Money Matters: Introduction

The Donkey

A rich man stopped in a small town. He encountered two men haggling over a mule. The rich man, thinking he could use the mule, out bid the two men and bought the mule.

Several weeks later the rich man again stopped in that small town. By coincidence, he encountered the same two men who had been haggling over the mule. The two men asked the rich man what he had done with the mule.

He responded, “That old mule could not do the work for which I wanted him; so, I had him put down.”

The other two men suddenly look very disappointed. The rich man asked them why they acted so disappointed.

The men responded, nearly in a single voice, “Until you came along, we had made a good living trading that mule.”

Market References

Fast food, shoes, iPads, Ferraris, Stocks & Bonds, and the national economy, we relate to all of them through references to money. We use phrases like: it costs…, it’s worth…, it increased by…, all followed by a number of dollars. We use these phrases as if they actually mean something and that we understand that meaning.

But, do these phrases mean anything?

Do we know whether we speak real meaning? If they do speak meaning, do they comprehend that meaning?

The Comprehension Gap

When we discuss market transactions, we tend to either ignore the role of money in those transactions, or we discuss monetary transactions, with little attention to the goods at the focus of the exchange. By ignoring the interrelationship between money and products we tend to expose what I have dubbed a “Comprehension Gap.”

What don’t we understand? Money or markets?

The donkey trade and the economic references provide hypothetical examples of this “Comprehension Gap.”

Money & Markets

You cannot fully understand most economic exchanges without understanding money and its role in exchanges. If we base our understanding of free markets on our current assumptions about money, we could suffer from grave misunderstanding. We need to make those assumptions explicit and precise to assure that our assumptions correlate with the real nature of the transactions.

So many misconceptions exist about money that clear thinking and communication about economics becomes nearly impossible. To clear up this confusion, we must start with some basic concepts

Economic Reasoning

Money exists inside and as part or market systems, not as separate from market activity. Thus, in order to fully understand money (and close the comprehension gap), we must first understand the principles and theories that govern market behavior.

I will address some of the basic elements of economic reasoning that will support our discussion about money.

Market Systems

Expanding production and limited consumption result in savings, and creates the need for exchange and the use of money.

How does the production process create a need for exchange?

How does increased production and exchange benefit all members of an economic system?

Exchange

Nearly all market exchanges involve money. In large markets, systems of exchange become highly complex.

How does that complexity lead to the use of money?

To understand to role of money in complex market exchanges we should know the basics of market exchanges.

We will examine market exchanges at all levels of complexity — from the simplest, which might operate based on direct exchange, to the complex, which require indirect exchange and the use of money.

Monetary Systems

We will examine the essential characteristics of an unfettered monetary system. How would people use money if governments and central banks did not interfere with the system?

Banking Systems

We refer to the organizations that handle the storage and transfer of money as banks. A network of banks forms what we call the banking system.

Banking systems can facilitate the coordination of basic banking functions. But, they can also manipulate the underlying monetary system.

Subsistence Fund

When we use money in market transactions, the money simply facilitates goods for goods transfers. Those transfers involved a vast number of goods, and each transaction has a different characteristic.

To make general statements about money I will describe a mental model frequently referred to as a “Subsistence Fund.”

Without further description, the subsistence fund consists of a collection of consumer goods required for the population of an economic system to subsist. I will flesh out this description later on this blog.

Pricing Mechanisms

Pricing mechanisms — particularly those based on money — perform a critical function in the transfer of market information.

We will examine market pricing and how flexible prices facilitate dynamic markets.

Intervention

Unfortunately, government and the banking system intervene in the smooth flow of money. This intervention disrupts the pricing mechanism creating a massive amount of misinformation within otherwise effective and efficient markets.

Money Myths

During the course of this blog, we will address many of the misconceptions about money and the banking system. We will address some of the more egregious myths and misstatements about money and banking.

Conclusion

Many people seem to disconnect money from goods or products. They either mention money and say very little about products exchanged, or they mention products and basically ignore the existence of money. Every mention of economic transactions should include the interrelationship between products and money.

The lack of systemic thinking provides one reason why people talk about one side of these exchanges and not the other.

Ignorance and misunderstanding provide another reason for people to ignore the connection between goods-for-goods exchanges and the role of money.

Money Matters will address these connections and correct much of the ignorance and misunderstanding about money and markets.

The next time you go to a store, a coffee shop, or a restaurant, think about the critical role that money plays in your everyday life. Don’t you think you should understand it?