What is Money?
I’ve often said you need to take money out of the picture to grasp certain economic concepts. It’s easy to get distracted by money. I’m going to explore how misunderstanding money can distort economic understanding and lead to some fallacious and ultimately harmful delusions. But first, what is money?
I posit that money can be looked at as a promise. Let’s say I want you to fix my car and I offer you cash in return, in this case, Federal Reserve Notes (FRN). Those actual pieces of paper are bordering on useless. The reason you might be willing to accept this exchange is because you’re expecting to be compensated with something you really want later. The notes represent a promise of delayed compensation. Let’s say you buy clothes with the cash. In effect, I traded you some clothes for fixing my car. Let’s say I sold some vegetables that I grew in my garden. I effectively traded vegetables for the promise of getting my car fixed. Money represented promises that allowed for an elaborate trade between multiple parties and got everyone what they needed.
I know a lot of people aren’t fans of FRNs and I’ll talk about that shortly, but the same applies with gold, for example. Most people have no personal use for gold but they know that someone out there does want gold to make jewelry or stereo cables or for countless other applications. It’s very possible neither you nor I personally have any use for gold, but we see it as a promise. We know we can trade it to get something we personally value later. The fact that it packs a lot of value into a small, practical size, that it endures well, and is hard to counterfeit make it good money, a tool for making that promise of compensation at a later time.
If we accept that money is basically a promise of deferred compensation, that has a lot of ramifications. How much is a promise worth? That depends on how much we feel we can trust that promise. If a total stranger promises to return something of value to you later, the value of that promise is more questionable than if a trusted friend makes the promise. On the other hand, if someone you know has broken a lot of promises in the past, their promise might be worth even less to you than a stranger’s. Picture a friend who gets what he wants by making a lot of promises that he has no intention of keeping. He can probably skate by for a while and appears to get something for nothing, but eventually the gig is up and no one trusts him. He stopped dealing in promises and started dealing in fraud. So what ramifications does that have for money?
Money is only as good as the promise it represents. One could easily argue, and many often do, that gold is a much more reliable promise than an FRN. For instance, because FRNs are easily produced in massive quantities, they are becoming less scarce and therefore are worth less over time. The longer you wait, the less compensation you will get for whatever you traded to get that promise.
Here’s another way to look at the promise of FRNs. If I know that a third party is going to intercept a portion of whatever you offer me for my goods or services, your promise is already somewhat broken, even though it’s not your fault. If 10% will be gone due to taxes before I can get my deferred compensation from a trade, then any promise made to me in the form of FRNs is 10% broken right from the start. If I want a dollar an apple and you have 10 dollars to buy apples, it makes sense for me to only offer you 9 apples because your promise has been devalued by the taxation of a third party.
This gets even more diabolical when you start trying to manipulate money, even with very good intentions. You’re manipulating promises! Let’s consider some wealth redistribution in the form of a graduated income tax. Let’s say Susan gets taxed at 10% at her income level and Tom gets taxed at 30% at his higher income level. This is intended to help Susan out which doesn’t seem like a bad goal. If Tom wants something from Susan, his money, his promise of deferred compensation to her is worth 90% of face value. If Susan wants something from Tom, her money is only worth 70% of face value to him so now he only offers her 7 apples for $10. You might see how this can trigger inflation.
If you’re the third party taxing Tom higher than Susan because she’s poorer, you might get really angry with Tom for raising his prices in response. She’s in need after all. Maybe you could force Tom to fix his prices. You could view his raising prices as a type of tax evasion, a way of dodging what is an attempt to help out the poor. That gets us to another way of looking at what money is.
When we talk about trying to get other people to do what we want, like Tom in this case, a familiar analogy is the carrot and the stick. Pretty much every form of motivation breaks down into either positive or negative reinforcement. The stick represents negative reinforcement in the form of violence or the threat thereof. The carrot represents an incentive, such as money. The price-fixing alternative, when Tom tries to adjust for the fact that Susan’s promises aren’t worth very much, is the stick. If you don’t threaten him with punishment to gain compliance, Tom is free to ask whatever he wants for his goods and services. When you break the promise of money, you’re resorting to the stick.
Here’s a simpler way to look at wealth redistribution as a means to an arguably good end. If Tom has a lot of money, what does that mean? Does it mean he has a lot of food that could feed the poor? Does it mean he has a lot of homes that could house the poor? No. It only means he is owed a lot of promises!
It’s very tempting to look at numbers in his bank account as a resource that can be tapped to solve an array of problems, but once you understand money to be a promise, it’s apparent how delusional that is. Money is an ethereal thing; not a broadly-useful resource in and off itself. To the extent that you take money from the “rich” to give to the poor, you are devaluing the gift itself in the process. You are trying to compensate the poor with broken promises. Can you take money from the rich and hire more doctors and nurses so we can provide healthcare for free to the poor? Certainly… for a while. The problem is you’re devaluing the very money you’re paying those employees with.
You can’t build a sustainable economy out of broken promises. When it comes down to it, if you want everyone to have food, regular people will have to grow it. If you want more people to have healthcare, you’ll need more people working as doctors and nurses. These new creators of palpable resources will have to be paid with something. Meanwhile, if you raise taxes or print money to do that, you’re devaluing money. It’s a vicious economically cannibalistic cycle in which the carrot of money is increasingly meaningless, everyone gets poorer, and the stick is all that remains to try to keep people producing and avoid an economic collapse.
Money is keeping promises. Keeping money good requires honoring commitments. The alternative to money is fraud or violence. So in that context, what is money?
Money is peace.