Followup To \"Up In Smoke\"

I didn't get a chance to respond to all of the comments in my previous post regarding the economic effect of physically lighting a $100 bill on fire, but after reading all of them, I still think the point I made is valid, with some qualification, and many of the responses, especially those claiming radical skepticism regarding the uses of money, merely complicated the issue. So in this post I'll try to elaborate a bit more in the hope that I can avoid those sorts of criticisms.

Cash does not constitute wealth. Stuff does. Money is merely a proxy, a medium of exchange, a tool that makes it easier to trade 500 bales of hay for a washing machine, without having to go through the trouble of first finding an owner of a washing machine who happens to be looking for 500 bales of hay, and then having to actually physically transport the hay to the washing machine seller and the washing machine to the hay seller. The washing machine and the hay constitute wealth. The paper we use as a proxy does not.

If we increase or decrease the money supply without actually changing any of the underlying wealth that money represents, three effects may follow.

First, the increase or decrease in money supply transfers purchasing power from some people to other people. For example, if the government simply prints more money and the underlying wealth of society remains constant, then the government essentially expropriates purchasing power from previous dollar holders to itself. As these new dollars flow through the economy, prices adjust to account for the fact that a greater number of proxies exist than did before, with no corresponding change in wealth. This is inflation.

Second, if we take into account the observation that different people have different rates of diminishing marginal utility of wealth, some people may be better off or worse off as a result of this net transfer of purchasing power.

Third, since money is merely a tool, we can ask how useful a tool any given size of the money supply would be. If the government excessively inflates the money supply, for example, the frequent changes may introduce noticable transaction costs. The hyperinflation of the Weimar Republic resulted in such lunacies as workers needing to get multiple pay raises each week, just to maintain a constant level of purchasing power, or wives meeting their husbands at work multiple times a day to deposit their paychecks before the next hourly devaluation. The need for this type of behavior represents significant transaction costs in terms of wasted time and energy, and demonstrates that in this case, the currency was not a very useful tool at all.

Those are the three effects of changes in the money supply I can come up with off the top of my head; there may be others I am missing.

I do, however, reject the claim that people look at a $100 bill as anything other than a medium of exchange as silly, uninteresting, and pointless, even if conceivably true, for the same reason I reject the claim that one can explain the act of a soldier jumping on a live grenade to save his fellow soldiers in terms of self-interest. The assumption of self-interested rationality in most cases is a useful one: it generally works as a description of the behavior of people who are not insane. But the usefulness of this assumption fails on the grounds of tautology if we expand the definition to describe all possible actions. Is it conceivable that the soldier jumped on a live grenade to save his fellow soldiers, not out of a sense of duty or love, but in the selfish hope that his death would result in the posthumous award of a Medal of Honor, and somehow this contribution to his legacy was his sole motivation for committing suicide? Sure, it's conceivable, but just as silly and uninteresting as the claim that we may all just be brains in vats or that the world sprang into being five minutes ago. While logically possible, we don't accept the logical possibility of these scenarios as reason enough to deny all claims to knowledge about the world. This is both skepticism and credulity taken to absurd lengths. So while it is true that sometimes physical currency can represent something other than a medium of exchange - such as the pizza shop owner who frames and proudly displays on the wall the first dollar bill he earned - these sorts of exceptions are few and far between, and we have no good reason to approach every new situation as if it could be an exception to the rule. We can assume, reasonably, that unless we have some evidence like the case of the pizza shop, currency is valued as a means of exchange and nothing else.

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At last, someone else has

At last, someone else has realised the fundamental of "constant, unrenewable wealth". I had been getting tired of reading nothing other than the Austrian(?) school of thought.

There are some very interesting results that fall out from this line of economics. One that is touched upon in your post is the partial cause and, more importantly, effect of inflation.

This is not, as some might have it, an argument to justify the "gold standard". The implications are far wider than that; especially when one starts to consider the current value of a resource, the continuing consumption of that resource, and the ability to purchase what remains of the resource.

I wait with interest for this to develop further.

(A suggestion - think about water as a resource; its value, its availability, its continuing renewability. Go here for some thoughts on the issues involved.)

More power to you...

Micha, I think it is valid


I think it is valid to believe that money also functions as a store of value. Why do you think otherwise? I use it this way all the time.

Micha, About the grenade


About the grenade issue and altruism. I don't think you understand some people’s position on this. Yes, some people are silly and assume that everyone is always acting out of narrow self-interest. Such an act of self-sacrifice would send them into mental gymnastics looking for some selfish ulterior motive. Not all people who see self-interest behind as acting behind the scenes thinks in such a simplistic way.

It is perfectly possible for an act to be both altruistic and self-interested at different levels of human existence. We are collections of replicators and therefore are made up of what are often conflicting interests. We consist of many genetic and cultural replicators often with opposing interests both intra and inter group. Dropping yourself on a grenade is never in ones narrow self interest. However under certain circumstances it can serve broader interest such as winning a war, saving your family, saving a friend, or defending a principle. An act of self-sacrifice can act as powerful engine in spreading a belief.

Nor do people who see a broader self interest exhibited in such an act think that it is impossible to commit an act of total self-sacrific. It's possible but unlikely, and such acts are frowned upon. No one likes to see someone give up their own life for absolutely nothing, or for a cause they do not believe in. It's one thing to sacrifice your life for your country and quite another to sacrifice your life in vain.
Cindy Sheehan believes her son gave up his life in vain and she isn't particularly happy about it. I don't think she would be so upset if he had died protecting some ideals [some memetic replicators] that she thought worthy.

We don't often find Muslims willing to fly building into planes on the behalf of spreading Christianity. It is because the religion Islam is part of the self of those individuals that they are willing to sacrifice for it. Thus in a way it is self-interested. Likewise, sacrificing oneself for ones children is an act of self-interest at the level of the gene.

Most of the behavior I see is somehow tied to the self-interest of some replicator or another. There is a good reason for this. Acts of absolutely pure altruism have no way of preserving the replicators that initiated them. Replicators that are truly altruistic are not persistent in the environment.

The only possible exception to this being persistence through recessiveness. Some bad genes and presumably ideas can be replicated if they are not always expressed. For instance, the idea of a lovers suicide pact seems to serve no useful purpose. It serves no purpose in spreading any ideology, like say martyrdom does. It is sacrificing for each other, yet the other that is sacrificed for dies. Such acts usually get publicized so the idea persists in print but is rarely expressed by being acted upon. It's an act that really should die out but doesn't.

So thinking in this way does not expand the act to all possibilities. There are actions that could be classified as truly altruistic in this view but they are not acts anyone is going to be inspired by.

I think it's a mistake to

I think it's a mistake to treat money as different from any other good. If I collect Rembrandts and someone discovers a bunch of new Rembrandts, they've transferred wealth from me to them. Likewise, if a Rembrandt museum burns down, wealth has been transferred from the owner of the museum to me.

In fact, now that I actually invest in a lot of things that aren't dollar denominated, it's pretty easy to see money as not being different from another good. GLD, SLV, VAW, and SPY behave very similarly to my municipal money market account, especially since I can make other purchases using margin without having to sell any shares. They're somewhat volatile relative to my money market account, but they're actually less volatile against oil than my money market account is, so which is the real "money?"

I agree with Sean, though I

I agree with Sean, though I didn't get much into it in the article I just wrote at AtlasBlogged in response to your article, Micha. I focused on the grenade digression, and I think Brian's point here is in line with what I had to say.

Sean, I think it’s a


I think it’s a mistake to treat money as different from any other good. If I collect Rembrandts and someone discovers a bunch of new Rembrandts, they’ve transferred wealth from me to them. Likewise, if a Rembrandt museum burns down, wealth has been transferred from the owner of the museum to me.

The mistake is to treat all goods the same. If you collect Rembrandts to hang on the wall for the viewing pleasure of you and your visitors, they are subjective use-valued goods (consumption goods) and the new Rembrandts need have no effect on their subjective value to you. Of course, you can tire of them and mentally transfer them to the category of exchange-valued goods, intending to sell them, and there may well be an effect on their exchange value. However, different Rembrandts are not necessarily interchangeable goods.

Regards, Don

I'm with Sean. Money is

I'm with Sean. Money is just another good, regardless of why people value it (for trade, for insulation, for the good feeling they get from supporting the issuer, etc.)

For some types of analysis, the distinction between exchange-value, use-value, and production-value is useful, but for basic wealth measurement, it can all be lumped together. Cash IS wealth, as is other stuff (and non-stuff like services you're owed).

These categories of value are inexact anyway. Some of the pleasure you get at looking at your rembrandt is the pride of owning a scarce resouce, and knowing that it is valued by others. There's a use-value to the exchange-value.

Don, I think you're missing

Don, I think you're missing the point. Part of the value of art to collectors is indeed its exchange value. The fact that the exchange value is not the entire source of value is beside the point. The point is that the paintings can still lose value due to someone else's actions.

This is even clearer with gold coins. Numismatic coins have both a numismatic value and a melt value on the market. The value of a coin can go down both becuase someone discovered a stash of the same dated coin or becuase the supply of gold has increased (or the demand has gone down).

Money is interesting because it usually has *far* more exchange value than heating or insulation or note-taking value, but IIRC there was a time in the Weimar Republic that people were burning smaller valued notes to heat their homes, because the notes were cheaper than the same heating value of whatever the traditional fuel was at the time.

Yes, different goods are different, but money isn't any more different than any other good.

So then we still have a

So then we still have a distinction between use value and exchange value, and we can still roughly classify goods based on which value predominaes. So maybe Don can still have his point.

Or are the concepts use value and exchange value themselves problematic? Is that a false distinction?

Micha, Can you clarify


Can you clarify this?

Second, if we take into account the observation that different people have different rates of diminishing marginal utility of wealth, some people may be better off or worse off as a result of this net transfer of purchasing power.

Why are different rates of diminishing marginal utility required for some to be better or worse off? Even if everyone had the same rate of diminishing marginal utility, wouldn't some people still be better off and others worse off?

I suppose that if someone

I suppose that if someone were born who was not able to recognize people as people, he might still be able to learn to engage in transactions, only he would see it as akin to non-transactional use. For example, having learned that planting a seed produces a plant, he might also learn that "planting" money "in" people produces goods.

Or are the concepts use

Or are the concepts use value and exchange value themselves problematic? Is that a false distinction?

It depends on your purpose for measuring value. I think the distinction is real, but often misstated. It's not two components of value, it's two different ways of measuring different definitions of value. I don't think they're additive, nor comparable directly. I'd argue (I'm not sure I believe it yet, but that won't stop me) that anticipating potential exchanges IS a use, and it's the anticipation of exchange, rather than the exchange itself, that gives money value for any individual.

Exchange value is convenient in that it's objectively measurable, denominated in exchangeable objects. Use value can't be measured that way. I'm not sure how to tell which one "dominates" a given good if they're not measured in the same dimension.

And voila, we're back to IUC!

At last, someone else has

At last, someone else has realised the fundamental of “constant, unrenewable wealth". I had been getting tired of reading nothing other than the Austrian(?) school of thought.

Unless I'm missing something, everything in this post is compatible with the Austrian approach to money, especially effect #1.

Ditto, Jonanthan Wilde.

Ditto, Jonanthan Wilde.

I disagree. Cash = stuff.

I disagree. Cash = stuff. It's just like a car. We allow it (ok, are forced to use it) to be a proxy, the fact that you can't take it back to the government and get gold isn't really relavant, nor is the idea that the government can make as much of it as they please. Treating it as wealth is actually an important part of the chain that explains property rights... I have a right to my body, a right to the things I create with that body, a right to what I can sell those things for, and a right to what I can buy with what I sold them for. Money is sthe same as the stuff I make, and the stuff I buy. The issue here is that we have allowed the government to have way too much power over the value of our stuff.

The 'value' of stuff varies constantly.

Sean, I think it’s a


I think it’s a mistake to treat money as different from any other good.

Money does not suffer from the restriction of scarcity like most (all?) goods do. Goods that represent actual wealth and not merely a proxy for it usually cannot be reproduced as easily as pressing a button on the copy machine. Of course, dollars are actually made of cloth and not paper, and reproduction is a bit more complex than a copy machine, but you get my point.

I disagree. Cash = stuff.

I disagree. Cash = stuff. It’s just like a car.

Cash is like other stuff, but also unlike it. The use of something as a medium of exchange is sufficiently different in an economically significant way from the use of something as a screwdriver that you're likely to get books written by economists about the first use (as a medium of exchange) and not quite as likely to get books written by economists about the use of screwdrivers.

Imagine an alternate world that is just like our world, but it has half the money. One of the first questions that's likely to come to mind is, "what does that even mean"? It's easy to imagine a world with half the cars: just count the cars. But what about half the cash? Suppose the other world is like ours to the point of having identical money in every country - only, half as many dollar bills. The dollar bills in that alternate world, let us suppose, have very close to twice the exchange value of our dollar bills in terms of other goods. Does this alternative world have half the cash, or does it have the same amount of cash? Or is the answer to this question undefined?

Suppose our productivity doubles but our money stays the same, with the result, let us suppose, that the same dollar bill buys twice as much of everything. That is conceivable. Has the amount of money doubled, or stayed the same, or is the answer, again, undefined?

I will begin to answer: one reasonable way to compare the amount of money I have in my bank account with the amount of money a German has in his bank account is to use the exchange rate to establish relative value. But there can be no exchange rate between reality and alternative possible worlds, so by that measure one cannot answer the question - the answer is undefined. Nor is there a real exchange of money between past and future, so the answer there is also undefined. One possible response is to declare loans to be an exchange of money between past and future. However, in that case, the hypothetical scenario is insufficient to answer the question. That is, neither (a) the doubling of the buying power of money nor (b) the constancy of the nominal amount of money nor both combined answer the question, which can only be answered by looking at the going rate today for loans that come due at the point of interest in the future.

In contrast you don't need to know any exchange rates to compare the relative numbers of cars.