What is Money?

We got into the topic of money a little bit yesterday—mostly how it developed and its humble origin as a run-of-the-mill commodity.

Money is a commonly used medium of exchange. Money has certain characteristics, which you might think would be found in a book titled “Basic Economics”,  but most economists seem to neglect this all important subject.

Money must be valuable: It is wealth, like a herd of cattle, a barn full of tobacco, a storehouse of salt, or a vault filled with gold. All of the above have been used as money at different times and in different places. Money has to be something of some value before it can ever be considered a commodity.

Next, it needs to be relatively scarce. There is a reason coins were made out of gold and silver, not iron. Today our coins are only token money, but were we to actually trade iron on its value, that would come out to about $50 per ton. For a young man taking his date to dinner and a movie, he would want to bring along at least one ton of iron and maybe a few hundred pounds change. Well, what about something along the lines of diamonds? Most simply, diamonds are too rare. Rarity is a problem. There simply are not enough floating around to be used.

Diamonds also are not fungible. That is to say, every diamond is unique. It’s impossible to consider a pricing system with diamonds—not only do you have size and carat, but also clarity. It truly boggles the mind…or mine, anyway. However, something like gold is fungible. One 1/2 ounce of gold is just as good as any other 1/2 ounce out there.

Another very important feature of a money that either allows for a more complex economy, or is brought about by a more sophisticated economy, is durability. The quality of not being used up over time is very desirous. This is why gold and silver have won out over time whereas cattle, salt, tobacco, and animal skins have finally reverted to regular old commodities.

Diamonds are durable, cattle are not—not over 15 years, at best, anyway—but neither are divisible. This is another essential to a more complex economy.  If I want to buy only 1 goat, but the going rate is 5 goats per 1 cow, what should I do with the other 4 goats? Now I’m back to bartering around to get rid of them. I only want 1 goat, I cannot trade 20% of my living cow, now can I? I can take either 5, or none. This isn’t good.  The same problem would arise with the diamond example above.

About the only things that seem to work are gold and silver, with copper making a guest appearance from time-to-time for extremely small exchanges.

I will deviate from some Austrians and add that bitcoin and crypto-currencies seem to be sound and meet all of the above criteria. Their inherent value being found in their ease of moving value through space without 3rd party participants. It’s possible to easily send any amount of value of bitcoins from a farm in Montana to a village in central America, so long as both people have internet, and with the bonus of no transaction fee. To send money through Western Union it would cost upwards of 10% of the amount sent.  That is the value of bitcoin, and had I caught upon this 2 years before I did, I just might be a rich man today.

But that should do it for the properties of money.

They are:
1) Value
2) Durability
3) Divisibility
4) Fungibility, or homogeneity
5) Scarcity

If you want a quick resource page, I recommend checking out: http://wiki.mises.org/wiki/Money

It has a good, quick little run down on money, as well as plenty of resources.

Chapter 17- Introduction to Money

We are finally getting to the area of economics where Sowell is actually very weak; famously weak. I’d read Sowell long before being introduced to the Austrian School and I remember when I did start talking to other Austrians and I told them I read Sowell, they would respond sadly and reluctantly, “Yeah, Sowell is alright, but he is kinda weak on monetary policy.” Back then I didn’t think that was such a big deal, but it is actually critical to having a sound view of economics in other areas. The fact that Sowell is so good in other areas despite being so bad on monetary theory is remarkable. So, I’m glad we’ve finally made it to monetary theory, and my guess is that we are going to be here a while.

Sowell doesn’t even get out of the first paragraph without running into problems. He writes, “While money is not wealth—otherwise the government could make us all twice as rich by simply printing twice as much money—a well-designed and well maintained monetary system facilitates the production and distribution of wealth.” The book would be better had that whole line been cut. What do you mean money isn’t wealth? And, a monetary system designed by who? And, maintained by who? He doesn’t even define money, taking for granted that someone who has never before picked up a book on economics knows what money is.

If you think I’m being too harsh, scroll down to the comment section and list 3 of the 5 qualities of money. I would also point out that Sowell doesn’t address the development of money. He does discuss, or mention rather, barter exchange, but how did we go from barter to indirect exchange? That is with money, where I don’t trade my labor directly for the things I want, but I trade my labor for money, and then trade the money for all the things I want and need.

Let’s start first with how money comes into existence and then define it. The theory goes, as men produced and engaged in direct exchange-barter their aims were often frustrated, and a man making shoes would want fish, but wouldn’t be able to acquire fish because the fishermen already had shoes. Therefore, the cobbler would go to the fishermen and ask what they want for their fish, and then what they would take.  It so happens they may need more hooks, but the hook maker has had his fill of fish, so the fishermen ask for buckskins. Thus the cobbler who uses buckskins himself in his profession, trades some of his buckskins to the fishermen for fish, and the fishermen take the buckskins to the hook makers to get hooks.

Here you can see the gradual transition between barter and indirect exchange. In this example, we haven’t quite made it into a money system necessarily, but you can begin to see how thinking men stop thinking so much about what they themselves want, and begin to consider what others want. Some, myself included, consider this to be the very bedrock of society extending beyond blood relations.

The idea goes that as more and more people begin to trade their goods in terms of buckskins, the buckskins slowly move from being just another commodity among many to being a commodity currency. When the butcher, the baker, and the candlestick maker are all satisfied in taking buckskins as payment, the buckskins are monetized. They become money. In fact, buckskins were more or less used as a currency in the early days of the Indian trade with tribes in North America.

First, it might be worth mentioning that there is no intelligent design when it comes to the formation of money, and furthermore, money is wealth. The buckskins were sought before they became money, and had a value in themselves as much as any other commodity.

Sowell, as well as others, are tempted to look at the “money” we have today, which is only paper. It is now “fiat” currency.  Fiat being the Latin word for decreed.  However, it is important to note that it didn’t start out that way. In the beginning, money was directly tied to gold with a hard and fast exchange rate of 1 dollar for 1/20th of an ounce of gold. That is a $20 bill was as good as one gold ounce.  Over time, through government intervention, and debasement by the central bank, the dollar has had its tie to gold cut, and gold is now trading for around $1,150 an ounce; a far cry from the original $20/oz.

This, notwithstanding, the qualities of real money and its origin are still worth understanding, and are critical to going further in economic understanding. This is why  Rothbard deals with money and its formation very early on in “Man Economy and State.”

Time runs short and I’ve got to be moving on, so we’ll have to cover the attributes of money tomorrow.  Until then, take care, and leave comments in the Facebook group; don’t be shy.

Comparing Standards of Living Between Countries: Wrapping Up Chapter 16 of Basic Economics

I think Sowell got it right at the very end when he wrote on statistics and how they can give a false impression; especially when it comes to developing nations and the statistical changes over time—referring to women working outside the home and things that the mother used to do, now is being done by babysitters and housekeepers instead. In the first case, as people begin to crawl out of poverty, they can afford more and better medicine, more and better food, and thus keep more of their children alive. Now there are more poor people, and the majority of the money has been spent on survival. So, it appears that the people are not getting any richer, or better off than they were. Nevertheless, of course they are, since they are not dead.

Sowell doesn’t get out of the chapter without getting into more trouble, it happened about a page after the start of the section “International Comparisons.” He argues the difference in median ages of different countries greatly overstates the difference of incomes between young countries like “Nigeria, Afghanistan, and Tanzania, all with a median age below 20 and older countries like Japan, Italy, and Germany, which all have a median age above 40.”

He argues, “Nature provides to the young the things which are extremely expensive for the old… thus statistics on real income per capita overstate the difference in economic well-being between older people in Western nations and younger people in non-western nations.”  He goes on, “If it were feasible to remove from national statistics all the additional wheelchairs, pacemakers, nursing homes, and medications ranging from Geritol to Viagra—all of which are ways of providing for an older population things which nature provides free to the young—then international comparisons of real income would more accurately reflect actual levels of economic well-being.”

Now, I almost didn’t catch this, but something didn’t quite sound right so I went back over it about 4 times…  What are we comparing?

Aggregate income, as eluded to in the first quotation?
Real income per capita?
Or economic well-being?

If we are talking about aggregate income or real income per capita, the wealth was already produced. If it weren’t possible to have pacemakers and all the life saving devices and techniques that we have, if they did disappear, a large number of the old folks would “disappear” too, and their money would be spent by their grandchildren, on go carts, play stations, hot rod cars, and weeklong vacations to Panama City. Therefore, the money would be spent either way. As it is, our old people live and they have pacemakers. In Afghanistan, they do not live to such an old age, and yet the young do not have PlayStations or even simple bicycles.

Now what about economic well-being? This is a little trickier. If we said quality of life, then perhaps, I can see that argument being made, but standard of living isn’t just what you actually have, but what is available to have. Sickness or accidents can strike at any age, if it strikes the young here, and the young there, then ceteras parabus. The yung’un over here has a vastly better chance at surviving, and full recovery than the poor kid over there.

I think this gives away too much. How much better off is a person who has lost the use of his legs with a wheelchair than without? What is the personal preference of the individual? Ask someone who is wheelchair bound if the chair makes him or her better off. They are worse off by not being able to walk, but a wheelchair is better than being carried on a litter, and far better than being entirely immobile. Economic well-being is subjective, and it all revolves around exchanging one’s current set of conditions for more desirable conditions. As always, action demonstrates preference and desire. By buying a wheelchair or Viagra or whatever else old people buy, they are demonstrating that their economic condition is improved by the purchase.

I really don’t have anywhere to send you for this one, except to read “Human Action” and “Man Economy and State”. I believe the latter may be more accessible, but a sound understanding of either would prevent such errors as these, and both were the basis of my ability in being able to identify and address these errors.

The Standard of Living. Chapter 16: Part 3 of Basic Economics

We’re finally about 1/2 way through chapter 16 and boy is it tricky. Sowell finishes up explaining GDP and GNP and goes into the standard of living and the consumer price index, or CPI. That is a collection of goods commonly bought whose prices year after year reflect the changing value of the U.S. dollar.  Sowell is keen to point out that there are goods in the CPI today that were not a part of the CPI 10 or even 5 years ago. He gives an example of the cassette video recorder which was sold for $30,000 when it first hit the scene, and was only included as part of the CPI after the price had fallen below $200.00.  He points to trends like this to argue that inflation is not as bad as is shown in absolute terms. A 3% inflation rate would actually be closer to 2% (a big difference when it adds up year after year).  Hhe argues that the standard of living is in fact on the rise; you might look again at the ever improving auto industry with standard features today that only the top of the line had 5 or 6 years ago—side impact airbags, increased fuel efficiency etc. Even features that used to be optional are now universal; all cars coming out today have power windows and powered locks. These are all signs that the standard of living is on the rise.

Now, I’m not here to tell you that it isn’t true, but I do want to be a counter weight to his argument.  In the first place, it matters who we are talking about. The standard of living for who?  Yes, I think the standard of living is improving for the wealthy and upper middle class unequivocally, For the poor, it is getting better in some ways, but how much does it really matter if new cars have power windows and side impact air bags if the cars are too expensive to be bought by folks of modest means? Even 3 and 4 year old used cars are out of reach for those on a tight budget. The trick is that so much of these “advancements”, especially in the auto industry, are not the result of market forces, but are instead the direct product of government regulations. True, fuel efficiency would continue to improve over time, but the government has imposed mileage standards on automakers, which has undoubtedly made them quicken the pace. Not to mention safety standards: curtain airbags, roll proof rooves, crumple zones, etc. It’s just fine for these things to be available, of course, but choice should not be eliminated for those who would like other options.

On another front, as far as inflation not being so bad, I’ve thought a lot about how to break this down into a readily comprehensible analogy, but for the most part I’ve come up short. Yet, I’ll try out what I have. Our economy is like a man walking up a flight of stairs, advancing with better methods of production, improved technology, and an ever-increasing capital structure. Yet, the monetary inflation created by the central bank and the fractional reserve banking system (we’ll get to these in later posts) is like an escalator moving the man slowly back down.  Now, I am willing to concede, or at least not contest, the assertion that Sowell makes that the standard of living is going up. However, inflation really is a bad deal, and it really is at 3%. Without inflation, the economy—the man climbing the escalator—would be further along than he is with inflation. The fact that he is still moving doesn’t make the downward motion any less bad, or decrease the amount of its effects—not even in the slightest.

True, we might not feel the full effects, just as we might not feel the effects of the sun coming out on a winter afternoon because just as it peaks out from behind the clouds the wind also kicks up and whatever increase in temperature we might have felt is totally negated by the wind chill factor. Had the sun not come out from behind the clouds we would have sure enough felt it get colder.

This is where yesterday’s post concerning the GDP PPR and GPP come into play. Now we’re able to measure, at least to some degree, the changes in standards of living, but this is, I think, beyond the scope of the topic.

GDP, GPP, and PPR (don’t worry it’s actually pretty easy): Chapter 16 – Part 2

First, I think it’s worth making a note about the GNP and GDP, and Sowell’s treatment of it. Very early in the chapter he makes the appropriate distinction between real investment, buying stocks and bonds in businesses on the open market, and buying government bonds. When a government bond is purchased, it is only a signal that at a future time, more money will be taken from market participants through taxes. Sowell is right, here, that the country is not made richer, nor will it be made richer by the government bond being sold.

Then, a little later, he brushes over the GDP, which falls into the exact error he was criticizing earlier in the chapter—or at least the flip side of it—counting government expenditures towards total national output.  When he calculates total investments, he subtracts all government investments out from his total because they aren’t real investments. Why not do the same with the GDP?

Murray Rothbard did exactly this; he developed 2 different calculations for calculating wealth produced year to year, or in the case of the latter, the wealth remaining after the state took its cut.  The first is the GPP gross private product, which subtracts out all the expenditures of governments, leaving only what was produced in the private sector. This is very important because with the GDP calculated the way it is now, all of the money spent on over priced parts by the pentagon—all of the waste spent at NASA—all gets put into the GDP. Then, when that figure is divided out by the population, to get the GDP per capita, the figure doesn’t give an accurate representation of the picture we’re in.  The government spent the money and something was produced, but no one wanted it. No one was willing to reach into their own pocket to buy it, and that is what matters. It is the actions of individuals bidding on goods and actually paying for them that lets us know they prefer what they bought, say a pair of shoes, more than the $60 they had to part with to get the shoes. Nothing even close to this process happens when the government buys F-35 fighter jets.  That’s why all government spending is taken out of the GPP.

Those millions of dollars for the F-35 didn’t come from nowhere, they came out of the market, they came from individual and corporate income taxes. Taxes make us poorer, even as far as they pay for goods and services that we would buy in the absence of government—fire protection, education, roads, courts, etc.—because there is no market process. With no competition to arrive at a market price for the wages of teachers and firefighters the prices paid are, more than likely than not, inflated beyond what the prices would be in a free market.

Because the government cannot spend a dollar without taking a dollar—sooner or later—either through inflation or direct taxation. We can calculate another figure: the PPR or Private Product Remaining. Let’s suppose you earn $10,000 in a year and are taxed $1,000. The government spends $1,000 and now an extra $1,000 is added to the GDP! However, only $10,000 was produced. The GPP addresses this, and would bring that figure back down to $10,000. However, you’re still $1,000 short thanks to taxes. So 10,000-1,000=9,000; that’s your PPR.  The PPR is the GPP minus all government spending, again along with interest… This would seem like double counting, but counting government spending to calculate GDP should have never happened in the first place; they should have subtracted. We have to subtract it out once just to get to what the private economy produced—the GPP—and then subtract it out again to see where we stand as far as wealth remaining.

There is bit of further explanation on the matter here, as well as some charts that show the GNP (essentially the same as the GDP) and the GPP and PPR all side by side for the nation from 1947 through 1983.  Robert Batemarco also calculates PPR per person, in the same way, subtracting out the incomes of government workers, to accurately calculate among producers what each producer produced on average.  Again, the logic is that government workers are paid not through voluntary exchange, but with tax money, taken involuntarily from what others have already produced.

We’ll try to get into this a little bit more next time, when Sowell addresses the effects of inflation on the standard of living, and tackles the question of whether the American standard of living is still improving or is on the decline.