What is Money?

The love of money is the root of all evil. 
1 Timothy 6:10 (King James Version)

He had heard people speak contemptuously of money: he wondered if they had ever tried to do without it.
W. Somerset Maugham
Of Human Bondage.

Very few people understand the digital and radio technology that makes cell phones possible, and yet practically all of us use it. Very few people understand what is money, and yet all of us earn and spend it on a daily basis.

Why was money invented? Why did it have to come about? If we can answer this question, we can begin to understand what is money. Let’s go back to pre-historic times when there was no money.

Peter was a caveman. He was good at making stone tools. In his cave he had stashed several arrowheads which he had carved from pieces of stone. David, Peter’s next cave neighbor, was good at picking fruits and drying them. In David’s cave, one could find baskets of dried fruits. David had to protect his dried fruits from nasty robbers, and for that purpose he needed a weapon like a bow and some arrows. Peter, on the other hand, needed dried fruits to feed his family. David and Peter then did what is now called “direct exchange” or, in simple terms, barter: some quantity of David’s fruits for one of Peter’s arrowheads. In this case, money was not necessary, and direct exchange in fact means “no money”.

Now Mary came along. She was good at making baskets. She offered the baskets to David, but she didn’t need fruits. David did need the baskets. Would Mary have any use for arrowheads? If she did, direct exchange would still be possible: David could give Peter some more of his fruits for one of Peter’s arrowheads, which Mary could then accept in exchange for a basket. What if Mary had no need for arrowheads? Then no direct exchange could have been possible among the three, and this was the situation that necessitated the use of money. Money in this case was what Peter, David, and Mary recognized as valuable, convenient, and could be exchanged for any of the other valuables: fruits, arrowheads, and baskets. And so it happened that David told Mary: “I have these beautiful shells which I have collected, would you accept two of these for one of your baskets? You can take these shells and exchange them for anything else you might need.” And that’s how money came about.

Money allows for specialization of labor. I do not have to plant my own rice or corn if I can exchange money for rice or corn. I can specialize in making baskets because I can exchange the baskets for money, and that money can be exchanged for anything else. Money also allows me to be free to decide how much to produce and how much to receive. If I were a slave and am told to produce a certain number of baskets, I would do so only because I have no choice. Being a freeman in a society that allows the use of money, I can choose both what to produce and how much of it to produce. Money allows for an alternative societal organization that does not require the use of force to make people act.

As more people used money, as technology advanced, and as human organizations became more complex, the thing used to represent money became more sophisticated. Metals like copper and silver were used, and also gold. The need for money preceded the need for government, but eventually government took over the administration of money.

Soon it became necessary to store gold in banks. It used to be that all the banks did was store money in the form of gold. But paper and ink allowed the banks to more than just store gold: each owner of gold stored in the bank was given a certificate of gold ownership. This certificate eventually became the medium of exchange (in addition to its other functions, like in the transfer of value from one generation to another). It was more convenient to hand a piece of paper to the seller of that horse than take a certain amount of gold from the bank. The horse seller, in turn, used the certificate for other transactions, with the tacit understanding that the certificate was worth a certain quantity of gold stored in the bank. Banks soon discovered that they too can just issue certificates to lend to borrowers or pay their dues. It did not matter which bank people used because all of the banks recognized each other’s certificate. Paper money thus came into being. The story differs from one country to another, but in general it can be said that when paper money came along, most governments were not involved.

As with anything new and untamed, paper money was abused by some banks. Some banks overprinted and lent paper money, many more times worth than gold that was stored in their vaults. This went unnoticed as long as only a few people claimed gold in exchange for the paper they were holding, but if enough people claimed gold for paper money, a bank inevitably collapsed. The collapse of one bank can have a domino effect and collapse other banks as well. Whenever this happened, it was a major disaster and people suffered.

The government had to step in and reign in the banks. Laws were promulgated to limit the ability of banks to print money. This did not fix the problem of inflation and runs on banks, however. And soon, for lack of a better alternative, lawmakers thought it was best for the government to take over all matters pertaining to money. Now practically all nations have central banks charged with regulating all other banks, and the value of paper money has been completely dissociated from gold. Central banks can print paper money (“fiat money” because it is all based on our “trust” of the government) as much as they see fit. The only constraint in most countries is that they do it to improve employment levels and to refrain from doing it when there is too much inflation.

Free market advocates like me believe that there is too much power concentrated in governments for managing the value of money. Whether inflating or deflating, sudden changes in the value of money reduces its effectiveness as a feedback signal that determines how much of any commodity is produced. Moreover and more importantly, inflation of the value of money serves as a vicious hidden tax on the people. When inflation occurs, it is very easy for politicians to blame businesses for the increase in prices, when in fact it is totally the government to blame for mismanaging the value of money. We all suffer when fiat money loses a lot of value, and most of us blame the wrong people for it.

Is it possible to remove money from the clutches of government? Do we really need government to assure us that one peso or one dollar is worth something? We will soon find out because there are now several attempts afoot to use computers and theInternet to introduce a new form of money. One is called BitCoin, a completely digital money system devoid of any government guarantee.

I see several problems. One problem is the classic chicken-egg dilemma: I could only use Bitcoin if stores accepted it, and stores would accept it only if there were a lot of people using it. The stores would only equip themselves with the necessary hardware and software to be able to accept Bitcoins if there were customers wanting to use it, on one hand. On the other hand, customers would use it only if the stores were so equipped.

It is not enough that I trust that nobody can tamper with my money stored as Bitcoins.

I think what is needed is for some established business, ideally a very big and reputable company, to back Bitcoins. Such company will only do it if it gains something out of doing so. And even if such company decides to go for it, there is no guarantee that the government will not intervene. And so then we’re back to where we did not want to go.

I believe we are still far from a viable solution to the money problem.

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About ctapang

I am a Software Design Engineer. I have just abandoned the huge army organized to make .Net programming the one dominant programming system. I now program in Typescript which (surprise) is also from Microsoft. Aside from my day job as a programmer, I am also involved in a movement (http://correctphilippines.org) to correct the Philippine constitution. It's an ambitious undertaking in itself, and there's no guarantee that improving our constitution will improve things. However, one thing is certain: if we don't establish a rational constitution, we will continue on our path of self-destruction. What kind of government is best? For me the best government is that which governs the least. We need the government not because it can provide for us but because it keeps us from running into each other. The proper function of government is that of a traffic light: it prevents us from bumping each other, but it does not tell us where to go.
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4 Responses to What is Money?

  1. Jackson says:

    “One problem is the classic chicken-egg dilemma”

    The truth is that the Bitcoin economy is already past this stage. Because BTC can be freely exchanged for existing fiat currencies (USD, EUR, YEN, …), the process of price bootstrapping has commenced. Low transaction costs, nonexistent regulatory burden, and ease of irrevocable value transfer, have made BTC attractive as an intermediary on top of existing currencies (akin to Paypal).

    More importantly, however, is that as the system is starting to prove its stability, merchants are starting to exchange goods and services *directly* in BTC prices (see http://silkroadmarket.org/). This elevates BTC from currency to full money (medium of indirect exchange.)

    The decentralized, open-source, and p2p design make government attempts at intervention largely irrelevant. The cat is already out of the bag.

  2. Nonoy Oplas says:

    Wow, nice post, Carlos. First time I head of “bitcoins” too. In most cases, government regulations come after an innovation by people and private enterprises. So maybe govt will not intervene in the trading of bitcoins, but it will create new regulations to all people and private companies that use BTC.

  3. Pingback: More on Bitcoins | Perpetual Cycle of Life

  4. Pingback: The Concept of “Pure Money” | Perpetual Cycle of Life

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