Ok, so I’ve talked already about the purpose of money and then delved more into wealth and where it originates from and how it is distributed, and I also introduced Wealth Units (WUs) as a standard unit of wealth and showed how WUs can be used to quantify the wealth price of things.
In this post, we’ll continue on with our early Avarian society to discuss what people can do with stored wealth.
As a brief review, remember that Avaria transitioned from the barter system to using precious metals (specifically, gold pieces) as money. And remember that money fulfills two purposes in an economy: (1) common medium of exchange and (2) storage of wealth.
Let’s say that Avaria has progressed to using standardized stamped sizes of gold pieces, so they have graduated to using gold coins. This has made exchanges with money even easier because there are standardized coin sizes, so quantifying the amount of gold someone is using for payment doesn’t require a super precise scale anymore.
Now let’s check in with Avaria’s blacksmith. 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. What can he do with that excess wealth? He has three options.
Option 1: Spend it. He can finally splurge on painting his house black like he’s always wanted. By the way, spending his wealth like this means he doesn’t have it anymore, but that doesn’t mean that all of it just disappears out of society. Instead, it’s being transferred to the paint supplier and the painter in compensation for them providing those goods and services, respectively. We’ll dig into the details of when wealth is lost from society later on.
Option 2: Save it. In other words, keep those coins hidden under his loose floorboard. Or maybe he can build himself a vault to securely store it. If he chooses this, it’s not like that wealth is lost from society; it’s just not actively being circulated in society. This isn’t a bad thing because it’s serving a very specific purpose of acting as an emergency fund for him just in case an emergency happens, such as an injury that prevents him from working for a time. When people in a society save enough to be able to continue paying for themselves to live and even continue making payments on any debts they have, this provides stability to the economy of a society, so it should be seen as a very positive thing. We’ll see in future posts how destructive to a society’s wealth widespread loan defaults can be, and then it will become clear how important to a society’s economy it is for people to have an emergency fund.
Option 3: Invest it. My definition of the term “invest” is that you give up something now with the expectation of getting it back, plus more, later.
I didn’t specifically list giving away his excess wealth as an option, and that’s because I would lump that in with Option 1 and say that he’s spending his excess wealth on good feelings for himself.
Also, I see Option 2 as a kind of limbo. The money is just waiting there until the owner eventually either spends or invests it.
Anyway, about Option 3, there are actually two different kinds of investments he can make: (a) He could simply loan his money to someone and charge them interest, 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 the 10 gold coins plus 1 more (for interest) 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 Avaria town printer who owns a printing press. Or 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 he is promised a share of the profit commensurate with the percent of the business that he owns). Investments can range anywhere along this active vs. passive spectrum, and usually the more active the investment the more risk and potential reward involved. 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.
The optimal way for someone to manage their money that they don’t need to immediately spend on living expenses is to save up an adequate emergency fund first (generally 3-6 months’ worth), and then to invest enough to stay on track for being able to retire at their preferred retirement age and have enough to live on through that retirement period, and then to do whatever they want with the rest (either spend it or invest it so they can retire early if they want).
So, as Avaria becomes wealthier, more people have more excess wealth stored up in cash (gold coins), 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 immediately put that stored wealth back into circulation to be used and reused in society, and I’ve already explained how that too is a good thing.
I’ll stop there for this post. In Part 4, I’ll talk more about how wealth gets lost from society, which is the other major factor in determining the rate of overall wealth increase in a society.
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