“I make myself rich by making my wants few.”

— Henry David Thoreau

“Money is just a way of keeping score.”

— H. L. Hunt

“Money is the barometer of a society’s virtue.”

— Ayn Rand

“I have always been afraid of banks.”

— Andrew Jackson, 7th President

“The thing that differentiates man from animals is money.”

— Gertrude Stein

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

— Henry Ford

What is money? Silly question, right? Everybody knows that money is cash in your pocket plus whatever is in your bank accounts. Oh yes, and you have some money in your 401-K and a couple of other investment accounts. Also, you invested some of your money in a good house in a good location (with the bank’s help, of course).

Does all of this count as “money”? If not, which ones are actually “money” in functional terms? It looks like the term “money” can include all kinds of valued stuff. Does it mean whatever you want it to mean in your current context?

Money as a “tool” or measure of value is extremely important. The whole world operates around money in its economic (and other) activities. Surely we have a solid definition of “money” since it is so important. Surely.

Money is whatever I use to buy stuff

Buy stuff. Maybe that’s the key to whatever “money” actually is. It allows me to buy what I want when I want it. Assuming of course that there is somebody around who wants to sell me this stuff. As a transaction, that is an exchange. I have “money”, the seller has stuff that I want, and we exchange these on some basis.

Suppose my “money” is a bag of shiny white stones, or alternatively, a cat. The stones might just work if they are topaz, or maybe opal, or even diamond, but the cat definitely won’t because it bites and anyway I’ve already tried a bunch of times. What to do?

I know – what about my wrinkled roll of dollar bills that you can’t hardly use for much anymore? Worth a try, so we bargain over how many wrinkled dollar bills might the seller accept for my basket of stuff. The seller argues that I am offering just some sheets of crappy paper in exchange for some actually useful stuff, so why would anyone be crazy enough to take this offer?

To make a long story short, the seller finally accepts my crappy paper because I successfully argue (con) that the crappy paper is backed by the entire U.S. Government, which in turn is backed by a couple of hundred million taxpayers. The seller should have no problem unloading my crappy paper for another seller’s useful stuff.

Problem solved: I can call my crappy paper “money” now because it facilitated an otherwise difficult exchange. Maybe I can offload my bag of white stones, or even the cat, in my next exchange, and call that “money” also.

Isn’t it wonderful how economics works in practice?

Are these money?
Are these money?

Money is fundamentally a medium of exchange

This is just great, yes? Whenever I need some that is actually useful and tangible, I can look for a gullible seller who is willing to accept my wrinkled crappy paper (or bag of white stones, or even the cat). Hard to believe but such folks are out there, and have been ever since the exchange of values mechanism was invented.

The trick here of course is that exchanges based on money, however defined, is fundamentally based on trust. The seller especially has to be very confident that it will be easy to find others who are willing to exchange such money (wrinkled crappy paper, stones, or cat) for real stuff.

This means that you can define money pretty much however you want, subject to finding sellers who trustfully define money just as you do. Maybe some argument over how many wrinkled crappy paper dollars are need in the exchange – you might recognize this as a “price” – but so long as the medium of exchange and quantity thereof are agreed to, deal done.

Worth noting that economists call the unit price (dollar per quantity of real stuff) a “Unit of Account”: a standard numerical unit of measurement of market value for goods, services, and other transactions. Unit price works just as well for us real people.

A final aspect of money is that, at least among the folks who actually believe that wrinkled crappy paper dollars have exchange (trade) value, money represents a “Store of Value”. This means in practice that I can at some later point use my stack of so-called money to buy actual useful stuff from willing sellers within this particular money context.

Without the store of value function of money, modern society cannot exist. Because a tool for storing economic value enables savings (capital accumulation) which enables investments, which enables entrepreneurship, and the production of goods and services.

Money, in this regard, is also a tool for transferring economic value from the present to the future. The goods and services available for consumption today represent the savings, investment, entrepreneurship, and production of the past.

Money is hugely important because society’s functioning depends on it

Without the store of value function of money, modern society cannot exist. Because a tool for storing economic value enables savings (capital accumulation) which enables investments, which enables entrepreneurship, and the production of goods and services. Money, in this regard, is also a tool for transferring economic value from the present to the future. The goods and services available for consumption today represent the savings, investment, entrepreneurship, and production of the past.

Money Enables Specialization. Because of money we live in indirect exchange societies. So, people can specialize in chosen tasks as opposed to having to be a jack of all trades. You no longer need to grow your food, build your house, fish to eat fish, and all other tasks you would have to do by yourself, with your family or tribe as it was in barter societies.  Nor does one need to get goods and services through force and violence. Instead, you can, based on your natural or learned abilities, produce goods or services, sell in the market, and with the money earned buy goods and services to meet your and your family’s needs and wants.  This is the division of labor. Money is the tool that makes the division of labor in society possible. The division of labor has enormous benefits that go beyond creating a better, cheaper, and growing pool of goods and services for people to choose from. The division of labor also promotes peaceful and largescale social cooperation, friendship, greater trade, cultural exchange, knowledge sharing, and more.

Money Enables Cooperation. In a direct exchange society, human cooperation is agonizingly restricted and life is primitive. As the enabler of indirect exchange and thus of the division of labor, money is both an extraordinary economic tool as it is an essential tool for large-scale peaceful and voluntary cooperation within society and between societies.

Money Communicates. The market economy is superior to available alternatives because, among many other reasons, it is more efficient, effective, and timely in allocating resources for the production, distribution, and consumption of goods and services.  That is made possible by the price mechanism which transmits information, signals, incentives, and disincentives that guide market participants in the dynamic and never-ending process of determining when to allocate capital, what to produce, where, how, by whom, for whom as well as what to consume and where to buy goods and services.  This happens in a fully decentralized and voluntary manner.

Checklist for determining what is money

Not everything that buyers and sellers agree to use in an exchange is money. Money:

  1. Provides a mutually acceptable medium of exchange
  2. Provides a standard unit of value measurement (aka a unit price)
  3. Provides a trusted store of value to enable subsequent exchanges

The first two deal with exchange mechanics. It is the last item – trusted store of value – where the big trouble with money begins. This means that all parties using a particular kind of money must trust that the value each unit represents will not disappear or drop significantly over extended periods of time.

And just what is this real value that is being stored? It is theoretically reflected in the purchasing power of each value unit (e.g., a dollar). Purchase of what? Most likely, a roughly constant (over time) bundle of goods and services. Food. Clothing. Shelter. Supposedly things that our use-value doesn’t change appreciably over long periods of time. So, if purchasing power for these items changes, then the money-value must have changed since the use-value has not.

This gets very complex very quickly, as you might expect. See Related Reading for an example.

Okay, so what is money under this definition?

Dollars. Easily meets the first two requirements but absolutely bombs on the “trusted store of value” requirement. As outlined in Related Reading below, the U.S. dollar lost roughly 96% of its purchasing power between 1913 and 2019. Just to stay even in purchasing power with this value decline rate, your income in dollars must be increasing on average at this rate.

Digital currencies (e.g. Bitcoin). Again, money criteria #1 and #2 are reasonably satisfied but the “trusted store of value” requirement is not, at least to me. Wikipedia defines cryptocurrencies (one of several types of digital currency) as:

“Cryptocurrency is a sub-type of digital currency and a digital asset that relies on cryptography to chain together digital signatures of asset transfers, peer-to-peer networking and decentralization. In some cases a proof-of-work or proof-of-stake scheme is used to create and manage the currency.”

“Cryptocurrencies can allow electronic money systems to be decentralized. When implemented with a blockchain, the digital ledger system or record keeping system uses cryptography to edit separate shards of database entries that are distributed across many separate servers. The first and most popular system is bitcoin, a peer-to-peer electronic monetary system based on cryptography.”

My take at this point is that anything digital is volatile and risky, depending on the backing source provider. Unfortunately, this includes virtually everything except maybe cash in your pocket. Cryptocurrencies are unregulated and decentralized. Their value is dictated by investor sentiments, usage, and user interest. They are volatile assets more suited for speculation, which makes them unlikely candidates for use in a financial system that requires stability.                       

Central Bank Digital Currencies (CBDC). Investopedia defines these as “Central bank digital currencies are digital tokens, similar to cryptocurrency, issued by a central bank. They are pegged to the value of that country’s fiat currency.” These are supposedly “government-backed”, like the dollar, making them about as trusted as each country’s fiat currency. They are in fact the digital form of a country’s fiat currency. Umm …

Gold and Silver. In principle, precious metals should roughly preserve their value over long periods in terms of a standardized purchasing power. The trouble here is that we no longer use these metals to buy anything. Instead we use dollars. The translation of current dollars to equivalent gold values makes it appear that the metal is changing price, but it is changing only relative to highly volatile dollars.

From Investing.com:

“In the 18th century (1792), the US established the first USD with the one ounce silver coin. There was no paper currency, only silver and gold coins. The US was on a silver standard, and one ounce of silver was worth $1.”

“Forty years later in the 19th century (1832), the US officially went on a gold standard. One ounce gold coins were produced at a face value of $20 each, and the one ounce silver coins retained their $1 valuation. Paper currencies sprung up from time to time, but they all eventually became worthless.”

“In the 20th century (1900), the US produced its first official paper currency. These paper $20 dollar bills were backed 100% by gold, and were termed Gold Certificates. There were also silver certificates that were obviously priced at the lesser value. $20 gold coins and $1 silver coins continued to be produced as well. The gold certificates were completely redeemable into gold at any bank. In 1933 FDR called for a bank holiday, called in all the gold in the country, made it illegal for Americans to own gold, and raised the benchmark price of gold from $20 to $35. Gold certificates were now a thing of the past, and the Treasury started producing Federal Reserve Notes. Then in 1971 Nixon took the USD completely off the gold standard, and it was legal for Americans to own gold again.”

Currencies, even the dollar, do eventually become valueless

Investopedia provides a helpful but not happy background for the likelihood of any currency to collapse, or become valueless: “Why Currencies Collapse”:

“History is full of sudden currency collapses. Argentina, Hungary, Ukraine, Iceland, Venezuela, Zimbabwe and Germany have all experienced terrible currency crises since 1900. Depending on the definition of ‘collapse,’ the Russian currency calamity during 2014 could be considered another example.”

“The root of any collapse stems from a lack of faith in the stability or usefulness of money to serve as an effective store of value or medium of exchange. As soon as users stop believing that a currency is useful, that currency is in trouble. This can be brought about through improper valuations or pegging, chronic low growth, or inflation.”

“Currency collapses are caused by a lack of faith in the stability or usefulness of money—either as a way to store value or as a medium of exchange.”

Next week: The surprising extent and depth of agreement in our disagreeable societies.

This post on money has become long enough that introducing the second major topic in a single post seems to have become impractical.

Bottom line:

These questions – what is money, and why are we all so agreeable – may seem completely unrelated, but they are not. Together, they address two of the most important processes that are shaping our world today. Money is essential to civilized life. But it is a concept, not a real thing. Money requires acceptance as a medium of exchange – goods for money – rather than a barter exchange – goods for goods. It needs a unit of value, or price mechanism. But most important of all is that money must provide a trusted store of value. Most of what we call money does not meet this third criterion.

Related Reading

Some notes on the nature of “money”:

  • The concept of money is one of the most important discoveries or inventions in human history. That is because, without money, humanity would be still in a primitive state of existence —the barter society. Over the past thousands of years, particularly over the past few hundred years, human living standards have improved astonishingly. Progress that happened, and is still happening, in the context of money-based trade, savings, investments and entrepreneurship.
  • Money is first, foremost, and fundamentally a medium of exchange. A generally accepted good (physical and now digital also) that intermediates transactions within societies and between societies.
  • Direct exchange means for a trade, a purposeful and voluntary exchange of goods or services to take place, let’s say, between a hunter and a farmer, their wants would have to coincide. The farmer would have to want a piece of meat and the hunter a portion of the farmer’s potatoes. This is what economists call the coincidence of needs.
  • Money emerged naturally as the solution to the ‘coincidence of needs’ problem and ushered in a new, more efficient way of trading and a superior social system altogether—the indirect exchange society. Human societies have been indirect exchange economies for thousands of years now thanks to money, a medium of exchange.
  • Modern society is based on the indirect exchange made possible by money, as mentioned earlier. Thus, the concept of money is one of the most important discoveries in human history. It is the concept that largely enabled humanity to escape a primitive state of existence to the modern society and living standards of today.  If money were abolished, modern society would cease to exist as we know it and living standards would completely collapse. Money must exist because of the impracticability of barter—a direct exchange society.  The barter economy is antisocial and extremely limiting, to say the least, because of the “coincidence of needs” problem. Trade, progress and human cooperation would be agonizingly restricted and society would remain in primitiveness.

Statista has a marvelous interactive graphic on the U.S. dollar’s store of value (in terms of standardized purchasing power) since 1635:

Zoomed in above chart to look just at 1913 to 2019.
Zoomed in above chart to look just at 1913 to 2020.

“When converted to the value of one US dollar in 2020, goods and services that cost one dollar in 1700 would cost just over 63 dollars in 2020, this means that one dollar in 1700 was worth approximately 63 times more than it is today. This data can be used to calculate how much goods and services from the years shown would cost today, by multiplying the price from then by the number shown in the graph. For example, an item that cost 50 dollars in 1970 would theoretically cost 335.5 US dollars in 2020 (50 x 6.71 = 335.5), although it is important to remember that the prices of individual goods and services inflate at different rates than currency, therefore this graph must only be used as a guide.”

Purchasing power of a roughly constant bundle of goods and services in 1913 was $26.29, and in 2020, was just $1.00 – a decline of around 96% over a little more than 100 years. Despite serious questions about what might be in the “bundle of goods and services” over time, this trend is far too huge to be ignored.

Even if my money is simple cash-in-pocket and my bank accounts, what I can buy with each dollar has declined by around 93% since the post-war high of $13.35.

Gold has a long history as a trusted store of value even though its role as a medium of exchange has diminished greatly in our complex societies and high transaction volumes. Here is what one gold guru thinks about gold:

“May 15 (King World News) – Egon von Greyerz, founder and Managing Partner at Matterhorn Asset Management (based in Switzerland):  Since no current President or Prime Minister nor any Central Bank Chairman understands what money is or the relevance of gold, we must turn back to history and Thomas Jefferson, America’s third president for a proper definition. “

“Jefferson also understood that ‘Paper is Poverty, It is only the Ghost of Money, and not Money itself.’”

“Gold is not an investment. Gold is eternal money. As such gold maintains its REAL value whereas paper money loses all its value over time. For 5000 years gold has outlived all other forms of money including paper money.”

“We must remember that every paper currency in history has gone to ZERO, with no exception. The current monetary system is taking its last breaths. With the dollar and most currencies having lost 99% since the Fed was founded in 1913 and 98% since Nixon closed the Gold Window in 1971, it is guaranteed that the remaining 1-2% will be lost in the next few years.”