User:Woozle/rethinking economics

Introduction
Two questions got me started thinking about the meaning of money.

1. The financial meltdown of 2008 poses a conundrum: nothing has been suddenly destroyed; our farms, factories and homes are still intact, our roads and bridges are still passable (despite some neglect), our power grid is in no worse shape than before, our communications infrastructure continues to grow -- and yet people are "out of work", being kicked out of their homes, sometimes even going hungry. At the same time, many of those factories stand idle, their workers sent home without pay, many houses (both newly-built ones and those repossessed by banks) cannot be sold.

In other words, as a nation we (still) have more than enough capacity to provide the things which many people are now being forced to do without. How is this possible?

2. A further question is posed by the recurring fears of impending hyperinflation, in which the money we currently use to buy the things we need on a regular basis would be rendered nearly worthless: if we still have the capacity, as a national community, to produce the things we each need in order to survive at a reasonable level, why couldn't we just keep on trading with each other, regardless of what the money is worth? What system could we put into place that would survive if the US dollar became worthless or undependable?

I am not an economist, and I have no special knowledge of economics or finance, but I do have experience untangling other people's convoluted and undocumented critical systems, documenting them, and redesigning them in a more robust way. Finance strikes me as being very much this sort of accumulated amalgam of shallow solutions.

It seems to me that when people talk about economics, they get very much tangled up in a particular set of ideas and customs that have arisen, and this prevents them from grabbing hold of the basic purposes of economics. They end up applying patches and kluges for the weaknesses of the current design rather than re-engineering it from a lower level which might really fix some of the design's inherent problems.

Clearly, the system by which trade is conducted is in need of a major design review.

Basics
Economics is not about money; it is about resources. The way we allocate resources (and have done so for many centuries) is through money, so most discussion of economics ends up being about money.

when the equivalence works
When looked at locally, it's true that money and resources are more or less interchangeable. If you have $10, you can easily buy a decent meal. If you have $100,000, you can buy several years' worth of meals -- or a small house (possibly a large house, depending on where you look), or a handful of cars, or some combination of these. Money is easily transformable into whatever resources you happen to need at the moment, as long as you have enough of it.

On the other hand, just because you have a house (or a warehouse full of several years' worth of frozen meals, or a small collection of cars) doesn't mean that you could quickly trade them for $100,000, or (more relevantly) for any of the other things you might need which $100,000 could buy for you. This is one of the reasons people tend to think in terms of "money" rather than "resources".

Another reason is that it reduces the accounting of resources to a single, simple number: instead of saying "I could buy most of a house of a certain size in a particular neighborhood, or several years' worth of frozen meals, or about 4.7 new mid-sized cars, or some combination of the above", you can just say "I have $100,000".

Yet a third reason is that we don't pay our bills -- the majority of our economic activity as individuals -- in resources. Imagining that your resources consist of a thousand inkjet cartridges and excellent typing skills, the vendors of goods and services still require payment in money (rather than cartridges or hours of typing) because:
 * money has an essentially fixed value -- my $5 can be traded for the same resources as your $5, while you might be a much better typist than me, or have higher-quality cartridges
 * negotiating for resources is complicated -- maybe the grocery store doesn't need any more typists or cartridges at the moment; having to negotiate with you for other ways to pay for your groceries costs in employee-time
 * money is arbitrarily dividable -- if we decide that a pound of bananas is worth one of your cartridges, what do we do when you only need half a pound?
 * Even it the store agrees to owe you half a pound of bananas or half a cartridge, what happens when you need a bunch of grapes instead? The obvious solution is to say that grapes are "worth" some number of pounds-of-bananas or printer cartridges -- but then what happens when there's a banana shortage? Suddenly a pound of bananas is a lot harder to get than one printer cartridge, and any store which allowed that trade would run out of bananas pretty quickly.

a very brief history of money
The idea of money seems to inevitably evolve out of the sort of situation described above.

It became clear at some point that there needed to be some thing upon whose value which everyone agrees, so that you don't feel like the grocery store is impugning the quality of your cartridges (or typing) when all they're doing is trying to deal with the increased difficulty of obtaining bananas. Assigning a value (in units whose value isn't subject to argument) to each item in the trade avoids this confusion.

In the early days of money, it was typically assumed that the thing we use as a value-standard -- the "currency" -- had to have some intrinsic value itself, hence precious metal coinage (gold, silver) in measured weight denominations. The English "pound sterling" was originally an amount of sterling silver -- a particular grade of silver which was highly useful for producing functional objects -- presumably weighing one pound.

Later on, someone came up with the idea that instead of the currency itself being valuable (commodity money), it could be issued as a promise that the issuer would, on request, accept it in trade for an item of fixed value (representative money). From the point of view of the issuer, this had a number of beneficial effects which should probably be part of our evaluation.

Finally, it was realized that once a currency had been widely adopted (or imposed), there wasn't really any need for an official "backing" of fixed value; such currencies are called "fiat money", and they are used by every modern country. Fiat money can be thought of as being backed by the production capacity of the country in question: if you have 10 United States dollars, you can be pretty sure that you can get a decent meal out of it, at least for now, which gives it a certain amount of value even though the US government has made no promise whatsoever regarding the actual value of those dollars.

inflation
One of the better-known problems with fiat currency is that it can be abused by the issuer. If a government needs more money than it has, it can print more. This ultimately reduces the value of existing money, a phenomenon known as "(cost) inflation". The result is that prices (and eventually wages) creep upwards -- and saved money loses a bit of its value. (You can think of this as a sort of universal tax requiring absolutely no paperwork or coercion -- arguably more fair than either sales or income taxes, since the people who suffer most are those who are holding onto their money for a longer amount of time and therefore presumably need it the least, while those who live hand-to-mouth barely keep their money long enough for it to lose any value. This may be a good topic for future discussion.)

Since we think of everything in terms of money, though, this means we tend to think that because things have become "more expensive", it means we are having to work harder in order to get them. This is only true until the wages also increase with inflation; while we're waiting for that, we are effectively being paid less. It may be that the organization we work for truly can't afford to raise our wages (yet) to keep up with inflation, in which case this represents a failure of the system: it's not that bananas have become harder to grow, and so we must work harder in order to be able to afford them, it's that:
 * the grocer, in addition to shelling out more dollars for the services and goods which keep the grocery store running, must also give the banana grower more dollars per banana, because...
 * the number of dollars the banana grower needs in order to grow a certain quantity of bananas has gone up, because the dollar-costs of the labor to grow the bananas and the farming supplies needed to run the banana farm have gone up, because...
 * the farm supply store has to shell out more dollars to keep itself running, and the farm workers need more money to pay their expenses, because their dollars also buy less than they did before, because...
 * the dollar-cost of the groceries they need to feed their families is now higher.

Nobody is slacking off, no task has suddenly become harder, no resource is suddenly scarcer. Why is everything suddenly more expensive? Answer: because some of the resources whose allocation is tracked by the existence of "money" have been quietly re-allocated elsewhere by printing more money – meaning that a little bit of our work, our created wealth, went out of the local ecosystem, and we have to work a little bit extra to make up for it (until the higher prices work their way through the loop and finally translate back into higher wages, once the resource reallocation is "paid for"). Arguably, those who have helpfully provided the allocation system have a right to skim off the top when they need it -- but it is important that we understand that this is what is happening.

finance
More to the point, we get lost in the idea of money being valuable in itself when we look at organizations whose job it is to manage money and make more of it: banking and investment firms.

The basic idea behind an investment company is this: they borrow money from people, and find things to do with it that will make more of it, which they then use to pay back their investors (plus a bit) and skim some profit off the top for themselves.

For the sake of simplicity, let's avoid -- for now -- a discussion of the process of money creation through fractional reserve banking, if only because we know that printing money is not the same thing as creating wealth (since it actually just concentrates wealth by taking a little bit from everyone). The question to which we need the answer is this: how does an investment firm add value (i.e. create wealth, not just money)?

Presumably, what is happening is that the firm knows a lot of businesses who need some money up front in order to be able to make more of it.

Woops, there we go again, talking about "making money". How do these businesses create wealth?

A typical example would be opening a small retail outfit: you need to buy equipment, renovate your location, and have cash on reserve to pay your staff and bills until you can actually open, start getting paid by customers, and eventually make enough profits to pay for all the money you borrowed to get going.

I'll be very interested to know how many people find themselves wondering (especially after I ask it) how this hypothetical small business is really any different from a Big Finance firm. After all, they both take in money, redistribute it, and keep some extra. The folks on Wall Street are just dealing with a lot more money at a time, that's all -- surely they deserve a piece of the pie, even if it's a much bigger pie.

This is where the difference between money and value is very important.

Let's say the business does home repairs. Let's also assume they do good work and are reasonably honest. They take your money, and in exchange your home becomes more livable. Your money translates into hours of labor plus any supplies used.

Your money pays for the replacement shingles for your roof and 5 work-hours of labor; in exchange, 5 years from now you still have an intact rafter there, and the clothes in the closet immediately underneath aren't ruined.

Because that new business existed, you didn't have to go with that other home repair guy you used to use who did mediocre work and charged too much. Maybe Mediocre Guy makes more money (because it was either him or do the work yourself), but dealing with him was not a value-adding transaction. You paid him more, and the roof came apart again just a year later; repeat enough times and you might as well just buy a new rafter every 5 years.

You could think of those things in monetary terms and see how you are coming out ahead -- but that's not the point. Money, in that usage, is really just a tool for helping us to estimate value. If the clothes cost $1000 to buy but were moth-eaten before the roof ever started leaking, you couldn't say you saved $1000 by fixing the leak. If the house was scheduled to be demolished in 5 years to make way for a new bypass, you couldn't say you saved the replacement cost of the rafter (unless you were planning to move the house before it was demolished).

Money is a number; value is resources. Clothes you can wear, and a house you can live in -- things that are somehow useful -- are resources.

writing in progress here