Money (Reprise)

I have recently done three posts on Money, here, here, and here.

Someone in an online forum recently went on a long rant about how money, in particular modern “fiat currencies” (i.e. money that is not backed up by precious metals but is instead simply declared as existing by some organization–usually a government–that has authority to do so), are worthless, not real, nothing more than shared delusions.

I run into that a lot from people who bemoan the move away from “hard” currencies (currencies that are defined in terms of a certain amount of some particular physical resource, generally gold or silver) to “fiat currencies”.  Gold apparently has magical properties that makes it “real” money and the other is “fake.”

Here’s the thing though.  Those little pieces of paper, disks of cheap metals, and electronic records do have value, important value.  And that value is in their function as a common medium of exchange.

Consider a case in the absence of money.  Suppose, I made chairs.  Being pretty good at my craft I make some pretty decent chairs, a comfortable and attractive place for even the very well-to-do to prop their rear ends.

So I’ve got these chairs that I’ve made.  But, you know, I’d really like an omelet for breakfast.  And for that I need eggs.  Now, I can go down to the guy who raises chickens for some eggs only there is a problem.  One of my chairs is really quite a lot to trade for three eggs (I’m hungry enough that a three egg omelet would be just about right; after all, making these chairs is hard work), even for three dozen eggs (probably about as much as I can eat before they start going bad. (I like eggs, but not that much.)

Even if I’m willing to just suck it up and offer the trade of one of my exquisite, hand-crafted, nicely padded chairs for some eggs, there’s a problem.  The guy with the chickens doesn’t want a chair.  “Got plenty, thanks.”

Now what do I do?

Given time and effort I could find someone who would be willing to take one of my chairs for something, and that something could then be traded for something else until eventually I had something the guy with the chickens wants in exchange for eggs.

The problem is, all of that takes time and effort which I could be using for other things.  I could be using it to make more chairs (which I could then trade for other things I want) or enjoying some of the things I’ve traded for, or just eating that omelet that I started out wanting.  Anything other than going around from person to person trying to work out a system of trades that finally gets me those eggs.

This running around from place to place is a cost to me.  If nothing else, its time I could use to make more chairs to trade for more items.  The opportunity to do so is lost because I’m spending time and effort just trying to make that one trade. (Thus, economists call this “opportunity cost.”)

If only there were something I could trade the chair for, something that can be used for larger trades (like the chair–or even things larger than that) and which could also be divided easily into multiple smaller trades (so I can get eggs from the guy with chickens, ham from the guy who raises hogs, and cheese from the guy with dairy cows, and maybe some onions and peppers from someone else).  If only.

Fortunately, we have that something.  It’s called money.  Money is, put simply, a common medium of exchange.  Somebody wants a chair?  I can trade one of my chairs to him for, oh, let’s call it one hundred quatloos.  Then, without having to worry about finding intermediate trades, I can go straight to the guy with eggs and give him ten quatloos for some eggs, to another guy I can give twenty quatloos for some ham, and spend some more for cheese and veggies.  And they’re all willing to do that because they can use those quatloos to trade for things they want.  And then, with a lot less work and effort, I can have my omelet.  Even have enough time saved to make more chairs.

Go me!

This something, this “money” has value from its function as a common medium of exchange.  It makes economic transactions easier and therefore reduces the cost, the opportunity cost, of those transactions.  It’s value is that it makes everything else more valuable because those other things can now be traded more easily and more conveniently with more possibilities.

Of course, once you have money of whatever type, “hard” or “fiat”, supply and demand applies.  What really separates “real” (hard) money from “fiat” money is the ease with which the supply can be changed.  It’s a lot easier to print more pieces of paper (and even easier to change some electronic records) than it is to come up with more gold.  This is why monetary policy is so, so important–and beyond the scope of this blog post.  But that “fiat” money is still just as real as the “hard” money so long as it serves as a common medium of exchange that can be aggregated (say, I sell a bunch of chairs to a bunch of people so I can buy a new house) or divided (as described above regarding those eggs).

Now I think I’ll go have an omelet.