Friday, October 11, 2013

New Kinds of Money

This is not a post about the new $100 bill - it's a little more theoretical.

Let me preface this by saying that I have no training in economics except for two basic undergraduate courses. But I am pretty decent with numbers, so I allow myself to think I have some understanding of the economy. Given the reputation of economists these days, my ideas might even be worth more than theirs!

Economies have bubbles. Just in the last 15 years, we've gone through the dot-com bubble and the housing bubble. We may well be in a stock market bubble right now. But what is a bubble?

Let's back up and think about what money is. Money is something that has a lot more exchange value than consumption value. US currency is just pieces of paper. Maybe a big pile of it could keep you warm if you lit it on fire, but its real value is that it can be exchanged for things you can consume.  

Somebody will say the distinction between consumption value and exchange value is an illusion. What I mean is that the value of things you need to live, like food, has a floor. A mass panic could cause the value of gold to fall to zero tomorrow. The value of food can rise due to fads and rumors, just like gold, but it will never fall to zero, because people must eat. The value of farm equipment is partly tied to the value of food, and so on up the chain. By the time you get to the end of the chain, you have stuff like Beanie Babies, whose value has nothing to do with consumption. They are a pure exchange good subject to panic-driven bubbles and busts.
If you're still with me, it's time for the bombshell: money is the perfect bubble. Its value is solely determined by human psychology (except, to a very limited extent, when it's on a gold standard.) But, you say, if money is a bubble, why doesn't its value fluctuate in wild and unpredictable ways? Well, sometimes it does - ask anyone who lived in Argentina in 1990. And second, natural fluctuations in its value can be counteracted by a central bank with the legal ability to print money or "destroy" it by selling securities. I don't know about you, but knowing that government policy may be the only thing keeping the value of money stable doesn't provide much comfort.

But if money is a bubble, then bubbles are money. Bubbles in things like Beanie Babies or dot-com stocks boil down to the economy spontaneously creating new kinds of money --- goods that solely have exchange value. It's against the law to print your own money, but if you could somehow orchestrate a bubble in, say, tulip bulbs, it would be just like printing your own money. So it shouldn't be surprising that people are always trying to do it.    

The thing people don't like about bubbles is their instability. Values get far above the floor provided by essential human needs, so they can fluctuate wildly. All it takes is a fast-spreading rumor and suddenly your Beanie Babies are worthless, even though they're just as cute and cuddly as when you bought them. Given that, I think we can all agree that it would be a very good thing if my claim that money is a bubble were to be totally wrong.

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