Understanding Money

I’ve been reading Atlas Shrugged for the last few months, and I’m finally halfway through.  The book talks a lot about the purpose, use, and meaning of money.  While reading this, I realized that most people don’t really understand money at all. Since this is a topic others have written about, I’ll defer to them.

Marc Fleury, founder of JBoss (and a very interesting character), has a good post about what money is and how it functions: The Financial Crisis for Dummies: Money. Marc is a very intelligent guy and the post has a lot of good points for understanding money.  I’ve included an excerpt below:

Money, it took me 37 years to make a bunch of it and it took me 40 to “get it”. In fact I am not sure I still completely “get” money. I mean that in the theoretical sense. After researching a bit I came to the conclusion that very few people actually understand money the way it works today. I previously discussed this here.

A definition of money
The first attribute of money is as a medium of exchange to make an economy churn. It is very much the oil in the economic engine. The meeting of neeeds is a rare occurence in a economy, but with the intermediation of money, from good to money to good, you can match disparate peoples, specialization occurs because money exists. Without money there is no economy but a limited barter economy. It also serves as a store of value. “Going to cash” is what everyone does when the markets go down because cash doesn’t lose its numerical face value. This leads to the liquidity preference that Keynes talks about. Finally, in a capitalist system a fiat money will be a bearer of interests. Keep that in mind. You can think of the “risk free” interest paid by the US treasuries on money. There are other properties of money that the litterature identifies (fungible, transferable, durable).

Types of money
Anything can serve as a money as long as it has the properties above. Historically gold has played a huge role as a money. As “out there” examples there is this tribe that used to swap shells in the sea as a money. Ownership of the shells meant money. Don’t laugh, we do exactly the same, but instead of sea-shells we use electronic records in computers. Any good history of money will give insights that are valuable into the nature of money but here is a short version: from gold to gold certificates. It is bulky to transport gold and prone to be stolen. Why not exchange the certificates of ownership of gold like the tribes exchanged certificates of ownership of seashells? Then the paper became as good as gold (bretton-woods in a sea-shell) then why not just use the paper and do away with the gold? and if the paper is good why not use binary representation of the paper in computers? That is where we are today, completely virtual instances of “fiat” government money existing only in computers and our imaginations, just like shells in the sea.

Debt is money and vice-versa
All money is a debt. When you give a good to someone and they give you a piece of paper in return, what the piece of paper says is that someone in the economy owes you an equivalent value of goods. Period. Reread this until you get it. So you have a piece of paper that can be redeemed at any time, you have a instant debt. Money is a debt on future production of the economy. US bills say that this “legal tender for all debts private and public”. It is enforced by law. All money is debt.
Vice-versa when someone emits a debt instrument, they are effectively emitting money. That money is in circulation in the economy, buys stuff. Debt is money.

Check out the whole post.

-Kevin
8.20.2010