On the value of money

If you ask people about the meaning of money they will either give you the textbook definition of the three roles, given that they are litarate in basic economics, or give you a very confused look. In one form or another, we used it every day for several millenia, yet most of us have never concieved the true meaning of it. ‘I can buy stuff with it, and that’s more than enought to know.’

Except it is not. Approximately a century ago economic litarature and interests were sufficiently developed to examine the phenomenon of inflation, or the change in the value of a monetary unit. The aftermath of a great wars of the 20th century served with the extreme real life experiment for the next decades. Fisher argued that the source of all evil is the changing nature the ‘monetary yardstick’, gold standard must be reestablished, and prices should be fixed. A couple of years later Keynes found that the source of all evil is indeed the change in the ‘price of money’, yet the solution is the manage the change, and let prices float.

But what is this price we are arguing about? Money, whatever form it takes, is a debt. If you own it you have saved, the market (meaning the group of users of the currency) owes you one, while if it is presented the seller supposed to settle the debt. Default is an option too, though it will erode the market. Hence the price of the debt is all the goods it can be redeemed for. Fisher’s dream, that every debt should be settled in commodities, actually has been in place since the beginnings. It’s just the ratio which tends to flucuate. If one can be certain that the debt will be settled, trust is high, capacity exceeds needs the price of money (not to be confused with price of goods!) goes up. If doubts arise about future shipments, vendors quit the market, or productive capacity destructed the price of money goes down, inflation picks up.

On velocity of money and willingess to exchange

Since capacity/consumption/GDP all measured over time and money is just a plain number/stock, we have to convert it to be able to make an apples-to-apples comparision. For this reason economists created the term ‘velocity’ of money, which means the amount of occasions money changed its owner within certain period of time.

Eventually this circulation will determine the price of money. As mentioned above money can be redeemed. Holders of the money stock must be willing to redeem their previous savings, otherwise a vast amount of goods will compete for scarce amount money, increasing the price of money. This in return will make it a good investment, further decreasing willingness to exchange money for goods (increase willingess to sell goods for money), creating a deflationary spiral. In such an environment the amount of money did not change, only the willingness to give it away, indicated by lower velocity numbers.

What Keynesian policy smartly included and contemporary policy is lacking is this willingness. The owner of the newly printed money must spend it, optimally without creating new capacity. In the 30s the governments did not only create the stock, but also velocity and artificial willingness (inducing further willingess on behalf of the private sector and kickstarting economic circulation). If you ever wonder why this time is different, look for this hidden feature of monetary policy conduct, and the austerity measures of governments. The real game changer for markets won’t be the extra stock, but the increased willingness to spend.

 

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s