On money

One thing I consistently see from right wing "economists" and gold bugs is a fundamental misunderstanding of the nature of money. So let's go back to first principles, okay?

In the beginning, there was no such thing as money. You raised corn. Your neighbor raised peas. Both of you are creating actual real wealth -- you are creating corn, and your neighbor is creating peas. When harvest time came, you agreed to give him a certain amount of corn in exchange for a certain amount of peas. Thus both of you ended up with both peas and corn and had a better diet than if each of you relied solely upon your own production for all of your worldly wealth.

That's what's known as a barter economy -- where you trade some of your economic output explicitly for someone else's economic output. In a barter economy it is impossible to confuse wealth with a token of exchange, because both are the same -- the actual real wealth that adds to your life (i.e., peas you can eat). Unfortunately a barter economy suffers the same problem as Communism: The intermediaries problem. A typical personal computer has about 500 discrete components in it. Each of these components itself requires a huge number of inputs in order to create it. Figure there's about 50,000 inputs to the typical computer sold today. Arranging a system of 50,000 barters to get the components of a single computer all set up together would be practically impossible. This is the intermediaries problem, where, once an economy evolves sophisticated-enough technology, barter breaks down as a method of making sure that what you require for your production is available when you need it. In the rare instances where a barter economy has occurred in modern civilizations, such as rural America during the Great Depression or Russia in the immediate aftermath of the Soviet Union, the result has been basically the cessation of the vast majority of economic activity until the economy is moved back to being a capitalist economy: an economy based on a common token of exchange (call it "money") that can be used to intermediate this complex series of swaps needed to get the inputs for the computer you want to build.

Ah yes, money. By now you should have figured it out from what I said above, but I'll lay it out plain and clear for you:

1. Money is a TOKEN OF EXCHANGE. Its sole value is what you can buy with it. If you can't buy beans with it, it's not money.
2. Money is not wealth. What you BUY with money is wealth. Bill Gates probably has less than $200,000 in actual cash in his bank accounts at any given time. His actual billions of dollars in wealth are what he bought with the huge cash flow he got from Microsoft -- the U.S. Treasury bonds, the businesses he bought, the land he owns, and so forth.
3. When money ceases to function as a token of exchange -- if, say, paper money gets sent through a shredder or converted to mattress stuffing, or metal coins get buried in your garden -- for all practical purposes it ceases to be money as far as the economy is concerned, and instead turns into just lumps of metals with only scrap or dental filling value or fancy toilet paper.
4. Money is not a store of value. What confuses the gold bugs and conservative "economists" is the notion that money is a store of value. It's not. It's what you *buy* with money that has value. Money itself has no actual intrinsic value except as mattress stuffing, toilet paper, or dental fillings. Money's one and only function is as a token of exchange. Attempts to use money as a store of value are inherently doomed to failure, because the value of money changes as the supply of money circulating in the economy and the supply of goods and services in an economy change.

The last is the biggest most major point. Bill Gates isn't rich because he has rooms of his mansion filled with $100 bills or tons of gold bullion. Bill Gates is rich because of what he owns that was bought with those $100 bills -- the businesses and bonds, the land and the mansions, all of which can be exchanged for money and thence for different assets as Bill requires for his upkeep or investment maximization purposes. Regardless of what happens to the value of money as the supply and demand for money changes, Bill will remain rich as long as the companies he owns (or whose bonds he owns) are healthy enough that he can sell their stocks or get paid off as bonds mature if he needs some actual cash to serve as a token of exchange.

In short: As I've repeatedly pointed out, you can't eat gold. It's what you can buy with gold -- or any other money -- that is what gives it value. And right now you can't buy anything with gold, I can't go into a supermarket and exchange gold for food, gold is just another asset, no different from owning farmland or a chain of restaurants. And it's an asset that has had decidedly bad returns on average over the past thirty years...

One last thought: Money is the fundamental requirement for capitalism. You can have a free market economy without money -- indeed, the first markets were barter-based markets. But you can't have capitalism without, err, capital. And at this point I'll stop, because talking further about the nature of capitalism and how it works as a theoretical system (I say "theoretical" since, like Communism, it is impossible for it to work as an actual practical system and in fact it never has done so) is a subject for another post.

-- Badtux the Money Penguin