06 August 2009

All that glitters...

I have to admit that I am musing on the topic of money and economics lately. Not just fiat money, you know, the folding stuff in your wallet that you spend. I am considering why gold has value.

There are two commonly held views as to why money has value:

1. Social convention--People are willing to accept it as payment.
2. Government decree--The government says so (Fiat money).

The first reason, that being that money has value because people are willing to accept it as payment is nothing more than a circular argument. It states that money has value because it is accepted. Why is it accepted? ...because it has value!

The second belief is also false. As history reveals, there are many country currencies that have suffered through hyperinflation or complete collapse click here.

Right now we are witnessing the collapse of the world economic system which is causing great grief to governments. The problem is what is going to replace it. Not to mention there is fierce resistance from the "haves" who see their power waning as their wealth becomes worthless.

Money originally started out as a commodity. Originally, people exchanged goods according to their wants and needs with one another. Examples of commodities that have been used as mediums of exchange include gold, silver, copper, salt, peppercorns, large stones, decorated belts, shells, alcohol, cigarettes, cannabis, candy, barley etc. These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or price system economies. The problem is that it makes trade difficult, so along came a medium of exchange that eventually became money.

Money has to fulfill three things to be useful:

1. It is a medium of exchange.
2. It is a store of value.
3. It is a unit of account.

Now the real hitch is value. The title of this comes from the fact that I read that gold has no real value. I read somewhere that gold's value is subjective. That is
1) The item is useful in satisfying human wants, therefore it is desirable
2) There is a limited supply to satisfy demand.
3) We are told it is valuable even though it can't be eaten, worn, or very useful.

There are actually three types of value in economics, Objective, Subjective, and relative. Objective value is a value set by a marketplace such as a commodities exchange and is otherwise known as market value. It's a bit like the social convention that says "gold is valuable because people find value in gold". Relative value is the attractiveness measured in terms of utility for a given instrument of exchange.

Although value in general is relative. That is even if gold has a market value (Objective), it doesn't matter whether you think it's valuable or not (subjective), it does not affect its objective value. However, the situation in which the gold is supposed to be of value does matter, because value in general is relative to individual and circumstances. For instance to person X, who happens to be stranded on a desert island, gold is not valuable. Its value to him is still objective. That is it won't all of a sudden change price because he decides so, that's a market force. But relative to him the value of gold is, objectively, zero since it isn't useful for exchange. That is there is no utilty to gold.

So, in a situation where the currency has colapsed and one needs food, which is more valuable to the person with food: gold or something they need?

I like to quote the TV show "Jute City": Money in of itself isn't evil, its when people take it from a medium of exchange and make it into a commodity that it becomes evil. Probably more of a paraphrase than a quote, but you get the idea. There is a cruder version of this which is "money is like shit, it's useless unless it's spread around."

Part of the problem is that people have been wanting to accumulate far more money and things than they need. That means the rest of us are stuck in an economic form of musical chairs since the economy is really based upon debt. I know, I just did a literary no-no by introducing debt into this mix about money and value. But really the fiat money has been backed by debt and not by value for some time now. That is the reason for the seeming economic fluctuations. Although to be quite honest, the economy has been in recovery for quite some time now: at least since Reagan-Thatcher came into office.

Why are so many people having trouble making ends meet given the economic recoveries?

Actually, the economic situation is like a game of musical chairs and the recoveries have just been changes of songs.

But the real gist of this is that the gold out there is worthless if it can't be spent. It's nice to think something has value until you try to sell it.

Then you really see the market forces kick in.