The Theory of Money, Part 3

Image credit: dmagazine.com

Links to part 1 and part 2.

Ok, so we’ve talked already about the purpose of money and then delved more into wealth and where it originates and is distributed, and I also introduced Labor Units (LUs) as a standard unit of labor and showed how it can also be used to quantify wealth and the true price of things.

This week, we’ll continue on with our early society to discuss what we can do with stored wealth/stored Labor Units.

Remember that blacksmith? Let’s say he’s been selling a lot of items and has accumulated a lot of gold coins that he doesn’t need to use in the near future. He has a three options of what he can do with that excess wealth/stored labor.

Option 1: Spend it. He can finally splurge on painting his house black like he’s always wanted. He is consuming his stored wealth, but it doesn’t just disappear out of society because it gets transferred to the paint supplier and the painter in compensation for them providing those goods and services.

Option 2: Save it. In other words, keep those coins hidden under his loose floorboard. Or maybe there’s a vault somewhere that he can rent space in to more securely store it.

Option 3: Invest it. My definition of the term “invest” is that you give up something now with the expectation of getting back more later. So he will give up that money now expecting to get it back plus some more later.

There are actually two different kinds of investments he can make: (a) He could simply loan his money to someone, or (b) he could purchase something that will earn money for him.

The loan option is straightforward. The farmer wants to buy a new plough, so the blacksmith loans the farmer 10 gold coins to buy a plough, and then the farmer pays him back 11 gold coins after the harvest. Hopefully the plough enabled the farmer to be so much more efficient that he earned enough to pay the blacksmith back the principal plus interest. The modern equivalent to this is investing in bonds.

The “purchase something that will earn money for him” option is more flexible, and it comes down to him putting his money into some kind of business venture. Maybe he has a passion for town news and wants to start a town newspaper with the new town printer who owns a printing press. Maybe he wants to own 30% of a new mail carrying venture that his neighbor is starting. These investments could be relatively active (with him contributing his own labor, like doing all that work with his printer friend to found a newspaper) or relatively passive (like buying 30% of his neighbor’s mail carrying venture, where the only thing he’s contributing is money and we is promised a share of the profit commensurate with the percent of the business that he owns). The modern equivalent to the active investment type is starting your own business, and the modern equivalent to the passive investment type is buying stocks.

So, as a society becomes wealthier, more people have more excess wealth stored up in cash, and then they can choose among those three options what to do with it. Note that choosing to save the money (as opposed to spending or investing it) is the only option that doesn’t put that stored wealth back into circulation to be used and reused in society.

Let’s stop there for this week. Next week, I’ll talk more about how wealth gets destroyed, how much money a society needs to be able to store all its accumulated wealth, and maybe we’ll even get into the origin of banks.

The Theory of Money, Part 2

Photo by Adams Arslan on Pexels.com

Last week, I talked about the origin and purpose of money and also how new wealth is introduced into a society. This week, I want to talk more about how wealth transfers from one person to another.

As I explained before, new wealth is always being generated using the land + labor combo (i.e., the natural resources from the earth, combined with human labor, produce new wealth). We could call the people doing this work the wealth-from-the-earth-gleaners (or maybe wealth-gleaners for short). Wealth-gleaners are the original owners of all wealth in society, and then they distribute that wealth to others in exchange for the goods and services they want. In this way, the wealth of a society is both generated and distributed.

I don’t want you to assume that just because someone is the original generator/owner of wealth that it means they will automatically be wealthier than all others. Think about a farmer working a particularly infertile plot of land. He may be only generating just enough wealth (in the form of crops) to have a roof over his head and clothes on his back and food on his table, and nothing extra. This is what Adam Smith called a “subsistence wage,” when you’re earning just enough wealth to continue subsisting and that’s it. This farmer’s wealth, as limited as it is, will still be distributed to others in society when he buys things he needs from them, such as clothes or a re-thatched roof.

An interesting effect of wealth-gleaners being the original generators of new wealth in societies is that the society’s growth of total wealth is limited by how much these wealth-gleaners are generating and introducing into a society. So, if you want the total wealth of a society to grow quickly, you want the farmers and other wealth-gleaners to be rich (i.e., generating way more than just bare subsistence wealth for themselves)!

The foundational nature of labor in the generation and distribution of wealth should be clear by now. So I’m going to take advantage of this by quantifying wealth in terms of standard labor units.

*Trumpets sound*

I hereby define a new standard unit of labor, which will be known as a Labor Unit (LU), as one hour’s worth of unskilled, low-risk, average-physical-intensity work.

Let me explain that a little bit. One LU could mean an hour’s worth of a farmhand picking fruit from the orchards, or it could be the blacksmith’s assistant carrying wood for the forge and pumping the bellows, or any other labor of that ilk. If the work is especially onerous and/or dangerous and/or if it requires training and expertise, then one hour of work could generate more than 1 LU. And if it’s super easy work, it could generate less than 1 LU/hour. This should all be obvious–when I work as a physician, I make more money per hour than when I worked at Costco as a teen.

One important use of this idea of a Labor Unit is that it can quantify the cost of production of anything. If a blacksmith’s time is worth 4 LUs per hour (he is very skilled), and it takes him 1 hour to make a cook pot, the cost of labor that went into that cook pot is 4 LUs. And if the cost of the metal plus the depreciation of his shop plus cost of wood for the forge plus cost of his assistant’s time etc. all totaled to be 2 LUs, then he will break even if he exchanges the cook pot for something else worth 6 LUs. If he sells it for 7 LUs because this pot turns out especially beautiful and round, then he has made a profit of 1 LU.

The beautiful thing about LUs is that their value remains constant over time because they are defined by a constant (1 hour of non-dangerous/average-onerousness/non-skilled labor). This means that if the price of cook pots goes down over time, it’s attributable to a change in the total amount of labor required to produce one (assuming profit is the same). For example, maybe the price of metal (in LUs) has gone down because a new innovation now allows it to be procured for less labor. This would be reflected in the price of cook pots going down (assuming profit is constant).

When we quantify the price of something in money instead of Labor Units, we add an additional confounding element. For example, let’s say an ancient society is using gold coins as money, and suddenly it’s all the rage to worship golden calf statues. The demand for gold has gone up, which means the price of gold has gone up as well. So maybe a single gold coin used to be worth 1 LU, but now a single gold coin is worth 1.2 LUs. Therefore, the price of that blacksmith’s cook pot has changed! He had a price tag on it that said “7 gold coins”, but he crossed out the 7 and wrote 8.4 instead. The customers might all complain, saying he’s gouging them! But really what’s going on is that the exchange rate from LUs to gold coins has changed. The cook pot is still worth 7 LUs (cost plus profit), but since prices are never displayed in my fictitious Labor Units, we have to quantify them in money, and therefore this additional LUs:money exchange rate is integrated into every price.

The upshot of this is that any time the price of something changes, it could be due to two different things. Either the LU:money exchange rate has changed (i.e., the “listed price”), or the amount of labor required to produce the thing (i.e., the “true price”) has changed, or both.

I feel compelled to add, for anyone who’s wondering what the point of all this is, that the real-world application of these principles of money may not yet be apparent, but these are the pieces of information that will allow later discussions on inflation and government debt and the role of cryptocurrencies to make sense. We’ll get there!

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