People wishing to achieve their ends often have to trade. They can exchange their goods directly, if they have matching preferences and suitable goods, or indirectly, with the help of another good, the medium of exchange.
A commonly used medium of exchange is called money.
Medium of exchange and moneyEdit
Jones can trade an apple against two eggs from Brown. But this direct exchange or barter limits the number of exchanges and the extent of social cooperation. Both must have a direct personal need for the goods of the other person (this problem is called the "double coincidence of wants") and the goods must be easily divided. Using another, marketable good between the traded and desired goods and services helps to reduce some of the problems.
- Indirect exchange means, "if, between the commodities and services, that are the ultimate end of exchanging, are one or several media of exchange."
Another grave problem with a world of barter is that it is impossible for any business firm to calculate how it's doing, whether it is making profits or incurring losses, beyond a very primitive estimate. Suppose that you are a business firm, and you are trying to calculate your income, and your expenses, for the previous month. And you list your income: "let's see, last month we took in 20 yards of string, 3 codfish, 4 cords of lumber, 3 bushels of wheat. . . etc.," and "we paid out: 5 empty barrels, 8 pounds of cotton, 30 bricks, 5 pounds of beef." How in the world could you figure out how well you are doing? Once a money is established in an economy, however, business calculation becomes easy: "Last month, we took in 500, and paid out 450. Net profit, 50." The development of a general medium of exchange, then, is a crucial requisite to the development of any sort of flourishing market economy.
A commodity that comes into general use as a medium of exchange is money. The concept of a "medium of exchange" is precise. But when exactly comes a medium of exchange into "common" or "general" use is not strictly definable. Whether or not is a medium money can be decided only by the judgment of the historian. Since there is a great tendency on the market for a medium of exchange to become money, it is called money for simplification.
Note that money is still a good - the most marketable good. Money is valuable to the extent that others are willing to accept it in exchange. But, money itself must first have originated as a directly serviceable good before it could become an indirectly serviceable good.
Origin and propertiesEdit
In the history of mankind, a great variety of commodities — cattle, shells, nails, tobacco, cotton, copper, silver, gold, stone wheels, and so on, have been used as media of exchange. In the most developed societies, the precious metals have eventually been preferred to all other goods because of their physical characteristics (scarcity, durability, divisibility, distinct look and sound, homogeneity through space and time, malleability, and beauty).
For a good to become money, it must have the physical properties and be considered valuable by itself. The price of a good, when employed only for nonmonetary purposes, is a good starting point to estimate its price for use as a money. Should the good stop being money, it will still have value due its other uses.
Historically, there were often several types of money used concurrently and for different purposes. For example, silver tended to be widespread in daily use, while gold served for larger and international transactions. Livestock was for ages associated with wealth (and while it is bulky, it can be easily transported). The role of cigarettes in prisons is also well documented.
- See also: History of Money and Banking
The emergence of money happens through a gradual process, in the course of which more and more market participants, each for himself, decide to use one commodity rather than others in their indirect exchanges. Thus the historical selection of gold, silver, and copper was not made through some sort of a social contract or convention. Rather, it resulted from the spontaneous convergence of many individual choices, a convergence that was prompted through the objective physical characteristics of the precious metals. Money selected in the free market. i.e. money that comes into use by the voluntary cooperation of acting persons, is also called natural money.
By adding a new component to the pre-existing (barter) demand for these goods, their marketability is still further enhanced. Based on their perception of this fact, other market participants increasingly choose the same goods for their inventory of exchange media, as it is in their own interest to select media of exchange that are already employed by others for the same purpose. Initially, a variety of goods may be in demand as common media of exchange. However, since a good is demanded as a medium of exchange to facilitate future purchases of directly serviceable goods (i.e., to help one buy more cheaply) and simultaneously widen one's market as a seller of directly useful goods and services (i.e., help one sell more dearly), the more widely a commodity is used as a medium of exchange, the better it will perform its function.
Because each market participant naturally prefers the acquisition of a more marketable and, in the end, universally marketable medium of exchange to that of a less or non-universally marketable one, "there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money."
Money did not and never could begin by some arbitrary social contract, or by some government agency decreeing that everyone has to accept the tickets it issues. Even coercion could not force people and institutions to accept meaningless tickets that they had not heard of or that bore no relation to any other pre-existing money.
If anyone could produce paper money on their own, without backing by an underlying commodity, a hyperinflation would soon follow. Free entry into the note-production business must be restricted, and a money monopoly must be established. Fiat money can be only established via the development of money substitutes (paper titles to commodity money) - but only fraudulently and only at the price of economic inefficiencies. Hoppe speaks of the "devolution" of money.
- Main article: Fiat Money
As the more marketable commodities in any society begin to be picked by individuals as media of exchange, their choices will quickly focus on the few most marketable commodities available. The demand for these commodities has now an additional component - not only for their direct use, but also for their use as a medium of exchange. This increase in the demand greatly increases their marketability. If e.g. butter begins as one of the most marketable commodities and is therefore more and more chosen as a medium, this increase in the demand for butter greatly increases the very marketability that makes it useful as a medium in the first place. The process is cumulative, with the most marketable commodities becoming enormously more marketable and with this increase spurring their use as media of exchange. The process continues, with an ever-widening gap between the marketability of the medium and the other commodities, until finally one or two commodities are far more marketable than any others and are in general use as media of exchange.
Or money certificates, are placeholders for actual money, that is stored in a bank and can be redeemed at any time by the present owner of the note. Instead of trading e.g. silver, people would trade with notes representing the silver. Apart from paper notes, the main types of such substitutes are token coins, certificates of deposit, checking accounts, credit cards, and electronic bank accounts on the Internet. The advantage are lower transaction costs, the downside is a greater potential for abuse (and historically, this lure appeared to be irresistible).
Credit money is created when financial instruments are used in indirect exchange. It is only a derived kind of money: it receives its value from an expected future redemption. For example, an IOU can be accepted by others, if they trust the reputation of the issuer of debt. This risk of default also limits its application.
"Not surprisingly, therefore, credit money has reached wider circulation only when the credit was denominated in terms of some commodity money, when the reputation of the issuer was beyond doubt, and when it was the only way to quickly provide the government with the funds needed to conduct large-scale war."
- Main article: Fiat Money
Often called paper money, fiat money is in a wider sense any money declared to be legal tender by government fiat. In the narrower sense used here, fiat money is an intrinsically useless good used as a means of payment and a storable object. All modern paper currencies are fiat money.
There are many reported advantages to fiat money as opposed to commodity-based money, among them:
- much lower costs of production
- the quantity can be easily modified to suit the needs of trade
- the quantity can be easily modified to stabilize the value of the money unit.
The main risk of this money is the possibility of a complete loss of value.
- See also: For and against paper money
The information technologies have been able to develop very efficient and beneficial new instruments to access and transfer. But no purely electronic money has been produced so far, except for government money, which is free from competition.
Production of moneyEdit
The production of additional units of money will decrease the value of already existing units. Those owning these additional units will tend to pay more money for goods and services or demand additional goods and services, and demand in turn more money when selling their own goods and services. Thusly, the production of money has a tendency to raise money prices, starting from the producers of money and spreading to other economical actors.
In the free market, the amount of money produced depends in the free market on the consumers. They decide not only the amount of goods (or money) to be produced, but also the the types of money widely used. Historically, coins of several metals and alloys were used concurrently, this appears to be the natural state of things.
It is often asserted, that higher money prices benefit debtors, as it lowers the relative value of their debts. This may not always be the case: if the lender's estimate of the rising prices is too high, the debtor may end up paying more on account of the expected inflation.
The final and possibly most important effect of a rising money supply is in its timing - the positive effect of "having more money" benefits the producer of money and those getting it first; while the negative effects impact the latecomers. This redistribution of of wealth and rising prices may be limited to some degree, but cannot be avoided.
The optimal quantity of moneyEdit
For all products except money, an increase is socially beneficial, since it means that production and living standards have increased in response to consumer demand. If steel or bread or houses are more plentiful and cheaper than before, everyone‘s standard of living benefits. But an increase in the supply of money cannot relieve the natural scarcity of consumer or capital goods; all it does is to make the money cheaper, that is, lower its purchasing power in terms of all other goods and services. Once a good has been established as money on the market, then, it exerts its full power as a mechanism of exchange or an instrument of calculation. All that an increase in the quantity of dollars can do is to dilute the effectiveness, the purchasing-power, of each money. Hence, the great truth of monetary theory emerges: once a commodity is in sufficient supply to be adopted as a money, no further increase in the supply of money is needed. Any quantity of money in society is "optimal." Once a money is established, an increase in its supply confers no social benefit.
This is not the situation with commodity money. Money originally emerged from an ordinary commodity that people demanded because it contributed tangible benefits to their life and well being - one of them the service of a medium of exchange. Therefore, an increase of the production of commodity means more useful goods.
Money can be employed in several ways:
- Money can be held. Holding it "buys" alleviation from a currently felt uneasiness about an uncertain future. If the future seems more uncertain, people will increase their cash holdings.
- Money can be used to buy consumer goods. People increase their consumption if their time preference rises.
- Finally, it can be saved, to buy producer goods and so form capital. People save because their time preference falls.
- ↑ 1.0 1.1 Ludwig von Mises. "1. Media of Exchange and Money", Chapter XVII. Indirect exchange, Human Action, online edition, referenced 2009-04-27.
- ↑ 2.0 2.1 2.2 Murray N. Rothbard. The Case Against the Fed (pdf), The Genesis of Money, p.12-15, referenced 2010-03-18.
- ↑ 3.0 3.1 Murray N. Rothbard "2. The Emergence of Indirect Exchange" Chapter 3-The Pattern of indirect exchange, Man, Economy and State, online edition, referenced 2009-05-05.
- ↑ 4.0 4.1 Dan Mahoney. "Austrian Business Cycle Theory: A Brief Explanation", Mises Institute, referenced 2009-06-17.
- ↑ Milton Friedman. "The Island of Stone Money" (pdf), The Hoover Institution, Stanford University, February 1991, referenced 2009-08-14.
- ↑ 6.0 6.1 6.2 Jörg Guido Hülsmann. "The Ethics of Money Production" (pdf), online version, 2. The Origin and Nature of Money, p.22-24, referenced 2009-05-08.
- ↑ Davies, Glyn. "A history of money from ancient times to the present day", Origins of Money and of Banking, referenced 2009-05-09.
- ↑ R. A. Radford. "The Economic Organisation of a P.O.W. Camp", Economica, vol. 12, 1945, referenced 2009-05-09.
- ↑ 9.0 9.1 Hans-Hermann Hoppe. "How is Fiat Money Possible? - or, The Devolution of Money and Credit" (pdf), The Review of Austrian Economics Vol.7, No. 2 (1994). Referenced 2010-04-28.
- ↑ Ludwig von Mises. "Theory of Money and Credit" (pdf), p.32-33, referenced 2010-04-28.
- ↑ Jörg Guido Hülsmann. "The Ethics of Money Production" (pdf), Chapter 2. Money certificates p.35-41, referenced 2009-05-10
- ↑ Jörg Guido Hülsmann. "The Ethics of Money Production" (pdf), 2. The origin and nature of Money, p.28-29, referenced 2009-05-10
- ↑ Walsh, Carl E. Monetary Theory and Policy, The MIT Press 2003, ISBN 978-0-262-23231-9, online version, referenced 2009-05-10.
- ↑ Jörg Guido Hülsmann. "Ethics of Money Production" (pdf), Chapter 1., 5. Paper Money and the Free Market, p. 29-33, referenced 2009-05-10.
- ↑ Jörg Guido Hülsmann. "Ethics of Money Production" (pdf), Chapter 3 Money within the Market Process, referenced 2009-05-10.
- ↑ Frank Shostak. "The Subsistence Fund", Mises Daily, August 2004, referenced 2010-05-10.
- Murray N. Rothbard, Man, Economy and State, esp. Chapters 2 and 3
- Ludwig von Mises, Human Action, esp. Chapter XVII
- Wikipedia page on money and history of money
- Frank A. Fetter, Economics In Two Volumes: Volume II. Modern Economic Problems
- Money, Bank Credit, and Economic Cycles (pdf) by Jesus Huerta de Soto