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WHAT IS MONEY

Ludwig von Mises defined money as the most marketable commodity. What this means is that money is simply stuff (a commodity) that we all want and use to exchange for different stuff.

This commodity, this money, was originally accepted because it had some other use. For example, salt was valuable in antiquity because there were very few places where you could gather it. But, more importantly, it was accepted because you could use it to condiment food, which is something that almost all people did.

Let’s recap. A widely marketable commodity is something that everybody uses for something. As everybody uses it, it begins to be accepted in lieu of other goods and services (stuff). It becomes a means of exchange. It becomes money.

Money (real one or as economists define it: commodity-based) has other uses first before it becomes money. And so real money has the following characteristics:

  • It is something that has other, physical uses before it becomes money (it is a commodity)
  • It is widely accepted (it is highly marketable)
  • It is scarce (it maintains its value over time because it is difficult to get more or to counterfeit)
  • It is stable (it is not perishable)
  • It is divisible (it can be split in smaller pieces and negotiated with)
  • It is transportable (it can be taken to a market)

Once this money is accepted widely, the market’s efficiency increases enormously. People begin to think in terms of producing and selling stuff, instead of trying to figure out how to exchange it.

This commodity-based money could be anything that has some other physical use. It could be salt and sea shells, gold and iridium, cigarettes and cookies (like in prisons). Furthermore, this type of money is not created by government decree or sanctioned by a law. It is selected by the market through the process of trial and error. That’s why we call it real money. Because it is as real as money can get.

 

VALUE AND PRICE

This subject is something that most economic theories get wrong and it was fully developed by Ludwig von Mises. It is vastly important, so please pay attention.

The general idea of bartering is to exchange something I have but don’t care for something I don’t have but want. How much of the stuff I have I want to exchange for the stuff I don’t have is called the value of my stuff.

I have a bag of marbles. I don’t play with marbles anymore. I play with model cars. A friend of mine has plenty of model cars, but no marbles. So I propose a trade: some marbles for one model car. How many marbles am I willing to give depends of how much I want that model car. Not only that, it depends of how much I want that model care today. Not only that. It also depends of how many marbles my friend wants, today. Tomorrow, things may change. So, if we both agree to exchange 5 marbles for one model car, then today the value of 5 marbles is one model car or vice versa. Today, the value of one model car is 5 marbles.

The concept of value is utterly subjective. There is no absolute or arbitrary scale to measure value. When we exchange one stuff for another we assign a value to the transaction. We. Today. Somebody else at some other time may or may not do it differently.

In a stable bartering market and in general terms, values tend to remain more-or-less constant. For example, under normal farming conditions and lack of famine, a cow will be “valued” 3 pigs. As value is subjective, it is also relative. A commodity can only be valued in terms of other commodity. For example, we could value every commodity in terms of pigs. Everything would have a pig-value.

When we begin to use real money, we must remember that it is also a commodity. When we value one cow as 3 blocks of salt, because salt is widely used as a means of exchange, this value receives a special name. It is called price.

In the same manner as we could value everything in terms of pig-value, now we can price everything in terms of salt-value or money. There really is no difference. We are still valuing one commodity in terms of another commodity, but we just changed the name of this value to price to make it clear that this latter commodity is widely accepted.

At this point in our lesson and considering only real money, there is no difference between value and price. The difference will become apparent in the following lesson, when we will introduce fiat (or non-real or non-commodity) money.

 

ADVANTAGES OF MONEY

As we have seen before, in order to ascertain value, we need to value every good or service in terms of a commodity. But since there is no agreement on which commodity do we need to base our value on, things get complicated.

For example, let’s say that I am exchanging bags of apples in a market. I exchange one bag for one chicken, or 3 smaller bags of corn, or one hat or one small knife or…or… or.. Figuring out the value of one bag of apples in terms of all the other commodities people may wish to trade with, is a big problem.

However, if there is money, I can figure out the price of one bag of apples in terms of money and since everybody else is pricing their goods and services in terms of money, I don’t need to remember the value of my apples against everything else, all I need is to know my price and everything else will be instantly comparable.

As a consequence of this, markets become much more efficient and expand in a snowball manner (economists call this a geometric expansion – suffice to say that its speed increases all the time). As markets increase in size, there are more choices, more choices mean more products and services satisfying our needs, which means higher standards of living.

Also, as a consequence of everything being priced in money, I can now easily calculate profits and losses. If I can do this, I can take better advantages of mass production, which lowers prices and so increases sales volumes which increases profits. In other words, being able to price everything in money fosters deflation which increases everybody’s wealth.

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Real money for a real economy - Part 3

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