Tuesday, May 12, 2009

What is money? (Part I)

"All the perplexities, confusion and distress in America arise, not from defects in their Constitution or Confederation, not from want of honor or virtue, so much as from the downright ignorance of the nature of coin, credit and circulation." -- John Adams

What is so mysterious about money? We trade pieces of paper, transfer digital money back and forth and to the average person this system seems to work quite well. We can go into any number of stores and take out some paper which they will gladly accept in return for something useful. What was John Adams talking about? Why do we need to know what money is if we can just know that it works? In order to answer these questions we have to go back to the beginning. Way back.

Consider the case of a shipwrecked man on a desert island. While searching the wreckage for useful items, he finds a suitcase half buried in the sand. Upon opening the suitcase he discovers $1,000,000 in pristine, freshly minted Federal Reserve Notes. He's rich! Now if he could just locate that desert island supermarket, he'd be set for life... Well, he died so lets consider the case of a shipwrecked man on a different desert island. This time, when he opens the suitcase he sees 1000 oz. of neatly stacked pure gold bars. Rockefeller! ... He died too. Some years later a third man gets shipwrecked on this desert island, but when he scours the wreckage he finds a suitcase filled with tools. Hammers, chisels, saws, the works! With these tools and a little labor he was able to start production of a sturdy shelter. Soon afterward he produces buckets to catch rainwater and spears to fish with. After weeks and months of production, he was rich! He had a steady supply of fish to eat, a shelter over his head, a fire pit to keep him warm at night, clean drinking water, and even wooden planks for engraving - to express his artistic sense.

What makes us rich? Is it money? Clearly not. The third man was wealthy due to one thing only - his production. To be even clearer: the source of his wealth lay in his tools, the means of production, also known as capital. If he had no capital, he could have no production. If he had no production, he would be no different than the first two men. He would be dead. Once again, wealth is created through production, which is facilitated by capital.

While we can now see that capital is the source of our wealth and not money, we still have not begun to understand what money itself is. Seeing as how the lone man on a desert island has no use for it, we're left to ask: what is money useful for? When does it acquire value? Perhaps money is more mysterious than we originally thought. Next time we'll dive into "the nature of coin, credit, and circulation" more deeply. If for no other reason than to understand what John Adams' was getting at!

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