Making the case for a Credit Contraction, Deflationary Depression.
There is much confusion as to what is going on in the world economy. The reason there is so much confusion is because most of us do not understand the three interdependent concepts of Money. Money and its use did not develop in a vacuum; it came about from the myriad of trials and errors our ancestors experienced in their daily exchanges with each other in times passed. Before we can understand where we are today, we must first understand where we came from.
Three Concepts of Money.
There are three concepts that are encapsulated in what we call Money, they are:
1. Medium-of-Exchange
2. Unit-of-Accounting.
3. Storage-of-Value.
We will address each of the three concepts so we can finally understand where we are today and better predict where we are heading economically.
First of all, let’s understand what a concept is. Dictionary.com defines a concept as follows:
http://dictionary.reference.com/browse/concept
Concept:
–noun
1. a general notion or idea; conception.
2. an idea of something formed by mentally combining all its characteristics or particulars; a construct.
3. a directly conceived or intuited object of thought.
–verb (used with object) 4. Informal. to develop a concept of; conceive: “Experts pooled their talents to concept the new car.”
We can see from the above definition that a concept is an idea that came about from our process of thinking. How do we get an idea into our physical world, or better said, how do we get something from our head to become real? Simple, we will it so. You by taking the necessary action on a belief or idea can make things happen as long as your concept or idea can take place according to the Laws of Physics or the Laws of the Universe. Pretty deep stuff huh? Don’t worry, it is not that complicated. We are born ignorant, that is, we are born not knowing about how the world around us works. Each of us is responsible for finding out what are the rules or Laws of the Universe that govern our existence in this world.
Imagine this, if you were the only one on the planet, you would not need Money. Why? Because you would not have anyone to trade goods or services with. You would have to do everything for yourself and produce everything you need for your survival from the natural resources of the Earth. You can now see that in order for the first concept of Money to come about you need more than one Individual. Ok, so let’s say there are two or more individuals, (For simplicity, we will not address political systems where one may coerce another with violence.) at the most basic level these individuals trade with each other by barter, that is to say, if one is a farmer, the other a rancher and another a fisherman, they can exchange their goods directly for those of the others. Problems arise in barter when the goods to be exchanged are not proportional to each others subjective assigned value or the other individual may not want what the other has to offer. A rancher may value his cow higher than his want for a couple of pounds of fish, while the fisherman may only want a couple of pounds of beef, ( See barter here: http://en.wikipedia.org/wiki/Barter ) or the rancher wants fish, but the fisherman does not want beef.
Medium-of-Exchange
Here is where we introduce the first concept of Money, that of a Medium-of-Exchange. Our medium of exchange must have certain characteristics, some of which are:
1. It must be transportable.
2. It must be divisible.
3. It must not be easily counterfeited.
4. It must be able to carry a high value to its inherent volume and mass.
( See Medium-of-Exchange here: http://en.wikipedia.org/wiki/Medium_of_exchange )
So how can we find a suitable medium-of-exchange? Well, our ancestors found it by experience, they tried using many things but the most qualified turned out to be a metal called Gold.
GOLD
Gold was found to be easily transportable, divisible; not able to be counterfeited, and could carry lots of value in a small size. It was because of Gold’s limited quantity on the Earth that enabled our ancestors the ability to set an arbitrary Monetary Unit. It would have been very hard for them to assign to any element a specific value as a Monetary Unit without reference to something else. As you would have it, it was Gold’s specific attributes that enable our ancestors to use Gold as the reference of value to the abstract concept of medium-of-exchange. Gold by virtue of its limited quantity divided by certain unit of measure could be used to set the price for other elements or products; and even time. To this very day and age, Gold is still the standard by which we can set our prices in relation to all the other elements.
By using Gold and a standard unit of measure our ancestors gave birth to the second concept of Money. They found out that they could account for other elements in terms of units of Gold. But weighting Gold was tedious and time consuming, they found out that they could make a certain quantity of Gold a standard unit of measure which easily became a standard unit of accounting. They progressed to minting coins. Gold’s limited quantity restricted the number of coins that could be made, therefore something else needed to be used in addition to Gold for use as a medium of exchange, hence, the use of Silver in relation to Gold.
By minting a standard Silver coin and assigning it a fractional value to that of a Gold coin they could expand their quantity of medium of exchange. For example, they could have one ounce of Gold equal ten ounces of Silver. This of course is not perfect, since Gold and Silver are two different elements, their proportions and ratios to each other can fluctuate. This caused prices to vary in reference to the two different elements.
Unit-of-Accounting
Once we have our medium-of-exchange we need to assign a Monetary Unit value to it, in the case of Gold we derive its Monetary Unit from its physical characteristics. Let’s say 1 ounce of Gold equals one Monetary Unit. This becomes our unit of accounting, which we can measure other element prices in reference to Gold. For example, we can say 1 Monetary Unit equal 1 ounce of Gold. So if we say, ten ounces of Silver equal one ounce of Gold, we have set our price of Silver ten times in relation to one Monetary Unit of Gold (1 Gold Ounce).
Now, let’s go back in time. We are camel sellers somewhere in the South Mediterranean. We have the latest and greatest model camel with humps and chromed hooves for a splendid price of 15 ounces of Silver. In comes Ahmed from the desert looking for a reliable camel. We showed him our models and after much haggling we settle on a price; we sell him a chromed three humped camel for 14 and a half ounces of Silver, we even throw in a new extra harness and manure catch bag (for used down-town in the village). Well, Ahmed has only two Silver coins weighting one ounce each and a bunch of small nuggets of Gold. After weighting the Gold, we find that Ahmed has 1 and three quarters of an ounce of Gold. We look up the day’s exchange rate of Gold and Silver on our daily sheepskin roll and find out that Rafik the money changer is accepting raw Gold at 1 ounce of Silver for 1/10 ounce of Gold. We do our quick math on our trusty abacus and charge Ahmed one and a half ounces of Gold. We charge Ahmed the additional 1/20th ounce of Gold for documentation and services fee.
Most of our local trade is made in Silver, so in order not to forget, we get a piece of parchment and write down our figures to the sale made to Ahmed. Since Lucca Paccioli has not popularized the double entry accounting system yet, we go ahead and write on our books:
Sold to Ahmed 1 camel for 1.5 OzT Gold or equivalent to 15 OzT Silver.
We need to find out how much we made on our deal with Ahmed, we tally up the costs, taxes and expenses and everything comes out to 12 ounces of Silver. Since we have a conversion ratio of 10 ounces of Silver to one of Gold, we find that we made three tens of an ounce of Gold or equal to 3 ounces of Silver. Not a bad 20% profit. We like selling camels.
Using the ounce of Gold as a reference, we can now plan and account to see how much potential business we can do and from there project our future profits.
The fundamental thing to note here is that we have taken something physical and drawn from it another concept, and that is the concept of a unit-of-account.
Storage-of-Value
The next concept is that of the storage-of-value. Once you had Gold, you could take it with you and trade with it. But if you did not need to use the Gold you could store it. Storing the Gold had the effect of making it more valuable, because there was less to trade with and could not be used effectively as a medium-of-exchange. Since no one can make Gold out of nothing, Gold retained its value, making it an excellent storage-of-value.
Three Concepts of Money.
There are three concepts that are encapsulated in what we call Money, they are:
1. Medium-of-Exchange
2. Unit-of-Accounting.
3. Storage-of-Value.
We will address each of the three concepts so we can finally understand where we are today and better predict where we are heading economically.
First of all, let’s understand what a concept is. Dictionary.com defines a concept as follows:
http://dictionary.reference.com/browse/concept
Concept:
–noun
1. a general notion or idea; conception.
2. an idea of something formed by mentally combining all its characteristics or particulars; a construct.
3. a directly conceived or intuited object of thought.
–verb (used with object) 4. Informal. to develop a concept of; conceive: “Experts pooled their talents to concept the new car.”
We can see from the above definition that a concept is an idea that came about from our process of thinking. How do we get an idea into our physical world, or better said, how do we get something from our head to become real? Simple, we will it so. You by taking the necessary action on a belief or idea can make things happen as long as your concept or idea can take place according to the Laws of Physics or the Laws of the Universe. Pretty deep stuff huh? Don’t worry, it is not that complicated. We are born ignorant, that is, we are born not knowing about how the world around us works. Each of us is responsible for finding out what are the rules or Laws of the Universe that govern our existence in this world.
Imagine this, if you were the only one on the planet, you would not need Money. Why? Because you would not have anyone to trade goods or services with. You would have to do everything for yourself and produce everything you need for your survival from the natural resources of the Earth. You can now see that in order for the first concept of Money to come about you need more than one Individual. Ok, so let’s say there are two or more individuals, (For simplicity, we will not address political systems where one may coerce another with violence.) at the most basic level these individuals trade with each other by barter, that is to say, if one is a farmer, the other a rancher and another a fisherman, they can exchange their goods directly for those of the others. Problems arise in barter when the goods to be exchanged are not proportional to each others subjective assigned value or the other individual may not want what the other has to offer. A rancher may value his cow higher than his want for a couple of pounds of fish, while the fisherman may only want a couple of pounds of beef, ( See barter here: http://en.wikipedia.org/wiki/Barter ) or the rancher wants fish, but the fisherman does not want beef.
Medium-of-Exchange
Here is where we introduce the first concept of Money, that of a Medium-of-Exchange. Our medium of exchange must have certain characteristics, some of which are:
1. It must be transportable.
2. It must be divisible.
3. It must not be easily counterfeited.
4. It must be able to carry a high value to its inherent volume and mass.
( See Medium-of-Exchange here: http://en.wikipedia.org/wiki/Medium_of_exchange )
So how can we find a suitable medium-of-exchange? Well, our ancestors found it by experience, they tried using many things but the most qualified turned out to be a metal called Gold.
GOLD
Gold was found to be easily transportable, divisible; not able to be counterfeited, and could carry lots of value in a small size. It was because of Gold’s limited quantity on the Earth that enabled our ancestors the ability to set an arbitrary Monetary Unit. It would have been very hard for them to assign to any element a specific value as a Monetary Unit without reference to something else. As you would have it, it was Gold’s specific attributes that enable our ancestors to use Gold as the reference of value to the abstract concept of medium-of-exchange. Gold by virtue of its limited quantity divided by certain unit of measure could be used to set the price for other elements or products; and even time. To this very day and age, Gold is still the standard by which we can set our prices in relation to all the other elements.
By using Gold and a standard unit of measure our ancestors gave birth to the second concept of Money. They found out that they could account for other elements in terms of units of Gold. But weighting Gold was tedious and time consuming, they found out that they could make a certain quantity of Gold a standard unit of measure which easily became a standard unit of accounting. They progressed to minting coins. Gold’s limited quantity restricted the number of coins that could be made, therefore something else needed to be used in addition to Gold for use as a medium of exchange, hence, the use of Silver in relation to Gold.
By minting a standard Silver coin and assigning it a fractional value to that of a Gold coin they could expand their quantity of medium of exchange. For example, they could have one ounce of Gold equal ten ounces of Silver. This of course is not perfect, since Gold and Silver are two different elements, their proportions and ratios to each other can fluctuate. This caused prices to vary in reference to the two different elements.
Unit-of-Accounting
Once we have our medium-of-exchange we need to assign a Monetary Unit value to it, in the case of Gold we derive its Monetary Unit from its physical characteristics. Let’s say 1 ounce of Gold equals one Monetary Unit. This becomes our unit of accounting, which we can measure other element prices in reference to Gold. For example, we can say 1 Monetary Unit equal 1 ounce of Gold. So if we say, ten ounces of Silver equal one ounce of Gold, we have set our price of Silver ten times in relation to one Monetary Unit of Gold (1 Gold Ounce).
Now, let’s go back in time. We are camel sellers somewhere in the South Mediterranean. We have the latest and greatest model camel with humps and chromed hooves for a splendid price of 15 ounces of Silver. In comes Ahmed from the desert looking for a reliable camel. We showed him our models and after much haggling we settle on a price; we sell him a chromed three humped camel for 14 and a half ounces of Silver, we even throw in a new extra harness and manure catch bag (for used down-town in the village). Well, Ahmed has only two Silver coins weighting one ounce each and a bunch of small nuggets of Gold. After weighting the Gold, we find that Ahmed has 1 and three quarters of an ounce of Gold. We look up the day’s exchange rate of Gold and Silver on our daily sheepskin roll and find out that Rafik the money changer is accepting raw Gold at 1 ounce of Silver for 1/10 ounce of Gold. We do our quick math on our trusty abacus and charge Ahmed one and a half ounces of Gold. We charge Ahmed the additional 1/20th ounce of Gold for documentation and services fee.
Most of our local trade is made in Silver, so in order not to forget, we get a piece of parchment and write down our figures to the sale made to Ahmed. Since Lucca Paccioli has not popularized the double entry accounting system yet, we go ahead and write on our books:
Sold to Ahmed 1 camel for 1.5 OzT Gold or equivalent to 15 OzT Silver.
We need to find out how much we made on our deal with Ahmed, we tally up the costs, taxes and expenses and everything comes out to 12 ounces of Silver. Since we have a conversion ratio of 10 ounces of Silver to one of Gold, we find that we made three tens of an ounce of Gold or equal to 3 ounces of Silver. Not a bad 20% profit. We like selling camels.
Using the ounce of Gold as a reference, we can now plan and account to see how much potential business we can do and from there project our future profits.
The fundamental thing to note here is that we have taken something physical and drawn from it another concept, and that is the concept of a unit-of-account.
Storage-of-Value
The next concept is that of the storage-of-value. Once you had Gold, you could take it with you and trade with it. But if you did not need to use the Gold you could store it. Storing the Gold had the effect of making it more valuable, because there was less to trade with and could not be used effectively as a medium-of-exchange. Since no one can make Gold out of nothing, Gold retained its value, making it an excellent storage-of-value.
posted by TheMerchant at 6:35 AM
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