Friday, January 4, 2013

How Money Works, Part I

Munnie! Monet!  Moolah! Dosh! Dineros! Scratch!
Cabbage! Loot! Wad!
For something that affects people's lives to such an extraordinary degree and is the central topic of both political debate and armed conflict all around the globe, Money is woefully misunderstood.  Many people I know hold deeply ignorant superstitions about money, highly conflicted emotional childhood associations with the subject, and strident noisy opinions on how it is supposed to work which are embarrassingly at variance to the way things actually are.

My belief is that in order to have any sort of thoughtful conversation about the issues facing this planet including the economy, poverty, hunger, disease, immigration, war, environment, energy, climate; in short, the very survival of the human species, we need to have a serious chat about How Money Works.

Yet some of you will say, "Money isn't everything!  There is much more to life, and money just isn't as important as you are making it out to be."  This is a prime example of those ignorant superstitions I mentioned before. Money is important.  It does matter.  The Preacher or Koheleth of Bible fame instructs, "A feast is made for laughter, and wine maketh merry: but money answereth all things."  (Eccl. 10:19)  Money forms the central part of the answer to every practical question in this world.  We will shortly discover that every living thing on this earth uses money in some form and that it is inseparably intertwined with the very concept of Life itself.

And the place to start is as self-evident as anything could be.  We need to know what we're even talking about.  We need to define "money."  To help us get there, let's first consider the question of gold.

Why is gold "valuable?" By which I mean, why does it have value.  What is Value, even?  A value is something that is important to you.  When you are hungry, food occupies your attention and you "want" some.  It is essential to you.  It is a value.  It has value. Everything even remotely associated with food likewise assumes a value:  crop seeds, farming implements, land, labor, storage, cooking utensils, fuel, culinary skill, transport of food, and the list goes on indefinitely.

When you are cold, warmth becomes important to you.  It has value, and everything associated with warmth assumes some of that value as well, such as clothing, fuel, shelter, labor for the provision of both, the right to occupy shelter, the space and land occupied by shelter and fuel, the security of that space, and so in indefinitely.  In short, value means survival, which is the one universal interest of all life.

Everything of value fills a need for somebody, is something of importance to someone, holds somebody's undivided attention, and is in at least some degree of demand.  An object has value if some organism (e.g. a human) wants it and needs it.  Is that plain enough?  That's the meaning of value.

There are different kinds of value, too.  An item may have immediate, realized value or merely the possibility of future value.  I distinguish between potential value and realized value through this slightly whimsical example.  Suppose I have a fish and you have an egg.  (Notice how easily Ownership arises as a natural, organic law?  It is a fundamental concept like gravity that cannot be overturned by any blackguard decree.)  Now suppose that I, having a fish, do not like fish so much, and you, with your egg, are not really in the mood for eggs today.

While the fish and the egg have the possibility of value not just as food but as desirable food, that full value is not being achieved in these circumstances.  The potential value is not currently being realized.  But suppose you and I reach an agreement in which we trade your egg for my fish, because you happen to like fish more and I happen to like eggs more.  Now how much value exists?  After the trade, the full value of both items can be realized upon consumption, and value has been created or increased by the mere act of exchange.

The following day I might be tempted to look for another fish, not because I like fish, but because I expect to be able to exchange the fish for something I like even more, such as an egg.  Catching a fish only creates a part of the value for me.  Exchanging the fish creates the rest of it. Initially, it has potential value, while its full value only becomes a reality upon consumption.  (This illustrates why all economic theories that consider only the production of goods and not the value of commerce and trade are complete bollocks.)

If this exchange continues for some time, I might, because of the difficulty of catching a fish and the relative abundance of eggs, no longer be satisfied with one egg per fish.  I might be able to negotiate, say, a dozen eggs for my fish.  Thus the "price" of a fish is a dozen eggs, and the "price" of a dozen eggs is one fish.  Nevertheless, value is still increased every time a willing exchange takes place. Both parties want more what the other has to offer, and both parties therefore gain.

Here's another example.  A tree grows in a field, and expends a tremendous amount of energy, time, risk and resources into producing a crop of fruit.  There's a lot of potential value stored in the fruit, but they are of little value to the tree.  Why did it even bother?  Because of first importance to the species is its continuation.  Animals and birds will seek out the fruit, of immediate value to them as food, energy, social and breeding advantage, and in exchange they will provide the essential service of dispersing that tree's seeds far and wide. Both parties gain.

Some may point out that this exchange is not really an exchange of value because it is not made consciously or deliberately, but on an instinctive, evolutionary level.  This is an unacceptable quibble, since most credit card purchases are made on exactly the same basis.  The economies of nature are every bit as taut and efficient as the stock market.

Certain species of ants actually keep livestock: tiny animals that are kindly husbanded by the ants and produce food that the ants prefer to anything they can scrounge on the ground.  The exchange is a fair one: the insect animal gains food and protection; the ants gain food security.  If it wasn't value for value and a gain for both parties, the system would break down and a different one would evolved.  This is continually happening, in fact, since no exchange is ever absolutely perfect due to the ever-shifting value of everything.  Some pushing and shoving is a necessary part of life.

With this clearer understanding of value, we can finally talk about the value of gold.  Gold has potential value as a commodity.  In ancient times it was one of a very few metals that was easy to work, though hard to find, and would not normally oxidize for anything.  It lasted virtually forever and you never had to clean it, and so humans endowed it with a mystical, divine aura.  Literally.  The elemental symbol "Au" comes from its Latin name aurum, meaning "shining dawn" that is the origin of our word for the alleged supernatural glow about one's person.

Gold electrical connectors are awesome.
The realized value of gold originally came from its ability to transfer that aura to the possessor and bestow him or her with social status. (Being a soft metal, it is quite useless for making tools or weapons.)  Feeling significant and socially connected is one of a humans' basic instinctual needs as an organism. We still use the commodity today for exactly those purposes in various forms of jewelry, decoration, tokens of distinction, mating status, or hierarchical position.  We also use gold in technology for providing incorruptible and reliable mechanical and electrical components used in virtually every machine made today, the true value of which can in every case be traced back to our fundamental instinctual needs, all of which are ultimately reducible to survival of the organism.  In short, gold helps us survive.

So if gold has become more, not less, valuable to us, why then is the price of gold no higher now than at most times in history, in comparable terms?  I mean, compared to the price of food, clothing, shelter, and labor, why is gold as cheap now as it was fifty, one hundred, or even thousands of years ago?

The reason is that price and value relate to one another in reference to the relative abundance.  Value may increase or decrease, abundance may increase or decrease, and so price is not a fundamental quantity but entirely derivative. Gold is today relatively in abundance thanks to more and bigger mines and advanced mineral extraction technologies, while at the same time the former industrial uses of gold (for manufacturing currency in the form of coinage, much more about which in a future post) are now obsolete.  Gold is no longer required in such enormous volumes, and so its "real" price remains more or less where it has been for millennia.

Did you see what we did there?  We slipped in the concept of money by talking about price, without defining either one.  Now that we have a suitably large reference frame that includes all of life and all of earth's entire history, we can finally do what we started out to do, which is to define money, a concept that far transcends mere human invention or arbitrary constructs or systems.  Once that is done we can (in following posts) begin to answer questions about price, currency, trade, scarcity, labor, charity, taxes, and all that jazz.

What is money?  Most people immediately respond that money is dollars.  Duh.  But what about euros, yen, pesos and pounds?  "Oh," they say, "I forgot about them foreigners. Ok, then, money is any kind of currency.  Cash, if you please."

And that person would be spectacularly incorrect.  Ever hear of a bank account?  They don't exactly keep stacks of dollar bills in a box with your name on it.  They only keep a running total of your deposits and withdrawals, and "your" cash is handed out to someone else to use until it ends up back at the bank again.  For you, they only store a number in a computer.  It's still money, but it sure ain't hard currency of any denomination.

Is money therefore defined as all currency in circulation plus all bank deposits?  Never mind defining just what exactly a "bank" is or isn't.  If you have $50 on an Amazon gift card, that's definitely money, no doubt about it.

Yet it's no more than a tautology to say that money is circulating currency plus deposits.  What makes money Money?  Why do dollars and euros, much less their virtual equivalents on deposit, have any value at all?  In my youth I was taught that dollars only have value as long as people think they do. That is a stinking, fetid load of codswallop.  And completely false, too.

Money is any means of storing, transferring and negotiating value.  Dollars and euros have value because someone has exchanged value for them and will generally only exchange them again for as much value as they can negotiate.  Coins are valuable not for the price of the metal in them, but for the face denomination that they represent as tokens of exchange.

Money is your way of keeping track of the value that you produce so that you get exactly what you've earned.  If you don't seem to have enough money, it isn't the money's fault.  You either haven't been keeping track very well of the value you create, or undervaluing it, or losing value in ill-considered exchanges, or you haven't been producing enough value to ensure your own survival.

I go even further than this in defining money.  Here it is possible to have honest disagreements with economists wearing bow-ties and herringbone jackets with elbow patches.  I define everything with potential value that is owned or controlled by an organism or groups of organisms (humans, perhaps) that can or potentially can be traded, negotiated, bartered or exchanged, as Money.  Some people disagree and call all that stuff  "Wealth."  But in the end, words aren't important, because wealth and money work the same way and follow the same fundamental rules.

Stay tuned for Part II of How Money Works in which we describe those natural laws which wealth (money) obeys.

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