A Brief Story of Money, Part 1
This is a subject of macroeconomics, the study of economies in the large, of unemployment, recessions, economic growth, inflation, and other features that transcend individual consumers, households, firms, and industries. Economics can be an intensely boring and difficult subject to study. Thank God, readers here at The Dark Wraith Forums have the benefit of one of the finest teacher of economics to ever have walked this sad and troubled Earth. Those who don't believe that should first take a course in principles of economics from the typical modern professor of the discipline, where they'll be treated to darkened rooms punctuated by PowerPoint presentations and graphs and charts and all manner of droning incontinence that is more than enough to bring the Bluebird of Happiness to despair and ultimate suicide.
Rejoice, then, as we travel the economics highway across the vast tundra that is the subject of money. In this first installment, the problem of defining money will be handled. That is crucially important, not only to later installments, but to the overall understanding of how economic agents function in a world where, on a daily basis, hundreds if not thousands of transactions can occur just at the personal and household levels. At the national and global levels, money in many and varied formssome of it not even apparent as money in any common sense wayis flowing in sums and intricate networks that only massive computing power can grasp in scope and depth.
The readers of The Dark Wraith Forums are, of course, not average by any means; and that's why this series is tailor made to the audience here. Readers will laugh, readers will cry; and ultimately, they'll come away from this series with only one question: "I spent a grand on a computer so I could read drivel like this?!"
And with that, we now begin... with a little play. Set in paleolithic times, this is the story of a paleolithic man by the name of Mr. Shakes, a previous incarnation of the man by the same name whose home is the now at the blog Shakespeare's Sister. Mr. Shakes has traveled a good distance to do business with another paleolithic man, Mr. Goat, in his modern incarnation an earstwhile commentator at, among other places, The Dark Wraith Forums. Other characters from the modern era will be incorporated by reference or in cameo appearances, and all actors are herewith acknowledged for their roles in this production.
[Fade in scene: Bright morning sun rising over rocky, steep hillsides. Caves visible along face of hill.]
[Sound of man walking, breath labored.]
[Pan camera onto caveman, carrying big animal skins, walking toward caves.]
Mr. Shakes [hollering, thick Scottish accent]: HELLOOOO! ANYBODY HOOOME? MR. GOOO-AHT! WAKE UP! IT'S MR. SHAKES!
Mr. Goat [emerging from ground-level cave]: Mr. Shakes? Good Lord, man, it's not even six o'clock in the morning. What're you doing out this way?
Mr. Shakes: I got sooome tradin' t'do wit' ya.
Mr. Goat: 'Trading'?! You mean you've actually got something worth trading?
Mr. Shakes [hoisting animal skins above his head]: That I have.
Mr. Goat: Holy Moses! You actually went out and hunted down beasts and got their hides?
Mr. Shakes: Not exactly. You know our old friend, Paul the Spud? Great hunter. Brilliant guy: he could conjugate verbs like a Proto-Indo-European.
Mr. Goat: Yeah, as a matter of fact, I'm expecting him any time now. Last time I saw him was two days ago; we were both getting a cup of morning coffee at Pam's House Blend. He even paid for mine. He said he'd be coming over to my cave to do some business.
Mr. Shakes [breathless, clamboring around boulders to Mr. Goat's cave]: Well, Paul's dead. I found parts of him out on the plains. Looks like he got nailed by a sabre-tooth tiger.
Mr. Goat: YEESH!... Oh, I get it. Those were the hides he harvested.
Mr. Shakes [dropping them at Mr. Goat's feet]: That they were. Scattered around in a field. I scraped Paul's viscera off the ones he apparently used to wrap himself up in. Seems he was tryin' t' look like some kind of fierce animal to the sabre-tooth.
Mr. Goat [kneeling down to inspect the hides]: Hmm. Doesn't look like the strategy worked very well, does it?
Mr. Shakes: Well, it would have worked a whole lot better if he hadn't been so panicked. It looks like he wrapped himself in the zebra skins.
Mr. Goat [shaking his head]: Talk about a bad move. Paul might as well have put a neon sign on his head: EAT HERE!
Mr. Shakes [laughing nervously]: I'll tell ya, this Paleolithic era just sucks sometimes. I really liked Paul.
Mr. Goat [standing back up]: So did the cat, it would seem.
Mr. Goat: So you're now the proud owner of five hides, and you want to do business?
Mr. Shakes: That's why I'm here. You're the entrepreneur. You do business with anyone, even the paleo-conservatives.
Mr. Goat: Well, yes, I'll even do business with paleo-cons; but so help me God, I'll go out of business before I'll do a trade with a neo-con.
Mr. Shakes [nodding]: A man with ethics, that's what you are, my friend.
Mr. Goat: You know the standard for hides, don't you?
Mr. Shakes: 'Standard'? There's an exchange standard?
Mr. Goat: Oh, yes. The standard has been around for ages. It was established by the guy who wrote T. Rex's Guide to Life: Kenneth was his name, I think.
Mr. Shakes: The standard has been around since the T. Rex?!
Mr. Shakes: That's the legend, anyway; but it really doesn't matter since everyone accepts it. That's what matters: we all agree on the standard. There's even a list of exchange values put together by a lady named Ms. Julien: everyone called it Julien's List.
Mr. Shakes: Well, if it's a standard, then I suppose I'll have to accept it. I was really hopin' t' get somethin' t' eat for th' family: me and th' wife an' our two little ones.
Mr. Goat: That shouldn't be a problem. I just secured a medium-sized animal that's more than enough to feed a family of four.
Mr. Shakes: Perfect! I'll take it... Uh... What particular species of 'medium-sized animal' are we talkin' about here, by th' way?
Mr. Goat [walking back into the cave]: Dog.
Mr. Shakes [cocking his head to the side]: You mean, like a family pet or somethin'?
Mr. Goat: Actually, I think it was a family pet. It talks.
Mr. Shakes [looking puzzled]: Ya mean I'm gettin' a talkin' dog, an' I'm supposed t' feed it to me wife an' kids?!
Mr. Goat [bawling out, whistling]: FIDO! C'mon boy! I found a new owner for you! [turning back around, talking in whisper] You don't tell your family what they're eating, fer cryin' out loud! And you most definitely don't tell the dog what your plans are for him. He's pretty darned smart.
Mr. Shakes: AH! Yes, I understand.
Mr. Goat [emerging from cave, scruffy brown dog following]: Fido? Meet your new master. He's got kids and a nice cave where you'll be a happy pet. These people will just love you.
Dog [jumping up and down]: Oh boy, oh boy! A family! Let's go, let's go!
Mr. Shakes [looking at dog admiringly, laughing]: Not so fast, there, Fido. I still have t' finish me business with Mr. Goat, here. [hands over the animal skins]
Dog [eyes bugging]: You're giving up five gorgeous animal skins for moi?
Mr. Shakes: That's th' deal.
Dog: You should keep those. You could make a new wrap-around for your loins. That one you're wearing looks pretty tattered.
Mr. Goat: He's got a point, there, Mr. Shakes. That wrap-around is in pretty bad shape.
Mr. Shakes [looking irritated]: It's not a 'wrap-around'; it's called a KILT!
Dog: A 'kilt'? Why do you call it that?
Mr. Shakes: Because some animal had t' be kilt so I could have it. [bursts into roaring guffaws]
Dog: Oh, now I get it! [joins Mr. Shakes in loud laughter]
Mr. Goat [rolling his eyes, muttering]: Great. A Scotsman and now a dog who thinks he's funny.
Mr. Shakes: I think that concludes our business, Mr. Goat. Now, you'll forgive me if I take this fine food... er, dog and head back down th' trail. It's a long journey, an' I want to be home in time to prepare supper... if y'know what I mean.
Mr. Goat: Yes, of course. It's been a pleasure doing business with you; and come back again when you've scavanged some more hides from the dearly departed.
Mr. Shakes [turning, climbing back across the boulders, dog following]: That I'll do, Mr. Goat. C'mon, Fido.
[fade scene; open again with Mr. Shakes and dog on trail]
Fido [panting]: Boy, this is a long walk, but it'll be nice to have a home.
Mr. Shakes: You didn't like living with Mr. Goat?
Fido: It wasn't so bad, except for that head-splitting high-C note.
Mr. Shakes: What do ya mean by that?
Fido: Oh, in the cave next door to his, the Fat Lady Sings every morning at the crack of dawn.
Mr. Shakes: Wow. It makes me glad I have such quiet neighbors. On the one side of me is the Old White Lady, and on the other side is Trailer Trash.
Fido: 'Trailer Trash'?! You mean you live in a mobile home park?
Mr. Shakes: Not exactly. It's just that our cave complex sits right on a fault line, so the whole hill moves around quite a bit every now and then.
Fido: Must be hard keeping good dishes.
Mr. Shakes: It would be if we were using something other than stone bowls. I guess this Paleolithic era does have its advantages, although it still takes up so much of the day just findin' th' food, killin' th' food, dressin' th' food, and then preparin' it for dinner. Economies of specialization will be great in food production once we get into the Neolithic era and later.
Fido: What kind of food do you normally eat?
Mr. Shakes: Most days it's pretty thin fare, but tonight we're eatin' well, I'll tell ya that much. An' that reminds me: we need to pick up our pace; we need t' get back while there's still some light so I can get dinner on the fire.
Fido: I'm with you on that. I'm starving. What're we having?
Mr. Shakes: Er, something special.
Fido: A formal dinner! Should I wear anything, you know, like, formal or something?
Mr. Shakes: Don't worry about that. I'll dress you for dinnner.
Fido [pausing, then laughing]: Ha-ha. That's a funny little play on words, there: 'dress you for dinner'! Sort of like I could take that two ways: you could mean you're giving me some nice clothes to wear, or you could mean that you're going to butcher me and put my dog meat on the fire for everyone else to eat. Ha-ha.
Mr. Shakes [absently as he picks up his pace]: Yes, I could.
Fido [furrowing his brow slightly]: Yes, indeed... You know, I was just thinking about what kind of great guy would trade five hides for a lousy, mangy dog that's going to be nothing more than a family pet. Such a noble act.
Mr. Shakes [still not paying attention]: Yep, Fido, it certainly is.
Fido: And that reminds me, what exactly does the name 'Fido' mean in caveman languages?
Mr. Shakes [breathless, walking a brisk pace]: Protein.
Fido [voice trailing off into the distance]: YIKE! YIKE! YIKE! YIKE! YIKE! YIKE! YIKE! YIKE!
Mr. Shakes [stopping, watching dog run away]: Damn! Me an' me big mouth. There goes dinner. Now I'm going t' have t' collect some mastadon poop chunks an' tell th' family it's giant potatoes again. Sooner or later, they're goin' t' figure that one out. I'll be so glad when they put up a convenience store out here... I'll be able to get a dog already hot and ready to eat... no more dogs freakin' out and runnin' off. [sighs] I miss me dog already.
[fade to black]
in association with
Pulp Economics Productions
[credit role in order of appearance]
· · My Pet Goat as Mr. Goat · ·
· · Paul the Spud of Adventures of the Smart Patrol · ·
· · Pam Spaulding of Pam's House Blend · ·
· · Kenneth Quinnel of T. Rex's Guide to Life · ·
· · Ms. Julien of Julien's List · ·
· · Fido · ·
· · Fat Lady Sings of The Fat Lady Sings · ·
· · Old White Lady and Trailer Trash of It's morning somewhere · ·
And so ends our little play, which in its sweeping, nearly epic scope was richly infused of information about the subject of this series of articles.
Money serves three principal purposes. First, it is a store of value. In this function, money holds the worth of goods and services exchanged for it so the value can be transported and used at a later time. In the play, Mr. Shakes carried hides that were worth something not just to him, but also to someone else. He didn't have to use their worth at the moment he secured them. Similarly, Mr. Goat had a dog, which represented the value he received in a previous transaction. Both the hides and the dog held value for later use and at a location perhaps other than where they had been acquired in trade or other transaction.
Second, money is a medium of exchange. Mr. Goat and Mr. Shakes agreed that each had something of value and these items of value could be traded for one another. Just because something has value, however, does not necessarily mean it is particularly useful as a medium of exchange. It would be difficult, for example, although not impossible for Mr. Shakes to have brought his kids to trade rather than the hides. Although usesful, perhaps even valuable to Mr. Goat, he might have been quite unwilling to accept the kids as something for which he would provide merchandise in trade. The kids could be fussy, difficult to sell, and rather gristly to eat.
Third, money serves as a unit of account. Mr. Goat informed Mr. Shakes that hides were a basis for determining the worth of other objects in trade. In the transaction that occurred, five hides was equivalent in value to one dog. No doubt, Mr. Goat's bookkeeper maintained a running account of inventory in terms of hide equivalents.
This use of hides, by the way, was not restricted only to Mr. Goat. Historians Frances and Joseph Gies, in their popular account, Life in a Medieval Village, note that valuation censuses taken in the Middle Ages listed land holdings in terms of hides, too. One hide was equivalent to about 120 hectares of land, although the exchange rate varied from place to place in Medieval England. Interestingly, although land would never have been bought using hides, the hide served quite well as a unit to account in a generally accepted way from one person to the next and from one manor to the next for land throughout Great Britain of the time.
Going back for a minute to the rather grim prospect of Mr. Shakes selling his kids, this brings up an important aspect of money that explains why there can be different kinds of money operating within an economy. Many items meet one or more of the three criteria set forth above; but some kinds of money are much more easily converted into something else. In the play, those hides were quickly turned into a dog. Mr. Shakes' kids, on the other hand, would not have been so readily convertible. Mr. Goat might not have accepted them at all, and Mr. Shakes would then have found himself knocking on every door at the whole cave complex until he found someone who would agree to exchange them for something that could then be sold to Mr. Goat. Even if Mr. Goat had accepted them, he might not have surrendered the dog until he was sure he could do something with the little urchins: he might have told Mr. Shakes to leave the kids and come back the next day for the dog.
The ease and efficiency with which money can be converted into something else of value is called its liquidity. In reference to money used in the United States, a dollar bill is "highly liquid." In the world of big finance, a government Treasury billa federal debt obligation that is of no more than a year in durationis highly liquid. In fact, for banks doing trades with the Federal Reserve, those so-called "T-bills" are almost perfectly interchangeable with dollars. In economics, we would say that the greenbacks and the T-bills are very close substitutes.
Now, think about this. A government T-bill is an obligationan IOUissued by the United States Treasury. The terms are essentially such: an investor lends the U.S. government some money, and a year later the government compensates the lender the face value of the security (the T-bill) that represents the obligation. That face value is a thousand bucks. So, if the going price for these newly issued T-bills is, let's say, $965.00 ("96.5" in the notation of bond prices) the investor is going to earn $35.00 ($1,000.00 $965.00) on a loan to the government of $965.00. That means the investor will have earned an annual interest rate of $35.00 ÷ $965.00, which equals about .0363, or 3.63%.
Consider, on the other hand, an investor making a loan to, say, Guy Andrew Hall of Rook's Rant. Mr. Hall is certainly a credit-worthy individual, so the IOU agreement he writes out on a paper napkin is surely just fine. He, like the United States Treasury, promises to surrender a thousand dollars in one year in exchange for some money right now. One major problem among many with this promise is that an investor cannot simply unload that paper napkin onto somebody else before the year is up. With a T-bill, the instrument can be "liquidated" at any time at any bank; but it's going to be really hard to find anyone who would buy that paper napkin from an investor. That means the amount of money lent to Mr. Hall is going to be considerably less than the amount of money lent to the federal government even if Mr. Hall's credit rating and general trustworthiness are as good as gold. In Mr. Hall's case, an investor might lend him, say, $900. That means, when Mr. Hall pays off the loan in one year, the investor will have earned $100 ($1,000.00 $900.00) on a loan of $900. That means the investor will have earned an annual interest rate of $100.00 ÷ $900.00, which equals about .1111, or 11.11%.
Notice as a side point, one that will be brought up again in later installments of this series, that the price of a security moves in the opposite direction to its yield: the price of the T-bill was $965.00, and its yield was 3.63%; but the price of Mr. Hall's IOU was $900.00, and its yield was a whopping 11.11%. This is a fundamental rule of all securities: the higher the price, the lower the expected yield; and the lower the price, the higher the expected yield.
Back to the main point, now, Mr. Hall had to pay far more than the government did, and it wasn't really because there was much more risk of default by Mr. Hall, and it wasn't because the investor had to surrender the use of his money any longer for Mr. Hall. The difference in those two yields, about 7.48% (11.11% 3.63%) was due to a liquidity premium being tacked onto Mr. Hall's borrowing. That paper napkin couldn't be unloaded by the investor without considerable difficulty, whereas the government T-bill could be sold in a second. That's where liquidity comes knocking as an important determinant of what constitutes different "layers" of money in an economy.
In the United States, money is broken down into categories based upon its liquidity. For example, the most liquid forms of money are put in a category called M1. This includes cash and currency in the hands of the public, demand deposits (checking accounts at banks), and traveler's checks. These types of money are either exactly or close to being bearer instruments: essentially, whoever holds ("bears") the paperbe it a ten dollar bill, a bank check, or a traveler's checkhas the relatively undisputed claim to the value represented by the instrument.
The next layer of money is designated M2. This includes all the money counted in M1, as well as somewhat less liquid instruments like savings deposits, shares in money market funds, and small-denomination, time-sensitive savings like certificates of deposit (CDs).
Encompassing both M1 and M2, along with even more illiquid forms of money, is the great big L category, which adds all kinds of financial instruments that can't be liquidated instantly or even in short order without a lot of pain. The nearly constant stream of innovations, twists, variations, and tricks makes the definition of L subject to frequent updates. Even M1 and M2 are not really all that fixed: all the time, financial instruments are popping up that have the characteristics of highly liquid money.
Important to note is that M1, M2, and L consider only financial instruments; but we have seen already that money doesn't have to be paper, it doesn't have to be associated with banks, and it doesn't even have to be sanctioned by some government or other official institution. Money has another dimension, another way by which it can be broken down into categories that are only to a certain extent related to its liquidity. This alternate classification system has more to do with the nature of the money and the focus it has on the three purposes, which were described as store of value, medium of exchange, and unit of account.
This different classification system begins with the most "primitive" (for lack of a better word) type: commodity (or barter) money. This is money that has intrinsic value in and of itself as a usable, consumable item. Fido was commodity money: not only could he be used in a transaction, he could also be eaten. A dollar bill cannot be eaten. Barter moneys have existed since time immemorable, and standardized barter moneys have been around just as long. Many are the stories, for example, of cigarettes serving as barter money in prison camps. All manner of domesticated animals serve as barter money in agrarian economies.
Beyond and after commodity money is metal money. Some metals have been widely popular across cultures, times, and continents. Gold and silver are examples. The metal, itself, could theoretically be consumable in production of everything from weapons to household tools, so metal money is in some ways a "less liquid" form of barter money, if liquidity were to be considered in terms of the ease and efficiency with which the money could be converted into a usable or consumable item. Metal moneys can be found in ancient civilizations, and they endure to this day as commemoratives in many so-called "advanced" economies. It was only in 1964 that the United States government stopped using the prized metal silver in coins of denominations greater than that of the nickel. Even the paper one dollar bill, as seen in the graphic at left, was metal money: note the label "Silver Certificate" at the top of the face of the instrument. That wasn't some esoteric promise by the United States government; that one dollar bill could be exchange at any time, on the spot, virtually instantly for four silver quarters or ten silver dimes!
The final version of money under this categorization method is fiat money. This is money that is money by decree of some authority. A purely fiat money cannot be used for anything other than its intended purpose as a store of value, a medium of exchange, and a unit of account. It cannot be eaten, it cannot be readily melted down into an ingot of great value, and its legitimacy rests solely on the power, reputability, and indisputabilty of its issuer. At left is a graphic representation of a modern one dollar bill. At the top it does not represent to be a "Silver Certificate" since the government will not guarantee its convertibility into any set amount of a metal. In fact, although the instrument is backed by the "full faith and credit" of the United States government, the issuer is the Federal Reserve Bank, acting as the agent of the United States Treasury. In other words, that dollar depicted over on the left is a "Federal Reserve Note": an IOU issued by the Federal Reserve Bank.
Readers might be asking, "Okay, but 'I Owe You' WHAT? What exactly is owed for the promissory note evidenced by that dollar bill we use these days?" It's a "note"; that means it's like a loan of some kind. The U.S. government doesn't say it will honor it with an exchange for silver, even though a bearer could use some of those dollars to buy metal in the private markets.
Does this mean that greenbacks since the mid-1960s have been funny-money? Not really. Fiat money serves its three purposes as a store of value, a medium of exchange, and a unit of account to the extent that its users accept its legitimacy in trade. Provided the government that decrees the paper to be money holds its legitimacy, or to the extent that it can otherwise impose its will upon the prospective users of its fiat money, the paper stands as good and worthy money. To the extent that the fiat money is the denominating currency for a sound economy, it will represent in international trade the worth of that economy. The stronger the economy, the more widely respected the currency.
As a promissory note, a United States dollar can be invested in the United States economy. If yields on such investments are robust, that dollar will be highly prized around the world, and manufacturers in others countries will shovel their products into America at low prices just to get their hands on some of those greenbacks, which they can then invest here to get those great interest rates. That, of course, is certainly not all to the good, since foreign manufacturers selling their products at low prices here means that domestic companies get their backsides kicked in international economic competition. That means a balance must be found between interest rates that are low enough to help domestic consumers and businesses borrow money and compete internationally, but not so low that they make the U.S. dollar a laughing stock in terms of its value in international trade. How that balance is achieved, and the forces that frustrate a reasonable point of balance, are the subjects of subsequent installments in this series.
In future installments, the so-called "money multiplier" and the "equation of exchange" will be set forth. These are relatively simple mathematical formulae that can be used to explain interest rates, inflation, and their relationship to short-term and long-term economic growth in an economy. The series will end with a description of how the Federal Reserve uses money to manage the economy. Readers who have made it to the end of this first installment should look forward with much anticipation and no small amount of joy to the not-insignificant intellectual and emotional rewards to come in this Pulp Economics series for the new American century.
The Dark Wraith thus and amply delivers.