Tuesday, October 08, 2013

Money, Money, Money

I got a big kick out of prof Harari's lectures on money - one of the prime drivers of the transition to a global culture. Money is one of the purest creations of the human mind, in the sense that its value is almost entirely the product of a shared imagined reality. It's been invented many times in many places, and is essential for any complex economy. Occasionally, but hardly generally, money consists of things of real intrinsic value, like cigarettes, cattle, slave girls, or baskets of wheat. More commonly, especially in modern societies, it consists of things whose intrinsic value is slight, like cowrie shells, coins of gold or silver, banknotes, or entires in an electronic ledger. The value of money lies in our shared expectation that it can be exchanged for all sorts of real goods and services.

What exactly underpins our shared belief that those coins or banknotes will continue to be useful to us? Beyond our shared imaginations, it's often the power of a state. Intrinsically scarce items, like gold or cowrie shells, can have a value that's independent of any particular state, and lately we have learned that even a digital item of manufactured scarcity - the bitcoin - can also function in that role. Such items have their own vulnerabilities. Gold can suffer drastic inflation in value if industrial demand or a fashion for gold jewelry occurs, and drastic deflation if a big new gold mine is dicovered. In any case, there is far too little of it to make it a useful medium of exchange.

Almost all modern money is supported by the apparatus of the state, and most of it exists only in those electronic ledgers. It's important to note that scarcity - natural or manufactured - is a crucially necessary ingredient of money. That's precisely why inflation is perilous. Too much inflation will rob the money of its value as a medium of exchange. Deflation paralyzes an economy and has even more severe effects.

More on money and default sometime.