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ON THE ORIGIN OF SPECIES (OF MONEY)

MONEY VS. WEALTH

Money is a medium of exchange. You exchange it for products (goods and services). The products, all put together, constitute wealth. So wealth is not money. It is the stuff you exchange the money for. So the wealth level of a society is the value in any currency of all the stuff that money can be exchanged for in that society.





THE ABSENCE OF MONEY

Money is not timeless. It was invented. Humans traded in the absence of a medium of exchange for some long time. I dunno how long. That's a matter for anthropology and archaeology. We reached physiological modernity roughly 500k years ago, so we had quite a while to get our act together, but the first evidence of metal working is only about 10k years old, in the Middle East.

This throws up a theoretical problem. What if I have a spare fur coat, but I want spear, while you have  a pair of boots and want a coat. Only one of us is actually going to get what we want if we trade. You'll get your coat and survive the winter on the plains, but I, lacking the skill to craft my own spear, have only gained an extra pair of boots, which I must now keep on my person to hopefully exchange for that precious spear later.

Yet another problem on top of this need to have multiple trades is the unpredictable nature of exchange rates; the value of pairs of boots relative to spears. If I'm lucky I'm living in a time when spears are easier to make and more readily available than pairs of snow-proof boots, and so I can easily persuade someone to part with their surplus spear in exchange for my boots - maybe even two spears! But life could just as easily confront me with a reality where boots are ubiquitous, and the kinds of spears needed to kill large roving mammals require several years' of skill to craft, making them worth two or more pairs of boots. Well, I guess I can just roll over and die of starvation, then.



FIRST DURABLE MEDIUM OF EXCHANGE

This awful situation calls for a medium of exchange. One thing, or type of thing, that is always used in trades so everybody has a decent chance of getting what they want out of a trade. A medium of exchange is better than a regular exchange good when you want a good because the medium of exchange can be used for anything.

No longer am I at the mercy of your whim as the other party to our trade; from now on, with a medium of exchange, if I want to buy spears, and you have spears aplenty, then I can just hand over the required quantity of the medium of exchange. The required quantity is equal to the price, and you begin by assessing how useful those spears are to you in order to decide what price you will part with one for.

Now, since this thought experiment involves only two people, the market consists of just the two of us; me and you. This means you are using the value of the spears to you to decide how much medium to exchange for them. So we are still not really trading in a free market, as you have me at a disadvantage.

Market prices, or the prices of each good, are set in every locality by the decisions of all parties to all trades in those goods over time. This creates prevailing market prices that people find acceptable, and from which they don't wish to deviate. When this is the case, when you are one of seven sellers with spears, and all of you have no connections to each other, then you are under market pressure to exercise market discipline by selling me the spears for the amount of medium set by the market.

But what about this medium? What other traits must it exhibit to become useful in everyday life?



STORE OF VALUE

Well, it kinda needs to have a constant value. That is, one pound weight of medium should buy as many spears on Friday as it did on Monday, excepting a change in the supply of spears. Overall, though, the rule holds water; the value of the medium, compared to the whole stock of stuff I can buy with it, should be as constant as possible.

To be clear, if the supply of stuff and services is constant, then the amount you get with one pound weight of medium should always be the same.

This is called storing value. It's what sound money does and unsound money doesn't do.



PRECIOUS METALS

Gold! Silver! Arr, yer booty shivers me timbers, et cetera. Good stuff, gold. Physical wear and tear only degrades it very slowly, and the rate at which humans have pulled it out of the ground has been insufficient to vastly increase the amount of it in circulation any time so far. The same is less true of silver, which is why 'silver standards' have been rarer through history than 'gold standards'.



MONEY SUPPLY

That quantity I mentioned above, the amount of gold or silver or paper currency in circulation, is the money supply, and so long as it stays constant, the prices paid by people for products stay relatively stable.

If we imagine a society where there was no economic growth - where the combined value of all goods and services was the same every day, month and year - and then we increase the money supply every year, then everybody will have to spend a little bit more money every year for the same goods! This point is picked up again further down.



CENTRAL BANKING

Central banking has a storied and complex history, but let's just say it starts out with kings setting up their own go-to bank for all their borrowing needs. And that relationship gives a king the means to raise the money required to pay for his wars. Central banks such as the Rijksbank of The Netherlands and the Bank of England were founded for just this purpose, and carried it out in some form until they also, gradually, became sole-issuers of currency and lenders of last resort.

Those two terms I finished with just there I will go into in more detail in a post about central banking in the future sometime. For the time being it suffices to say that the Central Bank of a country is called so because it enjoys the sole right to print new money from nothing. This feeds in to the Money Supply section above, because with only one bank supplying the base money to all the other financial institutions, while also being the lender to the government in the event of cash shortfalls, this body, which is accountable neither to the markets nor to the public, has no incentives or price signals to tell it how to behave; and so the fiat money it creates devalues more rapidly than sound, or gold-backed, money would.


FIAT MONEY

This fiat money exists by government fiat, hence the name. It suits the government because it makes increasing the money supply to lend to itself effortless, thus allowing for vast public spending without a representative tax rate. Fiat currency is the Enabling Act of government power.

'But Matty-moo, why is this important in our lives?' I hear you ask. Well, it's a matter of how our banking system is structured. If money supply increased by the same amount everywhere at the same time, everybody would be spending more, but their wages would go up as well, by exactly the same proportion! So if that was how our finance system worked, inflation wouldn't be a problem.

But it is. The money has to be created at one institution, the Central Bank, which then lends the money out to private sector banks. These banks can then lend the money on, requiring at least two stages before the money is actually being spent on products and commodities. The big problem here is that only a few people - compared to the whole population - are actually using the money, but the increase in supply has already announced its presence throughout the financial system, quickly increasing prices without actually increasing the supply of cash available to pay workers, making them - in a zero growth, zero contraction economy - poorer than they were before the increase in the money supply.

Another massive problem is, since the money is created out of thin air on the whim of just one bank and lended, those who get that money now owe it with interest back to the central bank. This means that every pound or dollar you possess is actually a debt certificate. The currency is debt.

Unsound money, right there. So how do you get sound money? Well, you need a constant or near-constant money supply, securing its status as a store of value, and you need it to be accepted in exchange for products, making it a medium of exchange. Simples!

Anything that really holds fast to both of those requirements is sound money, such as gold, or, just maybe, a new category called cryptocurrency. But that's another story!



On the next Ecomony Blogtime;

Matt makes light of his responsibility as blogger of public record by blogging entirely about socks!

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