Thursday, December 25, 2008

Reboot IV: Monetary Values

In real values, we do not have money as an intervening factor. Everything is at a technical engineering-type hard case, or nuts and bolts and no flippant monetary factor. The understanding of real value makes up the core of a real economist - in the sense that the economist understands the fundamental forces affecting the economy.

Money is a very naughty entity in the world which has all the wise men and religious leaders throwing their wrath at it - and money even threatens to destroy the integrity of politicians and the political process.

Money is this thing that we have all collectively decided to be the most valuable thing in this world and that we have all collectively agreed - implicitly - to compete for it and be judged successful or otherwise in life with its measurement. Hence, our clamouring for money.

The Theory of Money. The traditional theory of money says that money is a veil and an illusion to the real economy. Given the underlying working of the real economy, the quantity of money defines the level of prices in monetary terms - such that if the government chooses to pump primp and double the stock of money supply.

But clearly money is not an aberration to the real economy, as the current financial crisis has shown. Since money is the necessary intervening entity in the economic system that the world is currently embracing, the flow of money plays a critical role in the flow of the economy.

The expansion of the money supply will lead to an increase in demand and the greater utilisation of capacity and if sustained will lead the economy hit full capacity and if further expanded will lead to the import of foreign capital and foreign labour.

Can the money stock be continually expanded without end?

No, as the previous Asian financial crisis and the current US financial crisis have shown.

The flow of money can stop when banks make mistakes in their lending - in terms of specific customers, or specific economic sectors. In a nutshell, the future of an economy is in the hands of the credit officers in banks who process individual customers and the CEO who sets the overall direction of lending - with the guiding hands of the central bank. If the central bank and banks do not know what makes a good economy, or if there is interference in the workings of banks by politicians, then we will get a problem economy.

A problem economy comes about when banks, having lent out money borrowed from depositors, cannot get the loan back, then they have no more money to lend out or pay back their depositors. This happens when they are financing bad projects which are usually related to the stock market, the real estate and consumer spending. The best loans go to agriculture and industries, but I suppose banks have gotten lazy in their job around the world.

When the stock of money does not increase, there will not be a fall in prices but a fall in quantity sold given the existing prices. When prices fall, it is the time for the business to close shop because they may not be earning enough to pay their workers and the banks, and not to say make a profit.

Profit in Money Terms. We have seen that in the real economy, profit is the output that is left after having paid the workers and the other costs of doing business. The businessman is quiet happy to take the stock that is left after sale as profit.

But in a monetary economy, profit is sales proceeds after having paid for workers and the other costs of doing business. The stock that is left in the shop, which the real-economy entrepreneur would have been happy to use to feed his family, is now called unsold inventory. Money must be found to buy this stock in the shop, before he can be said to make a profit. This peculiar feature arises because many of the things we produce today cannot be eaten to keep one's soul together (as we depend on the poor farmers around the world for that).

Money is not a veil. The flow of money drives the direction of the economy and the money managers should know what they are doing. If the money markets are driven by greed and fear (and ignorance), then the world is set for trouble and turbulence.


de minimis said...


In my limited understanding, money is supposed to have an intrinsic value. As you have written earlier, money used to be backed by the Gold Standard in the Bretton-Woods arrangement. The Nixon Administration decoupled money from the gold standard.

Money is a medium for transactions. Money is a measure of value and pricing, as you have pointed out. Money is a measure of material wealth.

Frankly, it is an abstraction. But, has it become illusory when used as a measure of wealth?

Has the obssession with money distorted all the values that we cherish? I mean values such a love, family, friendship and comfort. I know this is beyond economic philosophy.

But, your posts has shown that you have a seamless and holistic appreciation of the life and living. Perhaps you can revisit these interconnected themes to provide your perspective and guidance for the rest of us.

etheorist said...

de minimis

Thank you for your comment. My short reply is:

1. Because of the loss of value of money, other assets come to hold value better. This begs the question of what is wealth.

2. The blind accumulation of money and wealth has come at a price in terms of personal values. In trying to be rich, we have won the battle but lost the war.