Sunday, January 4, 2009

What is Money?

Many people spend their lives trying to make money, but my experience shows that almost no one really understands what money is. For lack of a few concepts, most people place themselves at a tremendous disadvantage to the few who do understand money and how it works.

It seems almost inconceivable that something of universal importance could be universally misunderstood, at all levels, from child to economics professor. But there is a very convenient reason for all the confusion surrounding something as simple as money: profit motive. We'll pinpoint who benefits from widespread misunderstanding, later.

Before we move forward, ask yourself the question, "What is money?" Have you ever been asked?
"The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it." - John Kenneth Galbraith
What is money?

Most people are inclined to point to a distressed note, olive in color, tucked neatly inside their wallet. Everyone knows that these paper "Federal Reserve Notes" are money, right? Wrong. A paper note is "currency." Currency is about the only thing in the world that is not a form of money.

Money is any tradable asset.

An asset is "tradable" when it carries some tangible value, that is, when it is something that people value. A house is money, because people desire homes. A car is money. A paperclip is money. A service is money, if it is desired and can be traded for other things.

So what is the paper note in your wallet? Isn't it money, too? Well, a paper dollar bill does have some tangible value, I can write my grocery list on the back of it. For the most part, paper is worthless. A paper note is "currency." Currency is an accounting system for money. It is difficult to haul your vacation home to market for trade, so we carry currency instead. Currency in isolation, without backing assets, is worthless.

Assets are money. Currency is a paper accounting system for money. Paper is worthless without money.

It follows then, that the total value of any accounting system for money, or all the currency in circulation, is always equal to the amount of money that backs it. There can be a billion dollars of currency in circulation, there can be a trillion, there can be a quadrillion, or there can be a single dollar. The number of paper dollars, or the number of zeros printed on those dollars, does not matter. The sum total of all circulating currency always accounts for the total amount of money in existence, and nothing more.

This concept is critical to understanding what happened in 2008, and what is about to happen in 2009, and beyond.

So we know:

MONEY = any tradable asset
CURRENCY = a paper accounting system for MONEY

And so:

CURRENCY/MONEY = the amount paper per asset = PRICES
The amount of things an asset commands in trade = VALUE


VALUE almost never changes. The VALUE of a house is four walls and roof over your head, so it always commands a similar house in trade, regardless of their PRICES. PRICE can be anything, it is meaningless with respect to asset VALUE. PRICE, while initially arbitrary, should be stable. However, as we will uncover shortly, the people who do understand money will have none of that.

13 comments:

  1. Thanks for sharing this information. Miss your comments on MW but will add your site to my list.

    Once again, thanks for sharing.

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  2. Gee, I hope you're not going to stop sparring with the kooks on MW! That's too much fun!

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  3. Hope you don't mind me emailing a link to your blog to just about everyone I know. A number of my family are "professional traders" with suits on and have argued vociferously with me over the last year regarding the markets doings. Just want to thank you, thank you, thank you for sharing your thoughts in such an articulate manner.

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  4. I truly appreciate all the time and effort you are putting in. Thanks,
    Edengrace

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  5. I enjoy your blog more than any mainstream media. I think the media has turned into informercial, not truthful information and education for regular people who work hard to earn their living. Since I've been listening from people like you and reading history, I have been able to protect my assets from the money changers this time around.

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  6. I wish I knew this last year.

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  7. Of course you are correct, just don't distract the American people from their distractions. I mean Football is on the television and we need to know what Paris Hilton is doing. These are the issues of importance

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  8. FDR wrote: "So what is the paper note in your wallet? Isn't it money, too? Well, a paper dollar bill does have some tangible value, I can write my grocery list on the back of it. For the most part, paper is worthless. A paper note is "currency." Currency is an accounting system for money. It is difficult to haul your vacation home to market for trade, so we carry currency instead. Currency in isolation, without backing assets, is worthless."

    By this argument, the value of gold, silver, or some other "precious" metal is strictly defined by the industrial and other practical uses to which it can be put. Indeed, one could argue that paper, too, has many industrial and practical uses, perhaps even more so than gold or silver, and yet it is regarded (certainly by yourself, and by most others as well) as being intrinsically worth much less than gold or silver is. Of course, that's much more the result of the large supply of paper (and the relative ease of producing more) relative to the supply of gold or silver than it is the greater uses to which gold and silver can be put relative to paper.

    If you limit your definition of money to those things for which the *primary* value is related to its uses, then the list of items which could also be used as currency is likely to be a short one indeed.


    None of this negates your primary point, which is that currency is used strictly as a medium of exchange and that it has relatively little value on its own. As a result of its role, I think one might be able to make a convincing argument that it's desirable for the item used as that medium of exchange to have as little intrinsic value as possible, so that its very presence in an economic transaction doesn't significantly affect the transaction itself.

    And yes, that particular property of currency can be, and is, taken advantage of to our very significant detriment.

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  9. I wrote: "Indeed, one could argue that paper, too, has many industrial and practical uses, perhaps even more so than gold or silver, and yet it is regarded (certainly by yourself, and by most others as well) as being intrinsically worth much less than gold or silver is."

    Strike the "certainly by yourself" bit in the above. After a bit more consideration, I have to entertain the possibility that you don't regard "precious metals" such as gold or silver as having much intrinsic value, and may even regard their intrinsic value as roughly equivalent of paper.

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  10. Great thought provoking blog.
    Your Gold and silver under your definition is MONEY.
    However they are still also CURRENCY.
    That is what makes them unique. (Platinum and copper also could be defined as both.) But gold and silver traditionally have always had the qualities to make them ideal as currency because they are fungible and divisible. You can carry them to market unlike a house ! They pack a lot of value in a small space. The other thing is that they are intrinsically honest when used as currency. Debasement is immediately apparent. The fact that central banks still use gold in particular as reserves shows their importance to this day.
    Platinum has escaped the attacks by the central banks to depress the price. Gold and silver on the other hand languish because they are under constant attack. (JPM and HSBC mainly, but with the approval of the Fed). Why attack it ? If allowed free rein, that would be the death of the dollar and the crooked system. The trouble for the financial establishment to keep the price suppressed, is that it costs a lot of gold. The recent visit to $1000 cost the system 220 tons. The Chinese are now saying ,"Thank you very much !" All buyers late to the scene are saying the same thing.
    The real stuff trades well above the paper stuff. One could write a book about the suppression of the gold price ! But you only have to look at the price action on a 2 min chart to see it for yourself. It goes on every day now that Summers is back in the Administration.
    Any technical analysis for both monetary metals is a trap due to the manipulation which is blatant and given the nod by the regulators. I notice you are bearish. Gold is going through a correction that needs more time to work out. You may be right short term, but on the other hand those who use TA in the gold market invariably lose their shirts ! IMO fireworks towards the end of the year (18-22 months) but there are signs it will be sooner. There are already a huge number of far out of the money call options for both June and December. Trading in call options is by professionals and sophisticated traders in these markets. They are a way of acquiring metal without attracting attention and blowing the market sky high. They are a way also to cover huge short positions, or insurance against a monster short squeeze.
    So for me, no way would I short gold right now. Very dangerous !

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  11. Explaining the difference between assets and currency is fine. But focusing on re-defining the word "money" isn't helping.

    Sorry, but the common definition of money is out there and you won't be successful taking it back. Go to any online dictionary and note that the definition of money includes paper notes.

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  12. "Sorry, but the common definition of money is out there and you won't be successful taking it back."

    If I don't care that Bernanke, a econ professor from Princeton doesn't understand the very nature of money, then I guess I don't care what the dictionary says either.

    Any difference in viewpoint is settled by the ability to make money through an understanding of it, and academia cannot, or it wouldn't be academia.

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  13. It's clear that you don't care what the dictionary says. But if you want to reach more people, talking about "assets" vs "currency" will get the real point across and cause less confusion.

    I guarantee that people are reading this and saying "Money isn't money? What is this guy talking about?"

    Are you more concerned about Bernake not understanding the paper money (that is /currency/) in our pocket is not a hard asset or about his use of the *word* "money"?

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