According to this manifesto, there exactly four functions of government:
- To protect people’s health and property
- To oversee natural utilities, and one-of-a-kind goods (these topics are related via Georgism)
- To neutrally promote the creation and availability of information
- To maintain a national currency
This section will cover #4. After this post, the manifesto will have two more posts covering odds and ends.
In this post, I will overview the functions of currency. I will also explain why I consider it a function of government.
Do you want to read something interesting about money? Skip this post. Read this post instead. Damn, that was a good post.
So, to cut to the chase: a good currency is uniform, durable, portable, divisible, scarce, and accepted.
Instead of strict definitions, I’ll provided related thoughts.
Suppose I’m comparing the size of fruits and vegetables. I can compare their sizes directly. I can say, “my orange is about as large as 2 and 1/2 tomatoes, and my apple is about as large as 1 and 1/4 oranges.” But what if I want to know how my apple compares to my tomato? I have to either make another comparison, or do algebra.
That’s manageable with just three foods, but what if I want to compare a pile of 1000 vegetables? That’s 999 + 998 + 997 … + 1 comparisons. There must be an easier way. Fortunately, there is. It’s called centimeters and inches.
Centimeters and inches are a uniform standard. Every inch is the same as every other inch. I’m no longer comparing fruits to whatever other fruits are in the vicinity. I’m comparing them to broader standards. If I say, “my tomato is 3 and 1/2 inches,” everyone knows what I mean.
The former system corresponds to bartering, while the latter system corresponds to a uniform standard of currency. A dollar provides much the same value as a ruler.
Suppose I want to trade TVs for sofas in the bartering system. Under such a trade, I gain sofas at the same time that I loose TVs.
But the durability of money allows it to be saved. This way, you can make one-sided trades. I can lose TVs, then wait 5 years, then use my credit (money) to gain sofas from a different vendor. That is saving, and can last as long as the currency retains its value.
This is a huge logistical boost. Imagine if you had to transport goods to the market for trading every time you wanted to buy something. I would rarely trade anything. Money, by contrast, is portable, which makes it easy to bring to the market.
Money creates a separation between customer and seller. This is useful, because a customer doesn’t necessarily want to act as a seller. It’s easier to buy and sell separately.
Suppose I want to trade a TV with my friend who sells sofas. I figure my TV is worth more than a sofa. How much more? Maybe I decide one TV is worth 2.5 sofas. How do we make this trade? Does my friend trade me half a sofa? Do I sell my friend 2/5 of a TV?
There is value lost in any case. Money by contrast is divisible, which makes transactions more precise and efficient.
I can deduce the following equation to calculate the value of a currency (people who derived this equation separately may have different letters for the variables);
P = V / (S * M)
P = value of the currency
V = value of all goods and services bought with the currency
S = amount of the currency in circulation
M = a multiplier, based on the savings rate, or how many times money changes hands during the time frame in question
This equation is so purely logical that it’s hard to explain it; it’s hard to make it more simple than it already is.
Basically, all of a currency in circulation is being traded for all the goods in its purview. If 2% of all the value in the world was bound up in a single property, the price of that property would be 2% of the money in circulation (adjusted for M of course). When S rises, that 2% becomes more than it was before. That’s called inflation. If V doubled and S stayed the same, that 2% decreases to 1%. That’s called deflation.
Inflation can be viewed as a tax on savings. The introduction of new currency waters down the existing currency. That’s unfair to people who fairly acquired their existing currency, only to see its value reduced.
Deflation is like the opposite, a subsidy for savings. That’s unfair to the people who are doing the hard work of creating goods and services which increases V, only to get reduced sales because everyone is busy saving.
It is important to note feedback mechanisms here. Take for example the deflationary spiral:
Deflation –> subsidy on savings –> money is bound up in savings –> nobody spends –> no sales –> businesses fail to pay their workers –> workers have less money –> nobody spends –> repeat from there
V is essentially GDP. GDP tends to rise over time because information is always increasing (technology being a type of information). If the money supply doesn’t rise proportionately, then deflation will occur. So, to ward off both inflation and deflation, the following axiom should be followed:
The amount of new money created should equal, as closely as possible, to projected GDP growth.
Are there any exceptions?
Well, if inflation is a tax on savings, you may actually want that. A tax is a tax. Deflation, on the other hand, is generally undesirable, because the currency will fail to act as a currency.
When the growth in S fails to keep up with the growth in V, the currency starts to work more like a speculative stock, and less in a way to actually facilitate transactions. This is what happened to Bitcoin. When is the last time you saw someone at the grocery store buying food with Bitcoin? Exactly. Bitcoin has some value, but as an electronic gold substitute, not an actual currency.
In the past, we had a gold standard. Today, we have debt-backed currency. Which of these is better? Well, as a matter of fact, you don’t need either of these things! It doesn’t matter if a currency is backed by debt, or gold! These are merely self-imposed (and, in my opinion, counterproductive) constraints. The only thing that matters is that ΔS≈ ΔV.
In the words of Henry George:
The truth of the matter is that the power to issue money is a valuable privilege which, to secure the best circulating medium and to put all citizens on a footing of equality, ought to be retained by the general government, and to be permitted to no one else, either individual or corporation. The greenbackers, who have insisted that national bank notes should not be permitted, and that all money should be the direct issue of the government [not a central bank], are in the right. It is a pity that so many greenbackers [proponents of the gold standard] permit themselves to be used by the silver men, instead of insisting on their own principles. If we want two millions of notes issued every month, let them be greenbacks, and let the two millions now expended in buying silver be saved.
Nothing can be clearer than that the silver notes now in circulation do not derive their value from the silver which is supposed to be corded up in the treasury to redeem them. For they circulate at one hundred cents on the dollar, whereas the silver that is supposed to be lying in the treasury vaults for their redemption is only seventy-two cents’ worth. They would circulate just as well as if there were no silver in the treasury, and we might as well sell that silver off or put it to some more sensible use than hoarding it—say, for the construction of long-distance telephone wires for the post office department. And what is true of silver is true of gold. It is the credit of the government that furnishes the real basis for our paper money, not any deposit in government vaults.
Incidentally, it was by following this strategy that Germany restored the needed economic strength to initiate WWII (let’s ignore the connection to Hitler).
The value of money is a social construct.
Half of the things that are called social constructs are actually not. Sex is not a social construct. Race is not a social construct.
The value of money is a social construct, because money is not intrinsically valuable. Money is only valuable because society believes it’s valuable. This is a network effect. The value of money depends on the coordination of people who agree to use it for transactions, under the trust that others will do the same.
Due to the network properties of money, only one will come to dominate a region. The network effects are a barrier to entry for new currencies. One currency will have a local monopoly.
But then there is a big conundrum. If money gets its value from a network of trust, but the money supply must increase with GDP, then who prints the money?
We can’t let just anyone print money, for two reasons.
First, a very specific amount of money needs to be printed to ward off both inflation and deflation. That needs to be coordinated.
Second, the printed money must serve the interests of the general economy, not to enrich whoever prints it. Imagine if the money printing was controlled by an ordinary corporation, and what type of corruption that would invite. The corporation would sell out the economy to enrich itself.
Hence, the final function of government is to print the money, in such a way that does not enrich special interest groups, but that of the whole population. The government can also regulate financial transactions, insofar as they fall under “too big to fail,” putting the whole economy at risk.