The standard definition of money is in error.
The standard definition of money is given in terms of its three
functions:
1: Money is a medium of exchange.
2: Money is a measure of value.
3: Money is a store of value.
Number 1 is at best misleading. Numbers 2 and 3 are simply wrong, and these
things are easy to show. It is also easy to show that this is important.
First, the actual definition of money:
1: Money is a token, or
instrument, of demand, which is exchanged for goods or services. Or simply: Money is demand.
2: Money is a measure of demand.
3: Money is a store of demand.
In the standard definition, Number 3 cannot possibly be
true. Were Number 3 true, money would
have value of itself. The value of money
would be independent of what ever else an economy produced. But consider, the
best monies are those instruments which have no intrinsic value whatever. How can any amount of something which has no
value, be a store of value? Even where
commodities have been used for money, (and this may be the origin of the
error,) they have tended to be those commodities, precious metals, for
instance, which, because of their properties, were of only limited economic
use. The reason for this is known and simple:
These commodities had to be more valuable as money than they were
valuable as commodities. If they were
more valuable as commodities, they would be consumed, and so their use as money
would disappear. But this implies that
the value of these commodities, as money, over their value as a commodity, is
not intrinsic, but as with plain fiat money, purely a matter of other factors. That is, the value of the commodity as money is
not based on any intrinsic value of the commodity to the economy.
So fiat money has no
intrinsic value, and therefore cannot
be a store of value. If the economy produced only money, that money would have
no value. It does not have value as,
say, a refrigerator full of food has value, or a tank filled with gasoline. But, what the third function of money
actually is is as a store of demand. If
you have $100 in the bank, or in your pocket, you have a store of demand, which
you can keep as long as you want, and when you choose to, you can spend it. You can demand something which is offered for
sale, to the amount of $100.
Then you can take your $100 of tokens of demand and you can
go to the grocery store and with it buy $100 worth of food. This shows that money is also a measure of
demand: You have as much demand for
food, or anything else, as $100 will purchase.
If you have more money, you have more demand. If you have less money, you have less demand. If you have no money, you have no demand.
Money is not a store of value. Can it reliably be a measure of value? Economically worthless things may be in much
demand, and therefore command a price beyond their value. Yachts, for instance. Economically valuable things may be in little
demand, or supplied at prices below their value. Water, for instance. With money, you have demand for these things,
at the prices they are offered. But
their prices do not reflect their economic value, only the amount of demand,
the amount of money, which must be exchanged for them.
This counters the claim that the only value a thing has is
that set and measured by the market: The
toys of the wealthy are much in demand, but of little value. The goods needed by the poor are to them of
great value, but it may be that those poor are only able to demand a meager portion
of them. Markets only measure
demand. They need not measure value. This is the primary inadequacy of markets.
So because money is demand, or more exactly a token or
instrument of demand, it serves as a 'medium' of exchange: Because money is not demand for any
particular good or service, but is demand for any offered good or service, it may be exchanged for any offered good
or service. Money is a medium not in the sense of being an environment for
exchange, but in the sense of being a generalized instrument. It is an abstract good, which is offered in
exchange for other goods and services. The individual who exchanges his good or
service for money then himself has equal
demand on others for different goods or services. Money thus flows opposite to the flow of
goods and services, not to the degree of the value of these goods and services,
but according to the demand for these goods and services that are offered.
Goods or services are thus exchanged for an equal demand on
other goods or services. Money, then, is
an instrument for comparing the demand for dissimilar objects. However, we have shown it is not reliable for
comparing the value of dissimilar objects.
By mistaking demand for value, the standard definition of
money thus implicitly fails to distinguish between the value of an object, and
the demand for that object. In an
informal sense, this results in the failure to distinguish between the needs of
an economy, and its wants.To provide another example, the economy 'needs' streetlights in Highland Park, Mi. It 'wants' yachts in Newport, RI.
If we regard the economy as like a tree, money cannot
distinguish between the fruits of a tree, and its roots.
There is a larger issue. The standard definition of money
goes back, essentially unchanged, to 1875. See eg. Wikipedia. It is, implicitly, a key part of the
foundations of the entire field of economics.
That it is in error calls into question the soundness of the entire
economics project.
Interesting: not value, but demand. I have to read again in the morning, with my coffee.
ReplyDeletePerhaps in the 19th century, "value" was the correct word to use, and now it is not. The economy changes, you know. I like to evaluate ideas like yours in the context of a changing economy to see if that helps me make sense of the ideas. In this case I would have to consider how "demand" differs from "value", and what changes in the economy might be associated with the different terminology.
... At this late hour, I'm lucky I can get that much out!
Thanks for sending me the link.
I've made similar arguments, and have been reminded by others of a fourth dimension to the definition: "money denominates and extinguishes debt".
ReplyDeleteThat money makes demand effective is a critical point, however, as is the corollary that money, as insurance, is not demand for any particular good. That's an important feature -- the indeterminancy of money as future and potential demand. That you can go out and accumulate money, without knowing in advance what you might want to spend it on is a really important feature of money as an instrument of a decoupled economy, a means of entering into incomplete contracts and making contingent deals in an uncertain world.
Yes. Money as a general token of demand, which can be exchanged for anything offered up for sale, is what makes it useful. In that respect, it might be regarded as having a 'potential' value, especially when we remember as a token, money flows in direction opposite to what it purchases. Which may be regarded as 'kinetic?' Well, maybe. A gallon of gasoline would seem to have a real economic potential. Real economic kinetic? Just feeling around...
DeleteThe 'money as debt' brings out its macroeconomic functions, Money as demand, and as incorrectly defined in the standard definition, seem to me more microeconomic.
Greg, that's not a bad attempt to more accurately define the role of money in society, but I think there is a more holistic one. Look at all the participants and also define the act of satisfying demands.
ReplyDeleteHave you read the Econosophy blog? Toby is also thinking deeply about this stuff.
Yes. The "money as debt" perspective Illuminates the macroeconomic role of money, as a few of the many comments over at nakedcapitalism.com, where Yves Smith has graciously cross-posted this entry,, have pointed out. So what I've posted would then seem to be the proper microeconomic definition. The standard definition also fails to acknowledge this limitation. Another error.
DeleteThanks for the pointer. I will check Toby out.
Hi Greg,
ReplyDeleteI find the perspective that money is stored demand quite interesting, but have a conceptual problem holding value and demand separate. In terms of standardized measures, we ought to allow that phenomena such as demand and value can't really be measured in the way length and weight can (where weight gets quite complex re. gravity etc.). I.e., the 'standard' prices we want to think of as 'objective' measures of value (or demand) are really something more subtle than that. One aspect of what is really happening to create prices is power relationships. After all, money and power are impossible to separate, as are money, price and scarcity.
In terms of why money emerged in the first place, and leaving aside the debate as to how important this aspect of money theory is, I would recommend David Graeber's "Debt", and also Nigel Dodd's "The Social Life of Money". What is probably most clear is that the subject is almost endlessly controversial, but it is equally clear that the assertion that markets 'objectively' discover prices via the invisible-hand inter-operations of supply and demand -- and further that this dynamic is as natural to human beings as breathing and procreating -- is little more than a tawdry web of unexamined assumptions. In other words, value cannot be measured: it is a wholly subjective 'thing' that cannot inhere in any 'object', whether food in a fridge or gold or fiat money. For me it follows that demand cannot be measured either, since demand relates to value very tightly indeed. We do not demand what we do not value. It would be a mighty philosophical battle to distinguish the two once and for all!
(And of course there's utility and exchange value, but I don't have time to get into that.)
So, back to stored demand. There's always been demand, but there hasn't always been money. Indeed, there was farming before money, and therefore stores of grain and fruits before money. Storing stuff against starvation and winter and drought etc. has obvious value (utility) and is not unique to humans (squirrels, fatty deposits etc.), but does not necessarily lead to money and markets (e.g. squirrels don't have markets, and it doesn't suffice by way of explanation to point out that humans are more intelligent: for one thing, dolphins are probably more intelligent that humans). We need more than uncertainty about the future as a precondition to get from stores of grains etc. to trading, monetary exchange and price. This is clear from Graeber's "Debt", but also from plenty of other work on this topic. I would say you need in place the particular hierarchical power relations of the state BEFORE you have markets and price/money. Once these social forms have become established, then demand can be stored in money as you have reasoned above. But demand can also be manufactured, as advertising proves. That is, money and capitalism and consumerism, each currently intimately linked to the other, require ever increasing demand to function properly (i.e., perpetual economic growth). And that introduces the brutal mechanics of debt and compound interest, for that aspect is more that just macro-economics. It is also the inescapable maths of exponential growth and doubling time in conjunction with the wonders of double-entry bookkeeping and how money is created and destroyed.
Cheers
Toby
(Dear anonymous, thanks for the link!)
Hi Toby,
DeleteAh, first of all, if demand and value are each difficult to measure, then we have extra reason to be careful not to, a priori, conflate them.
I think one way to look at it is to regard exercising demand, that is spending money, as a local phenomenon, where as value need not be. To be sure, the rich man seems to value his yacht more than the money he spends on it. Here is one area where they might be regarded to differ: The ‘value’ includes the consumer surplus, where as money merely measures the price. But this is also a local consideration.
But value, and yes, also demand, but not necessarily on the same scale, are also a global phenomenon, and I think we can sort out a sort of ‘economic value’ of things, which is not so tightly bound to demand. When you exercise demand, you do not evaluate the state of the entire economy, yet that state is what really defines the economic value. I discuss this over at naked capitalism, where they cross-posted my post.
http://www.nakedcapitalism.com/2015/06/the-standard-definition-of-money-is-in-error.html
greg June 30, 2015 at 2:12 pm
“Actually, we can come up with a pretty objective notion of real value. Compare an oil well to a yacht. The oil well produces oil, The oil is valuable to the members of an economy. Its products are used to provide energy and primary factors of production which drive the economy and contribute to the wealth of all the economy’s members. This is the case even if we subtract the costs to the economy, both internalized and externalized, of capitalizing the oil well and producing, processing, and consuming the oil.
Now consider the yacht. One or a few people derive a moderate increase in utility for what may be as little as a few weeks a year, for the considerable cost of capitalizing and maintaining and operating that yacht. For that yacht produces nothing else of use to the economy. For this small benefit, it is a burden on the economy and that economy, and the other members of that economy are poorer in the lost opportunity of the resources the yacht consumed and consumes. These resources could have gone to infrastructure, or education, for instance. The rest of society pays, and keeps on paying. So one can go further than say the yacht is of no value to the economy, and say that the yacht is of negative value to the rest of the economy. Yet, the distribution of demand, that is the distribution of money, gives us the yacht, instead of the high schools, or the highways.
So. If we consider money as the measure of value, then the oil well and the yacht may be of equal price, and therefore equal value. But if we consider money as a mere measure of demand, then though they may be of equal price, and therefore equal demand, they need not be of equal value.
Of course, the wealthy purchaser of the yacht may consider the value to society of that yacht to be equal to the value to society of the several high schools which perhaps could have been built instead. Who would we be to argue?”
I have reposted it here for your convenience, (It’s the last comment,) but there are many other valuable comments over there, many not mine.
Hi Greg,
ReplyDeleteThanks for responding. I've been out of the blogging game for a while now, sort of because it seems to me the mess we're in as a species is past the tipping point and will lead to collapse. Blogging doesn't really do as much as needs to be done to help. That sort of thinking has silenced me of late.
I would say demand and value are impossible to measure because they are subjective responses to commodities (and to anything at all really), each of which wholly derive its appeal and meaning from its total environment and context, not something intrinsic in it, but this need not have anything to do with conflating one with the other. Indifference and regret are difficult/impossible to measure, but there's no danger of conflating them. Indeed, what if the 'invention' of commodities in our past that conflates demand and value. Before price, we could argue that demand is desire acted on: say plucking a fruit from a tree, something like that. Today, demand is mostly manufactured, artificial, and the how of that is so complex as to be beyond full comprehension. Value is deep in that mix.
Your example of a yacht assumes capitalism (or some version thereof) as the socioeconomic backdrop. What if it, and all other luxury yachts, were managed as a commons? We know, thanks to Eleanor Ostrom's "Governing the Commons" that commons are in fact workable, and for centuries, if the society in question has developed the skills to manage scarce things that way. Then a yacht and yachts generally would have (unmeasurable) value relating to how much happiness and pleasure they give rise to, and that would relate directly to the degree to which they are demanded. And in your example, there are probably all sorts of positive effects from luxury yachts not immediately apparent when viewing the situation through an orthodox-economics lens. It's not mission creep to get zen about these things. Exlcuding stuff to get 'clean' data, filtering out 'noise' actually risks yielding a hopelessly distorted impression that is then mistaken for accurate because it looks 'clean'. (See below.)
The demand for and value of an oil well depends on a society's economic infrastructure and sense of ecosystem health, etc. The utility of oil production and refining in a society is PERHAPS positive over the short term (depending on your perspective), but horrifically negative over the long term if climate science is correct (and even then human extinction might be a good thing!). Over what time period is its utility to be measured? And what if we can argue that oil-based industry powered humanity towards renewables and powered solutions to global warming? Then oil is 'good' (from a human 'progress' point of view) in some immeasurable way. But not for all those birds and other animals caught up in oil slicks, etc. etc and how human 'progress' is wreaking havok on planetary ecosystem health. The back on forth on this kind of thing is almost endless. And some rich people are very miserly and prefer money to possessions. Or prefer the future increased price to the possession that merely reflects their 'wealth'. Etc., etc., etc.
[Cont. below]
[Cont.]
ReplyDeleteThat said, I would tend to agree or suggest that economic demand is more measurable than value because it is expressed through price. Demand in the economic sense of market activity is brought into existence by the relationships between price numbers and advertising, peer pressure and products, and results in measurable acitvity (in terms of buying and selling), and yet the entirety is hopelessly muddy because of the context, the manipulations, the corruption, etc. But then I would further qualify that qualification to the above by saying there's a logical fallacy in the expression "more measurable". Measurability is probably a binary; you either can measure a phenomenon or you can't, and attempts to measure fundamentally subjective phenomena are deceptive at best, destructive at worst (over the long term).
The latter is one aspect of how I feel about modern humanity's obsession with needing to scientifically measure everything, wherein accurate measurement appears to prove the measured thing is then somehow definitively real or understood, or now under control, tamed. That economics is desperate to be scientifically valid (as are many other disciplines) is a kind of sociocultural sickness in my opinion. It has very deep roots indeed, but came to full flower during the Enlightenment. I like Lewis Mumford's works on this topic. Here's a favourite quote:
"The ecological complexities of existence overwhelm the human mind, even though some of that richness is an integral part of man’s own nature. It is only by isolating some part of that existence for a short time that it can be momentarily grasped: we learn only from samples. By separating primary from secondary qualities, by making mathematical description the test of truth, by utilizing only a part of the human self to explore only a part of its environment, the new science successfully turned the most significant attributes of life into purely secondary phenomena, ticketed for replacement by the machine. Thus living organisms, in their most typical functions and purposes, became superfluous."
Lewis Mumford, 1970, p.68.
As Mumford would point out, science is beautiful and vital because it encourages humility and knows its place and limitations, whereas Scientism is a dogmatic religion whose ambition knows no bounds. Orthodox economics is, in my opinion, wholly subservient to the latter.
Cheers
Toby
Opps, too much hasty editing, this one slipped through: "Indeed, what if the 'invention' of commodities in our past that conflates demand and value."
ReplyDeleteIt should have read: "Indeed, what if it is the 'invention' of commodities in our past that conflates demand and value?"
I like that line: "It is Important to Determine What is Important"
ReplyDeleteI figure that most of the things economists say are true. In order to make sense, those things must be prioritized. So, as you say.
//
Yours of 19 August says in part:
Because money is merely demand, it cannot reliably yadda yadda yadda.
That post depends on this one, and since I have not worked this one out yet, I cannot grasp the other. So I came back to this one.
It occurred to me that if I borrow money to buy something, a car or whatever, maybe I could equate "money" with "demand". But no, I can't get there from here. At best, the money and the demand are *equal*. But they are not the same. The money is not the demand.
(If I borrow to buy a car, the amount of new money created may serve as a measure of my demand for the car. But now the money exists, and somebody else has it. And when they spend it, that spending may also measure demand, but no new money is created to match that demand. So the "money equals demand" calculation goes awry.)
Money serves demand, or money satisfies demand. As Bruce Wilder said in his excellent comment above, "That money makes demand effective is a critical point".
If I expand your "money is demand" back to "money is an instrument of demand" then I have to fall back again on Bruce Wilder: "money, as insurance, is not demand for any particular good. That's an important feature". Holding money "as insurance" must be what Keynes called the precautionary motive: I don't plan to buy anything with this money; I'm setting it aside just in case.
Wilder stresses the importance of it. So did Keynes.
If one is holding money with no plan to spend it, then that money is certainly not demand. It may still be an instrument of demand. In that case holding it can create problems for the economy when excessive amounts are held. But the reason it can create problems... the reason is that money is a medium of exchange. Excessive holding of money (with no plan to spend it) interferes with exchange.
(I would point out that the holders of money as savings are probably the same people who most vigorously object when the government tries to expand the quantity of money to alleviate a "medium of exchange" shortage.)
//
If I need to know about money I go to FRED and look at AMBSL or M1ADJ or something like that. Money *exists* and can be counted -- or could be counted, if we could stop the economy until the counting was done. Demand cannot be counted that way. If you stop the economy, there IS no demand... no effective demand, at least.
Hi, Arthurian.
ReplyDeleteWell, if the things economists say are based on a foundation which may be only half true, and they don't know which half is true... Micro, I'm mostly pretty much willing to concede... But macro?
//
So, just because you have demand, that doesn't mean you have to exercise it. Clearly, though, if you don't have money, you don't have demand. Well, if you own *things,* you have the things, and you also have such demand as you can get by exchanging the things for money or other things...
Anyway, right now, I'm looking at the difference between the micro and macro realities of money.
Because money is 'effective' demand, to an individual, it does have (a derived) 'value' and constitutes an asset, to that individual, and *adds* to that individual's 'effective' wealth.
But, money does not *add* to the wealth of society. The quantity of money in a society does not *add* to the *real* wealth held and created in that society. So what is happening to the value of money as we travel between these scales?
Money as *demand* on society also seems to not scale. So that at least needs to be corrected. But neither does money as *insurance.*
So regarding commodity money, that which does not get turned into commodity can be regarded as the surplus of that commodity. Of course, if the surplus is over priced, then the surplus is underused. Unless it's not very useful: Its economic value largely notional, and a store of demand, rather than a store of useful value or a productive asset.
ReplyDelete