On Money

Money is something we take for granted, but economics is complicated and it’s not as intuitive as it seems. I’m no economist, my background is engineering, but since I’ve been blogging on politics I’ve realized that misconceptions about money and economics are grossly out of whack with reality and are at the heart of the gridlock problem in Washington.

Exchange Money Conversion to Foreign Currency

Exchange Money Conversion to Foreign Currency (Photo credit: epSos.de)

What is money? Back in the hunter-gatherer days, of course, it didn’t exist, but when agriculture was invented some ten millennia ago and people got possessive about crops and animals it was only natural to come up with a system of keeping track of stuff. Money was invented in the process, and so too was writing for that matter.

Personal or family money is quite different from government money. Sure, its units are the same in each case but its management necessarily differs. One would think we would have figured it out by now but it’s commonly misunderstood.  And even when some (educated) pols surely understand the difference, that doesn’t keep them from exploiting public ignorance on the matter.

What’s a dollar worth, anyway? When you come right down to it, it is as elastic as human nature. A tangible product is worth what someone is willing to pay for it and nothing more. I know someone who recently took his vehicle to a car dealership when it wouldn’t start and they tested and fixed him up with a new battery. The bill: $240. He could have gotten one for less than half that down at the discount store.

Another persistent mechanism for elasticity is the “sale”. The ads tout: Sale! All widgets are now 50% off ! The statement is meaningless of course because it never states the basis of the percentage cut. 50% of what? For how long was it offered at the higher price? How many were sold at the higher price? These points are never addressed but the method always seems to work because people instinctively think of money as inelastic.

Another aspect of money is that it is fungible.

Fungible: n. Mutually interchangeable.

A lack of understanding of this is seen in people who come into a windfall, as by winning the lottery, getting lucky at gambling or getting an inheritance. It’s common then to see them treating the new money as though it were different from the money in their bank or savings accounts, but it isn’t. It’s all money and it all spends the same. It’s fungible. People know this, really, but it’s human nature to be in denial about it. Reality only dawns when the car breaks down or an appliance dies unexpectedly.

Where does money come from? How did it get there? Why is government’s management of money different from that of people or families? I came across an interesting blog on economics the other day in which a money-manager posted what he thinks are the ten most common MYTHS about money. I’ll list them here with a brief comment for for some of them.  You may wish to visit the site for more on those with only a title.

1. The government prints money. Well, of course it does, but this doesn’t mean it actually creates value out of thin air. Most money in the system exists “ . . . because banks created it through the loan creation process. The only money the government really creates is due to the process of notes and coin creation.” Remember, money is nothing more or less than a system of keeping track of stuff, and when a government manages it, it is managing accounting and not creating stuff. We individuals, on the other hand, are strictly affected by the money values assigned to that stuff, as in salaries and loans and mortgages.

2)  Banks “lend reserves”.

3. The US government is running out of money and must pay back the national debt. Not really.  An economy runs on debt and needs it. All that money out there sloshing around is just an accounting system that keeps the flow of trade, work and acquisition of stuff going in a way that benefits people. Sure, there is the danger that too much currency will create inflation or that deflation will result in mass unemployment, but that’s exactly why the money supply needs to be managed. They found out in the Great Depression what happens when it isn’t managed and austerity is applied. If there’s too little money, commercial activity declines and workers are laid off.

4. The national debt is a burden that will ruin our children’s futures. This is very misleading, simply because of the elasticity of money.  The author says “ . . . at a macro level debt doesn’t get ‘paid back’. In a credit based monetary system debt is likely to expand and contract, but generally expand as the economy expands and balance sheets grow.” That’s not to say the money supply can’t be mismanaged – of course it can and that can result in rampant inflation, or deflation for that matter. But, TARP and the Detroit bail-out worked, both good examples of necessary management. Bottom line, debt is a vital part of managing an economy – it wouldn’t work without it.

5)  QE is inflationary “money printing” and/or “debt monetization”.

6)  Hyperinflation is caused by “money printing”.

7. Government spending drives up interest rates . . .   Many economists believe that government spending “crowds out” private investment by forcing the private sector to compete for bonds in the mythical “loanable funds market”. The last 5 years blew huge holes in this concept. As the US government’s spending and deficits rose interest rates continue to drop like a rock. Clearly, government spending doesn’t necessarily drive up interest rates.

8)  The Fed was created by a secret cabal of bankers to wreck the US economy.

9. Fallacy of composition. This is the author’s term for thinking the government’s money-management is the same as the individual’s. He calls it “the biggest mistake in modern macroeconomics”.

And finally, the author delivers this remarkable statement, one that I hope every reader will take to heart:

10) Economics is a science. Nope. “Economics is often thought of as a science when the reality is that most of economics is just politics masquerading as operational facts. Keynesians will tell you that the government needs to spend more to generate better outcomes. Monetarists will tell you the Fed needs to execute a more independent and laissez-fairre policy approach through its various policies. Austrians will tell you that the government is bad and needs to be eliminated or reduced. All of these ‘schools’ derive many of their understandings by constructing a political perspective and then adhering a world view around these biased perspectives.“

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About Jim Wheeler

U. S. Naval Academy, BS, Engineering, 1959; Naval line officer and submariner, 1959 -1981, Commander, USN; The George Washington U., MSA, Management Eng.; Aerospace Engineer, 1981-1999; Resident Gadfly, 1999 - present. Political affiliation: Independent, tending progressive as the GOP recedes from its Eisenhower roots.
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2 Responses to On Money

  1. aFrankAngle says:

    Good stuff … the post that is … but so is money. 😉

    I’ve always thought of money as an accepted medium of exchange. After all, if the government printed it but nobody accepted it, it;s worthless!

    Meanwhile, I’ll take the opposite side on economics as science because they use variables and assumptions. Just like science, one variable and then all these assumptions … BUT … just like science, if one variable is off, then the conclusion isn’t validate … and good luck finding an economic system with only one variable and all the assumptions in place.

    Like

    • Jim Wheeler says:

      Right, Frank. It is all too human and downright irresistible not to think of money as something valuable in its own right. But it’s not much more substantial than a scribbled note. It’s a little scary that it is a principal bulwark of civility, that thin veneer of behavior that separates us from the animals.

      Relative to the science question, I went back and looked up the reference that Cullen Roche provided for his item 10 and found this really excellent NYT op-ed on the subject.

      Thanks for chiming in!

      Like

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