adjust the supply to match the demand of a vibrant economy (parties cannot shift their trading patterns even as fast as the agencies can withdraw or redeem the currency). We have become dependent on patterns and practices made possible by fiat currency coming-into or going-out-of existence as is needed.

Even more strange is the discovery that money is not a thing, but rather a property of things. We have learned this at a gut or reflex level; we count up our assets by adding together cash, bank accounts, houses, corporate shares, insurance policies, etc; we trade with coins, paper bills, checks, credit cards, eftpos cards, stamps, coupons, etc. Credit cards actually work the reverse of most money systems, they create currency on demand and collapse it on payment — retailers can trade on payments before the customer has actually parted with with the assets.