A Primer On Money – Part I

What is money? People encounter so many different measures of money supply, with esoteric designations like M0, MB, M1, M2, M3, and MZM, that difficulty inevitably arises when trying to understand just what exactly constitutes this ubiquitous, yet ill-defined facet of life.

When considering such a question as ‘what makes something what it is,’ functional definitions often serve as the most intuitive basis of characterization. Thus:

Money is a commodity that lowers transaction costs through serving as a medium of exchange. I suggest this as a necessary but not sufficient condition and it is in a set of particular ways that money meets this condition.

Money is a commodity that, due to its wide demand, serves well as a medium of exchange.

As a group of people becomes sufficiently large and their daily activities sufficiently diverse, their exchange of goods becomes complicated beyond their ability to apprehend the exchanges necessary to produce the most desired outcome. For instance, suppose a baker spends the day baking bread. Friend 1 spends the same day bottling wine. Friend 2 spends it picking garlic. Friend 3 spends it milling flour. Friend 4 spends it pressing olives. Friend 5 spends it harvesting tomatoes. Friend 6 spends it milking cows. Friend 7 picks parsley. And Friend 8 bakes cakes. They all want to make their own Italian dinner that evening.

The solution is to trade in a substance useful to all. The baker likes wine. So do his friends. He sells his bread for wine and the wine for oil, bread for wine, again and again. The universal acceptance of quantities of wine in exchange amongst his friends means the buyer of the first good does not have to be one and the same with the seller of the second… The baker can take wine in exchange for bread in the full confidence that the wine which he receives will be accepted as payment for say, garlic and tomatoes…

Amongst the group of friends, buying and selling become different transactions and we can say this as half of each transaction involves the same commodity. They call it buying when I acquire a non-wine product and selling when acquiring wine.

Money is a commodity that, due to its fungibility, serves well as a medium of exchange.

Friend 1, again, is the bottler of wine. The wine is, on the whole, quite good. It’s all the same vintage so everyone knows what they’re getting when they propose to trade them a bottle of Friend 1’s wine for, say, a couple of loaves of bread. Friend 8, however, is not very good at baking cakes. When I say not very good, I mean not very consistent. He swears he follows the same recipes every time and to the letter, but his friends don’t understand how one could do that and get the wildly varying results that he does. Nonetheless, not the baker, nor his friends, are tempted to trade in Friend 8’s cakes. So, they don’t do it. The key here is that Friend 1’s wine is fungible. Each bottle is identical to the rest. Friend 8’s cakes aren’t. They compete to be the opposite of fungible.

Money is a commodity that due to its durability serves as a store of value.

One night, the baker had the crazy idea of not disposing of all the bread he baked on a particular day, but instead, storing what remained for a few days as a kind of safety net to insure against the possibility of a bad day of trade. The idea didn’t work out well. The bread went stale. He made some French toast with it, which was thoroughly enjoyable, but the bread was otherwise worthless. The baker thereafter learned his lesson. After that he did not try to store value in anything which was not durable. The wine, in contrast to the bread, gets better with age. So the baker keeps the wine as a reserve of value because of its durability.

Money is a commodity that due to its relative scarcity serves as a store of value.

Furthermore, Friend 2, due to the advantages of being able to readily dispose of wine, goes into the wine business. The very next day there is twice as much wine on offer. Everyone, as a result, went and traded their goods with Friend 1 and then went and traded with Friend 2. ‘We’ll be having a good night tonight,’ they thought, ‘and if we don’t want it all, we can exchange it for something else down the road.’ They all did have a good time that night. But soon everyone realized they did not want twice as much wine every night. Friend 2, however, was determined to stay in the business and soon nearly twice as much wine was on the market. The baker, who used to trade three loaves to the bottle was no longer willing to do so. There was more wine to be had and the baker was going to have his share. He now demanded two bottles for only three loaves. The same happened with each of the others. They demanded more wine for their produce. There was a lot more wine changing hands than there used to be as a result. Friend 2’s wine, like Friend 1’s was good. The baker was sore when he reflected on the consequent diminution in his the value of his wine cellar. His collection wouldn’t buy nearly as much now as it used to. He thus resolved to store only as much wine as he intended, over a period, to drink and put his remaining store of value in something else; something  people could not just start making when they felt like it.

For a time, wine was quite the convenience. If the baker wanted pesto on toast one evening, he sold bread to whoever wanted it in exchange for bottles of wine. He then took his wine to the herb picker and the oil presser and exchanged it for what he wanted. He did not have to count on them wanting an amount of bread equal in value to the desired amount of herbs and oil. Also, if he was not too hungry, he saved the wine that he had taken in for another day. This method saved the baker the effort of barter and the worry of how he would enjoy the fruits of his labour, without those fruits spoiling.

Wine then, for the baker, was money and it was money because it was a medium of exchange. It was chosen as the medium of exchange because it was fungible, because it was durable and because, for awhile, it was scarce.

The baker’s motives and decision-making are meant to model the motives and decision-making of most real world economic actors. Thus the characteristics of money that were identified in the example will be true of money anywhere you find it in use.

by Brandon Mitchell

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