Matthew John Hayden
Economics is the human response to scarcity, a response which takes the form of bidding prices, which are just exchange rates – or ratios – of one good against another. This means the value of one good is stated in units of another. Certain goods undergo a mutation to become a generally accepted medium of exchange, which we now call money. The origins of money and the reasons people value it are already explained by the guys at the Mises Institute, but let’s lift the lid here also. It’s a vital linchpin to contemporary economics, and a paramount prerequisite to studying applied economics.
Money is a medium of exchange. From the previous description of exchange it is apparent that exchanges without money are subject to what economists call the problem of the double coincidence of wants which can easily scupper potential exchange in a moneyless environment. This is because the chances of both parties to a potential exchange having something the other wants can be very low. If Person A offers a pillow and wants a birdcage while Person B offers a birdcage but wants a heap of sea shells, then no trade will take place, as only one party can get want they want.
Prices have been described as ratios of one good against another. What if one good becomes treated as a commodity – something that is fairly uniform like wood or stone – such as, say, shells, or precious metals? This leads to one or more of these commodities being accepted in more and more exchanges, gradually becoming accepted more for its usefulness as a medium of exchange than for its other possible uses. This regression from uniquely useful good to medium of exchange explains how, historically, it was gold and silver that became the standard money in trade throughout Europe, Africa and Asia.
Money is wonderful in its chameleonic grace. Whatever you want, at whatever time, and from pretty much whatever place, it just works, as many a smug developer will say about their latest app. But money has just worked for thousands of years already. And long may it last, because social evolution has led to money as our way to understand the costs of our actions. Whether attending a festival, buying a skinny latte, or driving across country, prices in festival tickets, cafe or store lattes, and gasoline for that darned automobile tell us what we will have to forego to enjoy these things. Money makes prices easier to understand. This is, simply, because all prices are expressed in units of the commodity that has been accepted as money. So whatever wins as money is valued by all those who engage in exchange. Why?
Because money can retain its value to its users. There are features all moneys have in common. Being commodities, they are divisible and fungible, which means that a given weight or quantity of these monies always has – ceteris paribus – the same purchasing power. It also means any coin of a given denomination can be exchanged for another coin of that same denomination without any loss of value on either side of the exchange. Monies must be durable, since a fast-spoiling commodity like butter can’t reasonably be expected to store value for very long. They are portable, so you can carry around enough of the stuff to exchange for substantial goods and services. And they are limited, so that only so many coins or tokens exist to be exchanged for goods and services at any given time.
It’s clear that the subjectivity of human experience makes economic value subjective, so the value or purchasing power of money will be a function of its use over time in lots of exchanges. It is just a commodity like any other, it’s just been discovered over a long time to be useful as a store of value from one exchange to another later one. Its initial subjective value – not intrinsic value, nothing has intrinsic economic value – will derive from the commodity’s price in barter-style exchanges, before shifting to represent the regression of the commodity in question away from its other uses. This regression is rarely universal to all examples of a commodity; plenty of gold has always been used in things other than money even through the pre-20th Century era of gold and silver monies.
Money in the modern world is quite different from the commodities of days past, being neither a commodity itself nor backed by a commodity. Instead it is backed purely by force of law. This means that it lacks two of the vital qualities of money enumerated above, because it is not limited in the way a commodity money is, and because it is not durable. Therefore this fiat money will be subject to a constant problem arising from the incentives facing its issuers at the government central bank. This problem is inflation.
Inflation is an increase in the supply of money. People often use the term incorrectly to mean rises in prices, but this is a silly use because all sorts of factors can affect a price and cause it to go up in the short term. If there is a long term increase in prices, say over a century, then calling the price rise itself inflation is identifying the symptom rather than the real economic process. This is a problem that comes up repeatedly in empirical positivist economics, whether the positivist is of a New Keynesian or New Classical persuasion. No, if prices are rising steadily over a century or more then it is because the supply of money relative to the goods and services it can be exchanged for is increasing.
It can be seen that money is the lubricant of modern economics, that sound pricing arises when prices are denominated in a commodity money. This means money is vital to the creation and deepening of vital economic phenomena that we rely upon every day such as the division of labour, and the advent and development of the stock market. Long may we all continue to benefit from the ease afforded by media of exchange and glory in the escalating value creation we can all enjoy from our peaceful co-operation in trade!