So what is money?
Is it gold? Is it silver? Is it the root of all evil?
Does the government create it or did it appear on its own?
Why do we need it and can we live without it?
Money, simply speaking, is a commodity that serves as a medium of exchange that is accepted by a significant amount of people in an economy.
But what does that mean? Well, when people long ago began trading in goods, they started out doing so in a system that we today call barter. Barter is a social exchange system that consists of exchanges of goods that are made directly against each other, such as trading butter for shoes or bread for clothing. Unfortunately, barter, as a system, has severe limits.
First, not everyone is going to be able to trade their goods for exactly what they want. This is because barter, in the end, requires a “double coincidence of wants” to be effective. If I were to want a new suit, for example, I would not only need to find someone who has the suit that I want, but also find a person selling suits who wants the hats that I have to offer. Trade is, therefore, rather limited.
The shoemaker might not want or need bread, for example, and the baker needs to find some other way than his bread to get his shoes.
Eventually, people begin to realize that, while their goods are not acceptable for the trade they want, there are other products that will be acceptable. The shoemaker may not want bread, to continue the example, but he is looking for butter. And so the baker seeks out the farmer to trade his bread for some butter, so that he might trade the butter for a pair of shoes.
People begin to trade for goods not directly, as with barter, but indirectly, in order to get the end product they desire. The baker found that he could exchange his bread for the butter that he could exchange for new shoes. The butter, a commodity, became a medium of exchange between two different goods, and facilitated an “indirect exchange” between participants in the economy.
Over time, certain commodities are found to be better at facilitating exchange than others. Some are more durable than others (cloth vs. butter). Others more portable (shoes vs. lead). Greater divisibility is important (copper vs. diamonds), as wells as recognizability and relative scarcity.
Based on these characteristics, certain commodities eventually rose to the top of the list of what people viewed as good media of exchange. They were easily recognizable. They were easily convertible into larger or smaller quantities without losing value. They were easily transportable. They stored well. Because of these reasons, more and more people began trading with them, until, eventually, just about everyone was using them in trade. They, therefore, started to be called “money.”
Even though many different commodities have been used as money, gold and silver have historically always beat out other competitors and have become the monetary benchmarks across the globe. But, more importantly, “money” is something that developed through voluntary exchange between individuals. It was never “created” or established by anyone or any government. Further, the value of money, as money, derives completely from the opinion that people have that the money can be exchanged for something else. Money, as money, has no direct use to anyone. It has use only in its ability to be exchanged. (Gold may have “multiple” uses, in that it has a direct use in jewelry or electronics manufacturing, but “as money,” it has no direct use to the holder of the gold other than for exchange, whether immediately or in the future). Alternative concepts of money as a “store of value” originally derive their meaning from the ability of money to be exchanged, whether now, or in the future.
So, “money” facilitates exchange, and allows people to better and more quickly exchange what they have and can produce for what they need that other people produce. Exchanges, in the final analysis, in an economy are really between two goods, the goods owned for the goods desired. Money is simply a facilitator of that very transaction.
And, as such, money is a “sterile” commodity. It is nothing and does nothing but what people desire from it. It is a tool, and is neither good nor evil. And like any tool, just because it can be utilized for dastardly ends, does not make the tool, itself, evil. “Evil” is a concept of flawed character in human action, and has nothing to do with the tool of money any more than the concept of “good.”
In addition to facilitating exchange, money, however, has an additional useful characteristic. As it serves as a waypoint in an exchange, it allows for the completion of the exchange to occur at a different point in time from the initiation of the exchange. I can exchange my bread for money now, and later (even much later) finalize my exchange for shoes. In the meantime, the money holds everything paused, awaiting my final decision. It becomes a “store” of wealth, in that, presuming outside valuations of the money do not change, it holds its ability to be exchanged over any amount of time.
Value can be accumulated through successive redemptions of goods for money, allowing me to either obtain goods of much higher value than I can obtain in an individual transaction or to hold off obtaining certain goods or services until a more favorable time. I can “convert” my perishable goods into durable exchangeable goods for storage.
So, what does this mean? It means that a developed economy, operating with the use of money, can be visualized as a large common “pool” of resources into which people pour resources they produce and out of which people withdraw resources they require, and which is constantly being accessed and replenished by millions of people simultaneously. The medium in this pool allowing for exchanges to occur is money. To access this pool, goods or services are brought to the economy, and are deposited into the economy for money. Possibly immediately, likely later, this money can be used to draw out goods and services from the pool, presuming they are available (there is never a guarantee that certain goods will be available, and the beauty of money is that it can be held onto until the desired good or service can be supplied). The market of prices, which are regulated by supply and demand, is what coordinates the stream of goods and services into and out of the economic pool, ensuring that resources flow to those areas most in need of their application.
In a well-functioning economy, the input and output streams remain balanced with each other. Unsustainable projects cannot be started, because there are no resources to sustain them. Mistakes can be made, of course, but only at the expense of those who have already contributed to the pool, and only with the consumption of a measure of resources that has already been introduced. Resources cannot be consumed outside of what already existed in the economy.
Further, through the use of money, projects of longer and longer duration are able to be started. The “storage” aspect of money allows for resources to be accumulated so as to sustain the actors over the time period of their project. A house can now be built as a consumers’ good, because bricks, lumber, shingles, windows, and labor can all be purchased in advance of the sell date. Without money, the brickmaker would have to expend his effort to make the bricks and then wait over the period of time that the house required to be built and sold before he could ever receive his payment. And the farmer would have to find ways to store the required vast quantities of meat and butter he needed to accumulate in order to pay for his house.
UPDATE:
After posting this article, I got a question from a good friend of mine on my arguments about “unsustainability”:
“Unsustainable projects cannot be started, because there are no resources to sustain them.”
Huh? Lots of unsustainable projects start everyday. Or does that mean none of our economies are well functioning?
So I took the opportunity to clarify my thoughts further:
“Mistakes can be made, of course, but only at the expense of those who have already contributed to the pool, and only with the consumption of a measure of resources that has already been introduced. Resources cannot be consumed outside of what already existed in the economy.”
I can see the confusion I created here by not getting to the other half until a later section. It is easier for me to break these up, because I haven’t gotten the time yet to write them all at once. I also go on the fact that people don’t necessarily have the time to digest more than bits and pieces in a given day.
I can also see the semantics of my word choices. I *can* start a trip to FL with only a half tank of gas, even though I won’t be able to get there. So I started a project (getting to Florida) in a manner that could not succeed for lack of materials required to sustain the project until the end.
A business won’t start a project without knowing they have the means available to finish it. In a healthy economy, the various indicators and signals will be valid and resources will be available to finish projects. Unsustainable projects *can’t* be started because the funding won’t exist to start them, because the investors won’t be willing to fund a project to nowhere.
Normally I wouldn’t extend this far, but the semantics are going to be important. Yes, I am making certain global presumptions. I also accept that the apple juice makers can’t know that there will be an apple harvest next year and that the project will be fulfilled. However, this is somewhat missing the forest for the trees. There is a certain “risk” element in entrepreneurship that can never be mitigated. To try and formulate an economic theory on every possible detail that unpredictable humans *could* do is a task in futility.
Where the argument (my blog) will go is that by creating money, the gov’t allows certain participants to withdraw resources from the economy without contributing. Projects will have been started (by both businesses that use the gov’t money and those that planned ahead) that have absolutely no way of being completed, because not enough resources exist to complete all of the newly started projects. But the signals to businessmen (interest rates, etc) imply that there are, in fact, enough resources available. The projects have *become* unsustainable. Even if everyone wanted to, they couldn’t all be completed, and a price battle for resources will ensue.
This is different from starting a project without having “gathered” enough resources to finish. The project is still “sustainable,” if you could convince investors to give you more resource-backed money, even though it is currently “unfinishable.”
Hope this helps!
Shade Tree Economist 