The Theory of Money, Part 2

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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! Part 3 here.

The Theory of Money, Part 1

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I have many interests. The ones I write about on this blog are generally related to government in one way or another.

One of the government-related topics I am really interested in, but haven’t yet written about, is money. And since I’ve been thinking about it and trying to figure it out lately, I’ll share a few posts on the topic.

Let’s go back to the early days of human civilization. Farmers worked the land and were able to raise a crop and then sell the food. Blacksmiths made things and sold them. How did everyone obtain the things they needed that they couldn’t make themselves? Originally, it was through barter. For example, “I’ll give you one bushel of wheat for that cook pot.”

But simple barter of these self-produced items has a problem. If a blacksmith worked really hard and made more stuff than he could sell immediately, then he had to find space to store piles of nails and cook pots and horse shoes and swords. That’s inconvenient. Or, think of the farmer who has a nice big crop of perishable food but doesn’t need to use it to barter for anything just yet. The need arose for a more convenient way to store wealth.

Enter precious metals. They are easy to divide into smaller units, they are intrinsically valuable, they don’t spoil, they don’t take up a ton of space, their value stays remarkably constant over time. They are a great form of money! They very conveniently achieve that primary purpose of money–which is to act as a means of storing wealth. They also enable someone to conveniently transfer that wealth to others in payment for a good or service, which is another really important characteristic of anything people are going to use as money. For these reasons, many (most?) civilizations eventually landed on precious metals being the preferred commodity to use as money.

I’ll talk about the transition from precious metals money to the paper money we have today, and also how cryptocurrencies fit into all of this, in another post. But there is one more theoretical aspect of money that I want to explain in this post.

If money’s purpose is to store wealth, where does wealth come from anyway?

I’ve already said that the farmer generated his wealth from a combination of two things: the land plus his labor. This land + labor combo is the origin of all wealth. And then after that wealth had been gleaned from the earth through labor, it could then be transferred to other people, including those who didn’t glean their wealth directly from the land, through exchange. For example, the farmer would give food to the blacksmith in exchange for making him that cook pot.

These days, relatively few people are employed in direct wealth-gleaning-from-the-earth occupations, but this is still the true origin of any wealth that is had on this earth. Therefore, any money anyone has today is actually stored wealth that was originally gleaned from the earth (or, sun, in the case of solar)! Part 2 here.

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