Money… What is it Good For?
Most people have a much better idea about ‘what money is’ (dollar notes, or money in the bank) and ‘what money does’ (buy stuff) than most economists.
Traditional economic theory regards money simply as a ‘unit of account’, or ‘the medium of exchange’, or ‘a store of wealth’. It does not even figure in their models of how the economy works!
You and I know different.
We know that we can cause unimaginably complex supply chains (spanning continents and years of time) to crank into gear to deliver us the things that we want… just by proffering a dollar note.
In truth, it is cash (including ‘money in the bank’, as well as ‘credit’) that drives the economy. Without money you are invisible to the market, so the market can never respond to your needs and wants. With cash, you can command the whole system to work for you. The more cash you have, the greater your power.
You’d think that it was pretty important then, to know how money gets created, to whom it is allocated, and in what circumstances it is destroyed.
Yet again, most economists (along with most people) have no idea how this happens. Though a few people and more economists are gradually waking up to the reality.
But before we get into today, it’s worth taking a wander down ‘memory lane’ to consider how money came into being. The only trouble is… no one now remembers!
The best we can do is create some plausible scenarios.
Here’s my best guess.
Once upon a time (since this is a fairy tale, it is appropriate that it has a fairy tale beginning)…
Kings had tax collectors go out and gather goods (wheat, cloth, livestock, etc) that were brought back into the King’s granaries, storehouses, and fields. The King would issue portions out to his soldiers and retinue in payment for their services.
Trying to keep track of how much of each type of good that each person was entitled to, and had in fact received, was no doubt a major headache for the quartermaster…using up lots of clay tablets, and the time of many scribes.
At some point, some bright spark decided to create and issue numbered tokens on a regular basis to each person in the King’s retinue. A different number depending on your status/role, but the same number to people of equal status.
These tokens could then be presented at the store, enabling the person to get their entitlement based on a predetermined amount of tokens for a predetermined amount of each type of produce (so many tokens for a chicken, so many for a sack of potatoes, etc.)
The beauty of this system was that the person issuing the goods did not need to know who was collecting them… as long as they got the required number of tokens for the goods supplied.
The quartermaster only needed to record the receipt of goods into the store, and the total receipt of tokens redeemed against the produce issued. If 100 chickens were issued, then (say) 100 tokens needed to be accounted for… and woe betide the poor fellow on duty if they did not balance!
These tokens were then available for reissue in the next week (or whatever period).
On the other hand, the King’s Treasurer did need to know who the person was, and their rank, in order to keep track of who got how many tokens each week.
Right off the bat, or soon after, it would have been realised that they needed a way to ensure all tokens were genuine. Otherwise, anyone could just front up to the store with some random token and get produce they were not entitled to.
In the past, all manner of physical objects have been used as tokens, including shells, split sticks, and even measures of rum. But for this fairy tale we are sticking to the story of ‘metal tokens’.
Initially, rare metals were stamped into small discs with the King’s image and a number (called the ‘face value’ of the token). This did not eliminate forgeries, but it made it quite difficult, given the limited technology available to any but the wealthiest.
These tokens came to be called coins (and cash and money, and later legal tender).
The key difference between a mere ingot of the metal, and the coin was the coin’s face value. It was this number that determined what the coin was ‘worth’ (what it could buy from the store)… not the type or weight of the metal comprising the coin. (Trouble arose when the worth of the metal in a coin exceeded its face value, but this problem was avoided with a later shift to paper money).
Soon, the wider community came to accept the coins in payment for their goods and services, knowing what they could redeem from the King’s store, for a given number of coins. The produce seller would bargain with (say) a King’s soldier for the maximum number, while the soldier (the buyer) would try to limit the price. Once they agreed on the price in numbered coins, they’d make the exchange. The soldier (buyer) got their goods, and the seller had coins that they could redeem at the King’s store for the goods that they needed.
As people became aware of how much easier the use of the coins made trade, they too started to use the coins in their own exchanges with each other, rather travel to the King’s store to redeem the coins.
As more and more money remained in circulation, at some point, the King’s tax collector hit upon another brilliant idea. Instead of having to collect all taxes in the form of actual goods, they could instead collect the taxes in coins. This would save the King both the manpower and trouble of collecting and storing physical goods that can decay; and the cost and trouble of creating new coins! By issuing, and then taxing back the coins, the money kept circulating
This quickly shifted more trade from the King’s store into the community, relieving him of a huge burden of physically collecting produce. Now, instead of soldiers and others in the King’s direct employ getting their goods from the King’s store, they could simply use the coins to get a better range of goods, and even services, in the community.
At this point, people no longer needed to know what the coins would buy from the King. They could compare prices across a whole range of goods and services, to make their own assessment of ‘value for money’. In effect, the resources of the whole Kingdom (that were for sale, or capable of being sold) ‘backed’ the ‘worth’ of the coins.
Later, paper notes supplemented and then largely replaced coins. It did not matter that the notes were virtually worthless themselves, because all that mattered was their ‘face value’ (and that the notes were genuine).
And so money was born in its current form.
Looked at one way, the coins and notes represented a debt by the King to those who held his money on issue; as they could come at any time and ask for produce in return.
On the other hand, the King’s debt, was an asset (money) in the hands of his vassals that they could use to buy anything for sale in the whole community.
At this point in the story, it no longer mattered that the King may have had little in his store, as the money could now be used to buy anything for sale anywhere the coins were accepted.
Money circulated from the King, into the community and back again, round and round. Taxes didn’t permanently divest his subjects of money as it went straight back into private hands as the money was spent by the Kings vassals. A deficit just meant that more money remained in the hands of his subjects, than had been recovered in taxes by the King.
What mattered then, and still matters now, is that the amount on issue (the debt) did not exceed the productive capacity of the entire community. (Unfortunately, most economists and politicians, along with most of the financial press have forgotten this relationship, and focus only on the State debt, without recognising the matching private asset.
Nor is any account taken of money’s continual circulation. Just noting a bank balance, either in the government’s accounts as a debt, or private accounts as an asset, does not give any indication of what goes in an out… and like sex, it is the in and out that really ‘counts’… pun intended).
While this story may or may not be true, what it illustrates is that money itself is just an idea that is given physical form through the issue of a ‘token’ (a coin or a note) that carries a number that sets the quantity of ‘monetary units’ the token represents.
Some people worry that ‘paper’ money (in particular) is not ‘backed’ by anything, or that it does not measure some ‘absolute value’, or does not have ‘intrinsic value’ itself (like gold). But as noted earlier, modern money is really backed by the resources of the whole community that accepts it; their natural, human, built, technological, organizational, governmental, and legal resources, as well as the knowledge resources of the entire world!
The money does not need to represent this value directly, as people only use money for comparative purposes in making decisions about what to spend it on.
As is well known, the price of anything does not necessarily (or at all) reflect its intrinsic value. A pack of cigarettes has a positive price, but few would argue that it has a positive value, either for the buyer, or for the community as a whole.
Price is quantifiable. Value is not.
To quantify any ‘thing’, you have to put a price on it.
Which is to say, price is assigned. It is not an inherent attribute of the thing priced.
Here’s a simple example where pure numbers can be used to make a comparative judgment:
Suppose you want to know which of three books will take longer to read. One book is relatively large and thick, another is smaller and thinner with smaller print, another is an eBook.
One simple way would be to do a ‘word count’.
In this case, the words themselves do not possess the property of ‘number’.
However, by simply attributing successive numbers to each word, you get a valid comparative measure to decide which books will take longer to read.
Price is like a word count. It is quantified using pure numbers we call ‘monetary units’.
As with the book analogy, the numbers attributed to each product and service allow us to answer one question: which is the more expensive?
The difference is that the numbers represented by the face value of money (monetary units) have social significance, as they determine two things:
1. How much of society’s resources the seller can consume without doing further work.
2. How much work the buyer must do to reciprocate for the resources they have purchased.
The buyer can have already done this work, and so have savings he can use for payment. Or, he can borrow the money, and repay it out of income from future work.
To ensure fairness in the whole system, we don’t want people defrauding each other.
This means we require some way of ensuring that the number of units attributed to the seller are what was agreed with the buyer, so they don’t later try to take out more than they put in by using fake units.
At the same time, the seller wants to know that when they come to buy, other sellers will accept their units as valid.
We also want to be sure that the buyer returns to society the same amount as he took out (not less), either before the trade is made, or after (if the money was borrowed).
If the money is borrowed, when the borrower comes to earn money, they want to know that the units they receive are the same as those that they spent when they got the loan, so they can reciprocate on a one for one basis.
The basic principle is that you get to take out what you put in. Not more or less.
This is money’s social role, which is as significant as its economic role in facilitating trade.
The key requirements are:
1. That the coins and notes (money) are all genuine. This is done, first by having the token produced in a standard way by the Government, and secondly by having features embedded in or on the coins and notes that make counterfeiting difficult.
2. Making it law that only money produced by the Government is ‘legal tender’ (money that can be legally used to settle a debt),
3. That the money is only issued in exchange for having provided (or having undertaken to provide) goods and services, and
4. That anyone to whom money is issued does in fact provide goods and/or services in return.
5. That the total amount of money that is circulating, does not exceed the productive capacity of the community.
In the context of money, the word ‘circulating’ can be misleading, as it may appear that the passing of a note or coin from the buyer to the seller is ‘dealing in the coins and notes as goods’. However, the coins and notes are just tokens used to represent ‘monetary units’. Money is not traded, it simply measures the price of the trade.
The physical transaction performs the same function as recording a negative balance against the name of the buyer in a set of accounts (to show the price of the goods and services consumed), while at the same time recording a positive balance against the name of the seller in the same set of accounts (to show the price of the goods or services produced).
Of course, coins and notes have flaws beyond counterfeiting. They can also be lost, stolen, or illegally destroyed. And, they can lose ‘purchasing power’ over time through inflation.
One of the biggest flaws is that many people who need money to survive have no way of getting it because they cannot work to earn it (but that is a whole other topic). If you’re interested, this article (A Universal Income that Underpins Wellbeing) discusses how we can solve this problem without increasing taxes or debt, or causing undue inflation.
Since ye olde times, banks have inserted themselves into the system in an attempt to mitigate the risks that coins and notes entail, and to provide other benefits. But with costs, risks, and flaws of their own.
The story of banking is the subject of the next essay.
