The "Where?" Part II: Money

Perhaps nothing in the economic sphere seems to be more misunderstood than money itself. This is truly a disgraceful situation. The public is mired in ignorance about what money is and is not, which means they can only be abused by those that understand it. The public is the unwitting participant in a game of wealth transfer which they cannot win because they don't understand the rules.

Adults spend the vast majority of their time working. This is nothing less than trading one's time for money. All in all, this is not necessarily a bad proposition, as long as the money maintains its value. After all, if you worked for food only, at some point you want to make sure you can store that food for later consumption, trade, or whatever purpose you like. That food represents hours of labor--time you could have used for something else but gave it up for food (payment).

Now if that food spoiled a few minutes after you received it, then you'd be less likely to spend a lot of your time working for it. You would only focus on what you needed at that time, and you probably would opt to not work more time for food that would be worthless to you. You need that food to maintain its value. You need it to be worth something over time so that it makes logical sense to work for it.

Money itself is not really any different. Money should have several attributes including as a unit of account, a medium of exchange, a store of value, and as a standard of deferred payment. Of all of these attributes, the ones we want to focus on are money as a store of value and as of a medium of exchange.

Most anything can be used as money, though some things are more "moneyish" than others. Throughout most of history, societies commonly settled on gold and/or silver as the primary forms of money for lots of reasons that are beyond the scope of this discussion. However, shells, bushels of wheat, cattle, rocks, feathers, and just about anything else you can think of has been used as money by some culture at one time or another. Usually the things chosen as money have been real, tangible items that were in limited supply and/or took significant labor to produce. After all, if handshakes were used as money, everyone would be rich! For obvious reasons, money had to have at least those two properties mentioned above: value as a medium of exchange and as a store of value.

By "medium of exchange," we mean that the money has to be readily accepted in the society for purchases of most everything. If everyone accepted eggs as payment, we could say that eggs were a medium of exchange. However, if you have eggs and the shoe cobbler doesn't want to accept eggs because he both doesn't need them and doesn't believe he can exchange them readily for something he does need, then eggs aren't passing the medium of exchange test—they're simply barter vehicles. A medium of exchange must be readily used for indirect exchange of goods and services.

By "store of value," we mean that money has to hold its value well over time. If your money spoils 10 minutes after you get paid (as in the example of food as payment spoiling), it's not holding its value. You can see the obvious problem with money when it loses it store of value attribute—confidence is lost, and that's when people start looking at alternative forms of money. This is one of the real secrets of modern economics—confidence is important. Remember this. We’re going to come back to this very, very important point.

The law of supply and demand is also important to money, and it is strongly related to the store of value attribute. Everyone inherently understands the law of supply and demand. If too much of something gets produced relative to the demand for that thing, then that thing is not worth as much as it was. As the supply goes up, the demand goes down and vice versa. Take, for example, diamonds and bread. Diamonds are worth more (cost more money) than bread. You will absolutely pay more for a diamond than for bread because diamonds are rare and bread is not. However, if bread were rare due to a natural disaster of some form, then you can bet that people would trade diamonds for it. Since we all need food to live, the demand for bread on a day-to-day basis is higher than for diamonds. However, the supply of bread is also much, much higher than for diamonds. The price of something is all about supply and demand. There is no more important law.

Supply and demand are relevant to the concept of money as well. Let’s pretend, for example, that the government now decrees that the only money that can be used for buying things in the economy is the money that is printed off of your printer at home. So, if everyone is allowed to print all of the money they want, do you think that everyone will be a billionaire?

Obviously not. First, if everyone simply prints the money they need, no one will work. Eventually we’ll run out of money because there will be no businesses to design, manufacture, and sell printers or printer cartridges. Once your supply of paper and ink runs out, you’re broke again. Similarly, we’d all starve eventually. Why would you be a farmer that has to work for money if you could just print it?

This brings us to another concept that is important here. Don’t worry if you don’t quite get it yet. It’s about capital vs. money. Capital is the money the farmer makes based on his efforts to grow food. It’s the money you have because you traded your time and labor. It is different than money, which is, for most purposes, simply a medium of exchange today.

But you can probably see that if we all print money, then there really is no economy. Things just “stop.” What is needed for a growing, robust economy is capital. That is what capitalism is all about—deploying money earned through labor into other business and investment opportunities. We’ll cover this more another time. The important thing to realize now is that printing money can’t make people rich. Invested capital that comes from earning and saving is what makes people rich.

So to summarize this section, money is something that is natural to human history. To really qualify as money, it needs to have several attributes, including being a good medium of exchange and a store a value. Supply and demand affect money, just like everything else. The more money there is floating around, the lower the demand. Money that is just printed cannot create a robust economy—that’s what capital is for. The money needs to be earned and saved. After all, it represents the accumulated labor of the society. You can’t just print the work efforts of millions or billions of people spending their time to create and advance society.

Next time, in Part III, we’ll cover inflation and deflation as supply and demand factors specifically for money. Plus, we’ll have some nifty charts again.