Why Does Money Matter?

You may have noticed that I post a lot about money, particularly this "modern money" stuff and you may be wondering why I care so much about money. I have long been fascinated with money, particularly with what gives it its value. I remember way back in middle school wondering why green pieces of paper had value, or why gold was so valuable (a topic I wish to explore more in a follow up post). I never really got what I thought were adequate answers nor did I seek it further until my interest turned toward economics in college. Now after four years of undergrad and a couple years in grad school, I understand why money matters and I think you should too.

To be clear, I am not saying love of money (greed) is a good thing...it isn't, but rather understanding just what money is and how it affects our economy is crucial to achieving our economic, political, and social objectives.

So what is money? The most often told story is that money is a commodity that evolved out of a barter economy. For example, tradespeople in small villages started using seashells or gold or whatever to exchange for goods that each made so as to avoid the problem of barter economies. The butcher wants shoes, but the shoemaker doesn't want meat, so the butcher would have to trade meat to someone for something that the shoemaker wanted in order to obtain shoes. This problem is called the 'double coincidence of wants' and money is thought to have sprung up as a medium of exchange to eliminate this problem. All could exchange their goods for seashells or gold or whatever which could then be exchanged for any other commodity one wanted.

This story seemed plausible to me at first, it does seem logical, but as I learned more I quickly became unsatisfied with this explanation. This view hinges precariously on everyone accepting the commodity to be used as money. It also assumes barter economies existed and doesn't translate well to today's fiat money system because the commodity used as money is thought to be intrinsically valuable (gold) which also poses a problem for those who used seashells.

Another view believes that money is a social unit of account tracking credits and debts, just like an inch measures distance, or a gallon measures volume. One dollar is a unit of account, a measurement of credits/debts. Thus money is always a two-sided affair, it is an IOU, with a creditor and a debtor. Having money means that one has claims to another's goods/labor/cup of sugar/whatever that other gave in the IOU. From this view, one can see that anyone can create money, it is the matter of acceptance that is key. I can issue IOUs all I want, but in order for them to become 'money', someone must accept them. Which means they must accept that my word is good. If I don't my 'money' defaults.

There is proof of such IOU record keeping dating way back to Babylonia, Egypt, Greece, Rome, and other primitive societies. Some measured these credits/debts in grain, some in cattle or livestock, some in gold, some in 'tallies' and 'stocks', some in seashells, and a whole bunch of other 'things'. The one common thread between these is that the state or central organizational authority has played a large role in determining the money and in keeping the records, most often because taxes were involved. (If you would like to read more about these societies and monies, send me an email or leave a comment, and I will post some resources. I will also talk about this more in my next post on the value of money).

As capitalism developed in Europe in the 16th, 17th, and 18th centuries and then spread throughout the world, money began taking on an even more central role. Money, rather than goods, became the sole or main object of the economic process. Mercantilism specifically called for nations to export goods to import bullion/gold. Capitalist enterprises produced in order to sell to obtain more money or profits to produce more goods to obtain more money and so on. This became known as the 'capitalist ethic'--profit maximization--which dominant theorists believed to be a good thing because with self-maximizing behavior and competition the 'invisible hand' would lead us to prosperity.

Money was no longer desired simply as a medium of exchange (if it ever was desired solely for such a purpose), it became desired as a store of value, it became the end and no longer the means. The economics process was to obtain money to produce goods to get more money (M-C-M', where M'>M and M=money C=goods/capital), not to exchange goods for money to obtain more goods (C-M-C').

This isn't rocket science and you don't need to be an economist to get this fairly common sense proposition. Most everyone knows businesses want more money, that they want higher market share and profit margins, that it's all about the money. (To be fair, there are many small businesses, usually family businesses, that care more about the service or good they offer to people than the money they obtain, but this is not characteristic of the economy as a whole even though it would be nice if it were).

So why does money matter? Because it has become the end of the economic process. It is what brings forth production and therefore employment in the economy. Businesses need to sell goods to produce and workers need wages to work. The flows and stocks of 'money', the flows and stocks of credits and debts in the economy, is at the most basic level what determines employment, output, inflation, and nearly all the economic variables we look at. To understand how our economy works, we must understand money.

But unfortunately, many economists don't care that much about money and don't really account for it in their models. They think that money is a commodity or evolved out of a commodity. They don't account for debt levels, or understand government debt at all. They misunderstand inflation, and don't believe we can fully employ everyone who wants a job all because they misunderstand money. To many of them, money is simply the grease. They don't understand that it is a social unit of account and thus miss some very major points.

I care about the 'real' economy and more importantly the social and personal aspects of the economic process, such as the fulfillment of work and the obtainment of the material goods necessary to the development of oneself and one's family. And now I recognize that money, our system of accounting for debts and credits, is a major part of making that happen.