Saturday, January 5, 2013

How Money Works II: Perpetual Motion Is Stupid

Cash is only one manifestation of Money.
Last time we discovered that money is merely a storage medium for value, and the concept of value encompasses the needs, wants and survival of all life.  In this post, we wish to elaborate on those natural laws that money (or "wealth" as some prefer) obeys.

But why do I say that Perpetual Motion is Stupid?  And what does that have to do with money?  I say Perpetual Motion is stupid because it is a lie.  It is in direct opposition to Nature's Laws, and therefore it has never worked, does not now work, and never will work in the future.  People who believe in, pursue and promote Perpetual Motion including so-called "free energy" devices and schemes are therefore Stupid.

Likewise, people who pursue and promote financial or economic schemes that attempt to violate the laws of money are also Stupid.  This includes certain well-known philosophers, politicians, ideologues  reformers, do-gooders and, basically most of your garden-variety hippies. But when we learn exactly how money works, we will no longer be stupid, will we.

How can I say that Money obeys natural laws when it is just an arbitrary human invention?  I can say it because money is NOT a human invention at all, nor is it arbitrary.  It is a natural phenomenon.   And as we learned last time, money is not the same as cash.  The ability to store, transport and exchange value arises naturally whenever life takes an opportunity to create more value than it requires in that moment.  Ants gather in the summer ahead of the coming cold and dark.  Bears feast on salmon brains at certain times, ignoring the tasty flesh entirely as the most efficient way to prepare for hibernation.  Humans exchange their time and products to each other and store that value to be exchanged later at the grocery store.  We may flatter ourselves by thinking we invented this system, but it is actually a natural extension of the fundamental biological economy of life.

Recall also from the previous post that the willing exchange of two dissimilar items always creates value.  This additional value is the driving force behind trade, commerce, and specialization.  The exchange itself is of value because in a willing trade, both parties gain.  The sum of value after the trade is more than the sum of value before.

An economy is nothing more than a vast number of single exchanges happening continually.  You exchange an hour's labor for an hour's pay, and an hour's pay for a tank of fuel for your car.  You exchange some of that fuel to locate a mate or gather your offspring, then drive to the store and exchange yet more of your stored labor for some food.

No matter how complex an economic system becomes, it must always reduce to increased value for value in every willing exchange.

To introduce the natural laws of value and money, consider the following somewhat silly tale of woe.

Imagine a refugee camp.  There are ten thousand refugees who for various boring, tedious reasons may never leave the camp.  They have no resources in the camp, and every day they are given a specific amount of food that must be consumed on the spot.  It cannot be stored, traded, or used in any other way.  It has no potential value.

Nothing can enter or leave the camp - no materials, resources, tools, goods of any kind.  The people sit and do nothing all day, because there is nothing to do.  One day a multi-billionaire suddenly gets religion and decides to help these unfortunate souls trapped in the refugee camp. He bestows upon each of them One Million Dollars in cash.

Now, that much cash is a problem in a refugee camp, where it is impossible to secure.  But since they are all thieves to a man, each stealing as fast as he can from all the rest, at any given moment they still each have on average one million dollars more or less.   Still, as no goods may enter the camp, there is nothing to actually buy, so pretty soon they get tired and stop stealing each other's money back and forth.

No matter how much they exchange the money with each other (and none are stupid enough to actually lose money by being swindled or cheated), nobody ever gains anything.  The total amount of money in this "closed system" remains constant, and it remains perfectly evenly distributed.  Nobody has anything to gain, and nobody has anything to lose.  Nobody has anything to buy or to sell.  Even though they are "rich" according to some people's stupid definition, there is no value, no economy, no exchange, and no real life in this camp.

You might propose that prostitution would inevitably spread through the camp like wildfire, and pretty soon only the hoes would have all the money. But if the hoes were to reflect that the so-called "money" does not actually have any value, then solicitations would be refused.

Unlikely, you say? Hoes with that level of insight?  Then we'll exclude that possibility by insisting for the sake of discussion that there remains nothing of value inside the camp to trade for.

What about gambling?  Even to just pass the time?  Fine - but we stipulate that their games are 100% chance, no cheating and no skill involved.  The average refugee will still have one million dollars more or less, and the distribution will be random yet fairly uniform around the camp.

Perpetual Motion is like this ridiculously rich refugee camp.  There is money all around, but none of it is useful for anything.  Perpetual Motion imagines it can create more money, more wealth, more value within this closed system simply by having the money pass from one person to another and back again.  In this closed system, the amount of money is constant and fixed, and the distribution is as uniform as it gets.  Like all closed thermodynamic systems, it obeys the First and Second Laws: energy is always constant and maximum entropy always reigns supreme, barring statistical fluctuations due to random events (e.g. gambling).

Money obeys these laws too.  If you have a closed system (like this refugee camp) then there can be no increase in money and the distribution is, if not initially then certainly before very long, more or less uniform.  The laws of money stipulate that for an increase in value to occur, the system must be open, and there must be resources from which the participants can create value.  As soon as that is the case, then value-producing exchanges can begin and wealth expands at a more or less predictable rate.

The $6 Million Dollar Chicken.
Now suppose some enterprising outsiders learn about this camp full of millionaires. Imagine they cut a hole in the fence, and offer to sell a breeding pair of chickens to some of the inmates.  How much would they be worth?  A million dollars?  Each?  A quorum of inmates might see the potential value and pool their money, outbidding the others, and buy the rooster and chicken for as much as, say, $12 Million.

This one small hole in the fence completely and fundamentally changes the dynamic inside the camp.  Eggs start to sell for $100,000 each.  Chicks sell for $1,000,000 each.  Businesses spring up, skills suddenly become valuable, and wealth begins to be created.

Let's imagine that one person pays $50 Million to another to build a chicken coop.  An interesting thing happens the moment it is finished.  The wealth of the camp jumps by $50M.  How?  Well, the builder now has $50M, and the owner has a $50M chicken coop.  That's a total wealth of $100M.  Where resources are available, wealth expands as fast as people can create value.

One thing we learn is that the total amount of money in open economies is never fixed.  For one person to get rich does not mean that another must get poor. In fact, exactly the opposite is true.  When one person gets rich, it is virtually always because he or she created a lot of value for a lot of people. All those people are actually ENRICHED by that one person's rise to riches.  Logically, we should be celebrating our successful rich people, not tearing them down or blaming them for problems that have nothing to do with them.  Those are the irrational superstitions I mentioned last time and false emotional associations people have about money that cause them to react in such an illogical, irrational way. They choose to focus on the few exceptions, like the occasional airplane that crashes. Those are the aberrations where people have taken money for which they did not create equivalent value.  In the long run, that type of activity is unsustainable and ultimately fails.

But like airplane crashes, those are the flights we hear about on TV while ignoring the millions of successful landings that happen every year.  There are over ten million millionaires in the world today, and over 1,200 billionaires.  The vast majority of them got rich by making YOU richer.  Think about that next time you ignorantly disparage the rich.

*   *   *   *   *

The improbable refugee camp of this parable demonstrates another essential point.  In the closed camp, how much was the one million dollars that each  inmate owned actually worth?  When there was nothing to buy and the distribution was uniform, the value of the money was zero.  That's right: one million dollars can sometimes be worth nothing at all.  That is an extreme example, but the same mechanism of currency devaluation applies elsewhere, even in open, productive systems.

When a government prints large amounts of currency, unless there is an equivalent amount of value being produced somewhere in the country, the currency becomes devalued.  In other words, you have inflation of prices since each dollar contains proportionally less actual value.  Cash has value only when it has been exchanged for value.

Devaluation of currency also occurs when you give away large amounts of cash.  There is no exchange of value, and therefore the cash has no value initially.  This lack of value diffuses thorough the economy, and the total circulating currency is devalued in proportion to the amount that was handed out.  Giving cash to the needy is therefore harmful to the needy as well as to everyone else. It is a gross unkindness to give them something of no value that they do not actually need.

If you want to relieve the needy, give food, clothing and shelter, and then only in emergencies.  To do otherwise creates a dependency that is an even worse unkindness to those you are attempting to help.  It's like giving away free morphine for everyone to take in case someone gets a headache.  Using it routinely creates addiction and diminishes humanity.  But use in an emergency does not result in dependency and can be extremely beneficial.

If you want to help the long term needy, do not give food and clothing, and do not under any circumstances give cash.  Instead, give education and opportunity in generous measure.  Give them the means to labor for their own support with human dignity.  Giving someone meaningful work even if it is hard, unpleasant labor is the greatest kindness you can give.  And before you call me a heartless scrooge, you should know that someone was once kind to me in exactly this way, giving me the chance to do some very hard, hot, dirty uncomfortable labor, for which I am extremely grateful.  It added tremendously to my humanity, whereas cash handouts would have dehumanized me.

We are creators - that is our nature.  Being human means being a creator of value, and to deny someone the opportunity to be human is inhuman.

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