Money and the Economy

Now we move to the role of money in the economy. Keep in mind that the essence of an economy, from my point of view, is control. Individuals are acting to produce products (goods and services) that are consumed as inputs. Each individual controls for consuming a reference amount of these products. To the extent that individuals are doing this successfully -- consuming the goods and services that they want -- they are in control. When there is specialization, the products that individuals in the group want to consume are, to some degree, produced by others. This means that all individuals in the group depend on each other, to some extent, to be able to control their own inputs.

What each individual depends on is having others -- farmers, hunters, child rearers, cooks, etc -- who specialize in producing certain products -- grain, meat, care, food preparation, etc -- provide the products they want to consume but that they don't produce themselves. The obvious way for individuals to obtain these products is to trade their own products for those produced by others. This exchange of products (goods and services) is, of course, a market.

As I noted in my earlier post, the market for exchange of products in small groups can be very informal; like the informal exchanges that go on in a family group ("if you make dinner I'll set the table") this wouldn't even look like a market. Some people in the group just agree to specialize in producing one product (perhaps a service such as child care) while others agree to produce another (a good such as food). The child rearers take care of the kids while the hunters are out producing food, which they bring back and share with the child rearers. Despite the specialization -- which (as Adam Smith noted) improves the ability to produce goods and services but makes individuals dependent on others for producing some of the products they want to consume -- everyone is able to control their inputs successfully because there is cooperation.

True markets, where there is what I would call quantitative exchange of the goods and services produced through specialization, probably emerged as both specialization and the size of the economic group increased. I imagine that the first quantitative exchange markets involved barter, which simply means that each person would exchange some amount of the specialized things they produce for the specialized things that others produce. So the potter trades a pot for some amount of grain from the farmer and some amount of childcare from the caregiver; the farmer trades some amount of grain for the a pot and some childcare; and the caregiver trades some childcare for grain and pots. The amount each trades for each is determined by a "bid-ask" control process; the bidder has some reference amount (of his own product) that he is willing to pay and the asker has some amount (of his product) he wants to get. This interactive control process will generally converge to a point where the bidder pays about what he's willing to pay and the asker gets close to what he wanted to get. This market process, then, determines what each product (of specialization) costs in terms of all the other products. It is quantitative in the sense that the cost of each good or service exchanged in the market can be measured in terms of the number of other goods and/or services needed to obtain it.

I imagine that the market process using barter would be somewhat cumbersome, especially when the goods and services to be traded are hard to subdivide. If a camel is worth 2 years of grain, 2 years of childcare or 10 ceramic pots, how do you use it to get the 6 mos of grain, 6 mos of childcare and 2 pots that are the products you actually want to consume. The answer is "money"; a common medium of exchange that would let you "divide" the camel into smaller purchasing parts (monetary units). So if the camel is worth 1000 units, then 6 mos of grain is 250 units, 6 mos of childcare is 250 units and 2 pots are 200 units. If you can sell the camel for 1000 units you can buy what you need and have 300 units left over to get other stuff.

Money itself is just a symbol for what things are worth in terms of what other things are worth. All that the money units themselves must be are relatively small (so it's easy to carry or store many of them), durable (so that they don't rot away) and hard to counterfeit (for obvious reasons). This is why gold is a good monetary medium; it has all these properties. It also has the property of being valued in itself This probably led to the belief that money itself must have value. But this is clearly not true as the success of paper money attests. It's not really value that is needed but agreement (a reference or goal shared by all individuals) that whatever is used as money will be accepted in exchange for the goods and services produced by the group.

So, for me, money is just a convenient quantitative symbol for how much of one good or service is needed in exchange of another. The exchange rate -- how may fractions of a camel are needed to but 6 mos of grain, for example -- is determined by the market. How this market works seems to have been the main interest of economists. As a non-economist, I'm content to accept that the markets work (trough the bid-ask control process mentioned earlier). The market works in the sense that the "exchange rate" for goods and services is fairly constant over time (ignoring inflation and deflation for the moment). The market provides a fairly stable solution to the assignment of monetary value to different goods and services.

What is interesting to me about money is not so much how it gets it's "value" (how the market works) but the fact that it is a way of dealing with specialization. Money facilities control of the products people want to consume as inputs but that they themselves have not necessarily produced. So money allows me to go to the market and buy the food I have not grown, take a ride in the airplane I have not built and fix the car that I can't fix. I do this by purchasing these products with the money that I am paid for the specialized goods and/or services that I produce. Again, an economy is, I believe, all about control; but it's about that special kind of control where many of the products each individual wants to consume are produced by others. Money is just a means of facilitating people's ability to control this consumption (input).

The story would end there except that money introduced some interesting new capabilities (and problems) that have to be considered when trying to model an economy. I think the most dramatic new capability introduced by money is "time binding", to use Korzybski's felicitous phrase. In this context it may be better to call this "anticipatory control". Unlike many of the goods and services that money can buy (such as food and paper plates), money doesn't spoil (well, it can spoil people but the money itself stays the same). So it can be stored (saved). This saved money can then be used to time bind by being loaned to purchase goods and services now with the promise of payback in the future. This capability led to the development of a banking and financial sector of the economy. Banking and finance involve individuals providing products (financial goods and services) that allows them to control present inputs using outputs that will occur in the future. I'll try to deal with this in the next episode.