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Monday, October 14, 2013

What is money? Talismans of value and the market in favors (Rethinking liberal theory part 13)

by John MacBeath Watkins

I have stated that I believe property is not objects, but the system of rights, obligations, and meanings we apply to objects and ideas. But what is money?

This is a troubling matter for many people, and for the current crop of conservatives, it is a question they wish to forget. After all, if money were gold, it would be an object, and not so complicated. It would be harder for people to fool with it and somehow more concrete and easier to understand. This is a peculiar view, because gold is not valuable in and of itself, it is only valuable in that people value it. It is a symbol of wealth, but then, so is a stack of greenbacks.

And we left the gold standard for good reason. It resulted in a system that undermined economic performance during the Great Depression. Getting rid of the central bank and going back on the gold standard has been tried with disastrous results.

And money is really not a simple matter. Economists have several measures of how much money is out there, based on several definitions of what money is. The process by which money is created is not intuitive, if you are a believer in hard and unchanging values. Here's a graphic from Wikipedia on how money is created:

The notion that money can be created by issuing loans and destroyed by paying them back seems wrong to people who don't understand what money is.

Money represents a favor owed. We might call this the The Marquis de Carabas standard, after a character in the Neil Gaiman novel, Neverwhere. When the Lady Door needs his help, the Marquis asked what his payment will be. Door answers, I will owe you a very big favor, and the Marquis is satisfied with that.

Because in fact, all trade is a trade in favors. If I buy you dinner, you will owe me dinner, or else some other exchange of favors is at work (perhaps you are my favorite nephew or niece, and I enjoy the favor of your company.) But perhaps I can say, no, buy my friend a meal, I owe him one.

Money makes favors fungible. I am a bookseller, and I can do someone the favor of giving them the book they want, and instead of doing me a favor in return, they can give me a talisman that represents a favor, a symbol such as a $20 bill or even a favor represented, as someone writing on the Ron Paul blog once put it, nothing but "blimps on a computer screen."  (That typo has since been corrected, but I find the imagery so appealing I wish it hadn't been.)

I can use these talismans representing favors to repay my landlord for allowing me to operate a bookstore in his space. The talisman is a symbol of the underlying meaning, and the meaning is that someone is owed a favor. That is the value money represents.

This market in favors can be tricky. It represents the values of all those who participate in it, the value of a back rub from a skilled masseuse, a meal prepared by a cook or chef, which may very in the quality of materials, the skill of preparation, and the surroundings in which it is consumed, or the company of a courtesan.

Prior to the marginal revolution, we could not even articulate why diamonds are worth more by weight than water.

A system that allows us to trade favors with strangers has many pitfalls. Some are obvious, such as efforts to obtain favors, not by doing favors, but by force or subterfuge, such as robbery or fraud. Some are less obvious, such as the paradox of thrift: If everyone in a society tries to pay back their debts at once, it will impoverish society and leave everyone poorer, because just as money is created when debt is issued, it is destroyed when it is repaid without being loaned again.

Another problem is the debasement of currency, which can happen when a nation's central bank doesn't function properly. In 1493, a book by Charles Mann about the Columbian exchange, Mann describes such a situation in China.

Paper money was invented in China, first with merchants issuing what amounted to letters of credit (an instrument still widely used in the shipping industry.) Then, the Chinese government discovered that it could issue paper money, and it needed to, because China's silver mines, which had supplied the material for its more valuable coins, were getting paid out.

But China did not invent central banking. Repeatedly, Chinese governments issued too much paper money, causing inflation, effectively meaning its citizens were owed fewer favors than before.

So, they went back to using silver. But as you carry silver around and exchange it, there is wastage, silver wearing off the little bars you carry in your purse. China was faced with a shrinking money supply -- not enough talismans to represent all the favors owed -- which was a drag on the economy. Essentially, there were not enough talismans around to represent a growing number of favors, so each talisman had to represent more favors.

One way of thinking about the resulting deflation is that when we do a favor, we expect its value to decline over time with human forgetfulness. If I fed you yesterday, I'm more likely to get a reciprocal meal today than if I fed you 20 years ago. Deflation privileges older favors over doing favors now, which is to say, it privileges existing wealth over the creation of wealth, and savings over labor. Inflation fits with the attitude, what have you done for me lately?

We seem to have accepted that the gradual erosion of the value of favors over time, in that most central banks now target inflation at 2 percent or less. I'm unclear on why this number was chosen, since it puts interest rates perilously close to the zero bound, and limits what the central banks can do to respond to a crisis such as we saw in 2008. Probably economists must do more work on how quickly past favors lose their value.

The solution to the shrinkage of China's money supply came when the Spaniards arrived in the Philippines with silver from Central American mines. The Chinese actually began purchasing silver to use as money from the Spaniards with products of their industries and agriculture, and in fact, it was about the only thing the Europeans had that the Chinese wanted until the British introduced opium. In 1743, George Anson captured just one of the treasure galleons that engaged in this trade, and it was a prize greater in value than any other taken while the prize laws applied to naval warfare.

It was a British subject, a Scot named John Law, who first argued that paper money was preferable to metallic money, which should be banned.  Unfortunately, he had to flee the British Isles after winning a duel. From Wikipedia:
The wars waged by Louis XIV left the country completely wasted, both economically and financially. The resultant shortage of precious metals led to a shortage of coins in circulation, which in turn limited the production of new coins. It was in this context that the regent, Philippe d'Orléans, appointed John Law as Controller General of Finances.
France really did suffer from a shortage of money, but while working to solve this problem Law created another, the Mississippi  Bubble, which resulted in his dismissal from his post. He used his brilliant mind and capacity for quick calculation to support himself by gambling for the rest of his life.

The Grey Lady of Threadneedle Street, (AKA the Bank of England) completed the work of inventing the role of the central bank, mitigating the paradox of thrift by acting as a lender of last resort when the financial community panicked, and in general provided a steadying hand on the banking industry which helped England to industrialize.

Much of macroeconomics is concerned with stabilizing the market in talismans representing favors in such a way that people will continue to do each other favors. After all, I would be delighted to give people books without asking for anything in return, but I do ask the grocery store to provide me with food, and if I have no favors to trade to them, why would they, when they don't know me from Adam's off ox?

Marx thought people should do each other favors without the intermediation of money, but no one has managed to make this work on a large scale. Trying to make an economy work without money or property is a bit like banning language becomes you don't like people shouting. Any powerful system of human organization can be abused, but to ban a useful and ancient institution because it is sometimes abused seems an odd response. Any powerful social institution can be used for good or ill, including property, religion, money, and government.

The key is to structure society in such a way that these institutions do far more good than harm.

Links for this series:

Rethinking liberal theory 1: Thomas Hobbes, blasphemer and patriot
Rethinking liberal theory 2: The outlaw John Locke, terrorist, liberal, and advocate of freedom
Rethinking liberal theory 3: A compact to protect property, or a conspiracy to create meaning?
Rethinking Liberal Theory 4: John Milton and the many shapes of truth
Rethinking Liberal Theory 5: Adam Smith, moral philosopher of the marketplace
Rethinking Liberal Theory 6: Mythmaking and manufacturing
Rethinking liberal theory 7: Hegel, the end of history, and the triumph of the liberal idea
Rethinking liberal theory 8: Liberalism and individualism: The invention of the Util and the way west
Rethinking liberal theory 9 Property and freedom: Why language is the basis for the social contract 
Rethinking Liberal theory 10: Physiocrats & mercantilists: The economic philosophies of the founding fathers
Rethinking Liberal Theory 11:Stateless income, global capital, and the death of empires
Rethinking Liberal Theory 12:Capitalism:So much more than market
Rethinking liberalism 13: What is money? 
Rethinking Liberalism 14: Tribalism and the emerging new world order
Rethinking liberalism 15: The poverty of neoconservative philosophy
Rethinking Liberalism 16: More on the poverty of neoconservative philosophy


  1. People get a quality life only if they have enough money. Everything circulates around money only. Banks and other financial institution bring you many schemes which help you make plenty of money. Thank you for sharing the article about "what is money".

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