How Money Works

Our perceptions of and ideas about money are almost preconscious. Money was already in existence at the beginning of history. The most sophisticated mathematics of antiquity deal with interest calculations. Our most strongly held convictions surround money. Only our notions of God can compete, and even then, money is often the center of religious teaching. The Apostle Paul went so far as to say that “the love of money is the root of all evil.” So let’s begin simply and build. Money flows in a circle.

Money comes to people in six ways

1. They trade something for it
2. They create it
3. They confiscate it through deceit or force
4. They receive it as a gift
5. They borrow it
6. The money they possess is augmented by the destruction of other money

Money flees people in six ways

1. They buy something with it

2. They destroy it

3. Someone confiscates it through deceit or force

4. They give it away

5. They lend it

6. The money they have is diminished by the creation of other money

Modern money is a hodgepodge of different entities. Most modern states have a central, state owned or operated bank. These banks usually issue the national currencies of the various countries. In addition there are a myriad of commercial banks, money market funds, and other entities that extend credit or commercial paper that are accepted as money, and are often convertible to currency. The fact is that the great majority of our medium of exchange is created by for profit, business entities. Private citizens enjoy no such rights.

Money is extremely malleable, able to absorb and articulate massive sums of new money. This allows those who are authorized under the modern protocols of money to redirect whole sectors of the economy. This is done by the extension of credit to those deemed credit worthy in the form of demand deposits. These demand deposits gain their purchasing power by taxing all other monetary divisions in the system. This is the principle form of taxation in the system, dwarfing all other forms, and virtually unknown to all who pay it, but counted on by those who live off it.

Some of the best minds in the world devote their entire lives to keep this circle, or wheel if you will, turning smoothly. Even these best efforts often fail.

The Invisible Hand

Money is a Tertium Quid, a third thing. It allows people to trade without looking for someone who has something that they wish to trade for, they can buy and sell. Indeed the words buy and sell are meaningless without money. People park their purchasing power in money until they wish to use it. This idealized system of trade creates a milieu in which the activities of millions or billions of people can be coordinated, articulated, and harmonized. Money is the principle tool of the invisible hand.


The Mechanics of Money

Money has two structural principles that operate on human behavior and explain the mechanical interaction of humans and money.


1. The Substitution Effect - The substitution effect is money's marginal operator. When the price of potatoes goes down, potatoes become more attractive vis-a-vis other things. If the price of books goes up, they become less attractive vis-a-vis other things.

2. The Income Effect - The income effect is money's average operator. When the price of apples goes down, the people who buy apples have a little more money. This ripples to all money in the system, all monetary divisions are enhanced. When the price of wheat goes up, the people who buy wheat have a little less money. This ripples through the economy, all monetary divisions are diminished.

Types of Goods

Normal Goods - When the price of a normal good goes up, consumption goes down by about the same amount. When the priced of a normal good goes down, consumption of that good goes up by about the same amount.

Superior Goods - When the price of a superior good goes up, consumption goes down but by a lesser amount. When the price of a superior good goes down, consumption goes up but by a greater amount.

Inferior Goods - When the price of an inferior good goes up, consumption goes down but by a greater amount. When the price of an inferior good goes down, consumption goes up but by a lesser amount.

Giffen Goods - When the price of a Giffen good goes up, consumption goes up. When the price of a Giffen good goes down, consumption goes down.

Wieser Goods - Wieser goods are not purchased individually. If they are available free, the only decision is whether they are available or not. This is dependant on "heroic" action of individuals or society.


Giffen's Paradox- The World of Hyperscarcity

In 19th century economists were puzzled by the fact that when the price of corn went up, people demanded more of it. British economist Sir Robert Giffen finally explained it. The lot of the working classes had begun to improve, and they had begun to vary their diet, adding meat and fresh vegetables to their staple of corn. But when the price of corn increased they had to use more of their income to buy the same amount of corn. In order to maintain the same caloric intake, the only commodity cheap enough was corn, so they stopped eating fruits and meat and went back to corn, for virtually all of their food intake. The income effect was so great it over came the substitution affect. The iron law of demand was dead.


Wieser's Paradox of the Well-The world of Hyperabundence

Imagine a village dependent on unreliable riparian sources for their water. They discover that digging in a certain location will yield an artesian fountain with limitless, uncontrollable amounts of water. Economic theory tells us that no individual would undertake the effort to dig the well because it would have a price of zero, as no gate could be established. Again, the income affect would overcome the substitution affect. Wieser ventured that someone would simply dig the hole, without regard to economic gain. Common sense tells us this is true, if and only if the owners of the riparian water sources could not prevent.

The Limits of Monetary Rationality

Money's rationality, that is it's ability to be used as an effective tool of comparison and measurement, exists only between the extremes of hyper-scarcity and hyper-abundance. It's natural movement is to oscillate toward the extremes and become dysfunctional. Money's balance is maintained only by intentionally managing it. Humans must keep money in the range of rationality, by avoiding the pitfalls of extreme poverty and obscene wealth.


Money moves from person to person each time there is an economic exchange. As long as it continues on its regular path it is difficult to say much about it. It is when it changes courses, or stops, or starts, that we get a chance to examine it in detail. It is when a person changes from apples to oranges, or from cotton to silk, or from cognac to ripple that money reveals itself. When money is born, or when it dies, a ripple can be spotted.


Exchange

A trade of a product or service for another product or service. It can be voluntary or coercive.

Monetary Exchange

A trade of a product or service for money

Money

Money is a digital proxy of value. It can take the form of coin, paper, computer bits, journal entries, checks, shells, rocks, or verbal promise.

Value

The worth of one good in terms of another, a ratio.

Worth

Immediate usefulness of a good or service.

Price

A price is an amount of money the buyer gives and the seller receives in an exchange.

Cost

Amount of worth surrendered in a purchase or sale

Benefit

Amount of worth acquired in a purchase or sale

Offer

Amount of money for which someone is willing to sell a product or service.

Bid

Amount of money which someone is willing to pay to buy a product or service.