Saturday, August 13, 2011

Money doesn't matter

Disclaimer: I'm fairly intelligent, I'm used to delving into the philosophical foundations of various modes of thought, and I've read a fair bit beyond my coursework. I am, however, still a very junior economics student, so take what I say with a grain of salt.

Part I: The National Economy
Part II: Money Doesn't Matter

In Part I, I showed that conceptually, we can treat a national economy as a "whole", existing more-or-less in isolation. One important consequence of looking at something as a whole is that concepts that identify relations between parts of the whole do not apply to the whole itself. The most important concept that identifies relations between parts of an economy — households and businesses — is money.

In ordinary circumstances, money is a debt held by an individual household or business and payable by society. If I hold a \$100 bill, then society "owes" me some amount of goods and services: I can go into any store, present my debt, and have it satisfied in goods and services. Money is debt both in a "fiat" currency as well as in a "hard" currency such as gold. Gold is money only if most everyone in society sees it denoting a debt they have a duty and interest in monitoring; without this social agreement, gold would be valuable only to people who had some actual use for it, such as jewelers or electronics manufacturers. The only difference between a fiat currency and a hard currency is how these representations of debt are authenticated. Money, therefore, is a relation between one part of the economy, the household or business holding the money, and the rest of the economy. Looked at as a whole, however, every debt has a net value of zero. The individual that holds the \$100 is +100; the rest of society, who owes the goods and services, is -100. As a whole, +100 + -100 = 0. The net value of all the money in an economy is zero.

There are a few other ways of looking at money in a macroeconomic sense. Suppose, for example, in one day we were to multiply everything about money by a billion (10^9). Thus, if yesterday you had \$10,000 in your bank, today you have \$10,000,000,000,000. When you go to the grocery store, a loaf of bread that cost \$5 yesterday today costs \$5,000,000,000. If you paid \$1,000 for your mortgage or rent payment last month, this month you'll pay \$1,000,000,000,000. It seems pretty clear that nothing much would change, even increasing the amount of money by many orders of magnitude. Or suppose that one day all the money in the economy were to simply disappear. We would still have all our farms, factories, oil wells and refineries, cars, houses, cell phones and computers. We could still physically produce the same amount of stuff we produced yesterday*. Money does of course matter even in a macroeconomic sense, and I'll talk about how it matters in a later installment. But money doesn't matter in the way that it matters to ordinary people acting as a part of the economy.

*As best I recall, I first heard about this idea from Buckminster Fuller.

Every ordinary capitalist macroeconomics textbook will show the "long run aggregate supply" — how much goods and services the economy as a whole can produce — plotted on a graph with real (i.e. physical) output on the x axis and "price level" (the value of money) on the y axis. It's plotted vertically, meaning that in the long run the total amount of stuff we can produce does not vary by the price level. Increase or decrease the total amount of money in the economy by 1%, 10%, 10 times or 10^9 times; the total amount of physical goods and services we can produce in the long run stays the same.

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