What is money? (Part II)

Last time we demonstrated that wealth is only created through production. That eliminated the possibility of money as wealth, but did not shed any further light on what the nature of money is. To continue our investigation we have to consider a new scenario.

The original scenario analyzed the economy of a single man isolated from others. What dynamic emerges when we introduce more people into the picture? There are two possibilites: either each man fends for himself and is responsible for producing all of his needs, from housing to food to health, or there is a division of labor. As society transitions from a single man to a village, each productive citizen specializes in a particular good or service. One man may become a fisherman, another may harvest wheat berries, still another may tailor clothes. This division of labor improves the quality and variety of goods for everyone.

Yet there still exists a logistical problem. How does the fisherman acquire his new trousers (because back then they didn't wear pants they only wore trousers)? He trades his fish directly to the tailor. This is known as barter exchange. This will solve the problem for some cases of exchange, but it soon becomes apparent that not everyone wants what the other party is offering. If the tailor has no taste for fish, then the fisherman will be pressed to find a new commodity that does suit the tailor's taste. So the fisherman finds out that the tailor wants butter, trades some of his fish with the dairy farmer for butter, returns to the tailor and exchanges his butter for the new threads. Problem solved. This process is called indirect exchange and in this case the butter is the medium of exchange.

Notice how the medium of exchange in this case was itself a useful commodity. This is an important point to remember.

An interesting question can be raised at this point. Are all mediums of exchange created equal? Is there any significant difference between the various possible mediums? In his book "What Has Government Done to Our Money?", Murray Rothbard says the answer is no. He explains that the commodities that are chosen as the medium of exchange are more marketable than other commodities. In other words, they are readily sold. He lists several categories that make one commodity more marketable than another: Divisibility, durability, and transportability.

In the example above, butter is used as a medium of exchange with excellent divisibility, poor durability, and fair transportability. A cow might be considered to have poor divisibility, but strong durability and transportability. It is clear that over time certain commodities will rise to the top, and those will be the ones with the greatest marketability. Rothbard argues that gold and other precious metals eventually become the most widely used commodity as a medium of exchange. Gold and other precious metals wind up becoming money. The truth is that all of these various commodities are money, but not all monies are created equal, because they are not all equally marketable.

To illustrate the properties of money lets examine one more scenario. Assume we live in a society where gold is the preferred medium of exchange. Lets say that a new technology emerges which confers a tremendous social benefit but must use gold. If the net effect of this new technology sufficiently damaged the marketability of gold, a different commodity would inevitably take its place. Perhaps platinum, or maybe tungsten carbide. In other words, the marketplace would choose a new medium of exchange to compete with gold. History does bear this out with the emergence of silver and copper coins.

To summarize: Money is always a commodity in itself, and the commodity that finds itself in greatest favor for use as the medium of exchange is one that is most marketable at that time. Money is not confined to one commodity, the marketplace will use whatever varieties of money necessary to expedite trade.

This is a satisfying account of the origin of money, but there are still questions. What is our money? How do we make the leap from commodity money to paper money? Lastly, we still haven't gotten any closer to understanding John Adams' statement. We will look further into these questions next time.

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!

How can we approach economics?

Economics can appear to be an esoteric area of study for those unfamiliar with it. It can even be intimidating, or boring. Yet the news is rife with reports on the state of the economy. We are told that we have a "bad" economy, or that "our economy is fundamentally sound". What do these statements really mean? How do we begin to understand such platitudes?

Henry Hazlitt outlines his approach to economics in his book, Economics in One Lesson:

"...the whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups." (17)

If we are to be "good" economists, then, we should strive to see as many consequences of actions or policies on as many groups as possible. We would be "bad" economists to the extent in which we fail to envision the consequences of our actions on all groups. This idea is elegant in its simplicity and carries a greater power to explain our world than one might initially think.

I'd like to highlight that Hazlitt characterizes economics as an art. It is a method of thinking more than an exact science. To many in modern academia this is a critical mistake, but his "one lesson" is successfully applied to many areas of life. Oftentimes when we apply this method of thinking we learn that what we intuitively assumed to be truth is revealed to be fantasy. This is where economics ceases to be boring and becomes fascinating - it provides a methodology that illuminates our minds and explains our world, solving many problems that have plagued humanity for thousands of years. Economics is another area where we generally find ourselves looking into Ozymandias' mirror.

Statement of Intent

Ozymandias is a figure in Percy Bysshe Shelley's poem, Ozymandias. He represents at once the height of human arrogance and folly, as well as the truth of his inevitable demise. When Ozymandias' gazed into his mirror he did not merely see his physical image; he saw "the King of Kings". His mirror could never fail to show him the truth, yet he could never see it. How is this possible?

We are a dual creature, both instinctual and intellectual. When instincts inform our opinion we will only see what we want to see. The intellect is a curious journeyman, a relentless effort to peek beyond the boundaries of its current understanding. The metaphor of Ozymandias' mirror is that our assumptions about the world diminish our capacity to see it.

The intent of this blog is to explore the theme of Ozymandias' mirror, that the world is a marvelous and magnificent place but we are constantly limited by our assumptions of it. There are no specific topics that I wish to focus on, but exploring and applying economic theory in history and current events, philosophy, and sharing new and interesting art or music is a good start. I encourage anyone to comment and ask questions. That being said, anything goes really and I hope you enjoy the content.


-Rafi