Making Money

January 4, 1999 marks the creation of the Euro, a common currency used throughout the European Economic Community.  As an economist, I love to talk about money.  The concept is, when fully understood, both awesome and terrifying.  Understanding this may also give us some cautionary ideas about the Euro.

            There is a great deal that money cannot do.  You can’t eat it, wear it to keep warm, cure yourself by taking it as a pill or read it and make yourself wiser. Money, as a discrete entity is not a useful item.  It is only when we use it as a medium of exchange that it reflects function.  But its worth as a medium of exchange is entirely based on trust.

            Money is a social construct.  What is more, it is the social construct of an evolved, sentient creature.  Humans started as hunter/gatherers.  They needed food and shelter so they went out and procured it daily.  Sooner or later their group structure became solid enough that they saw—and trusted—the advantages of trade.  The best hunter could catch rabbits all day and trade his excess for the sharp tools created by the best flint knapper in the village.  People who were good at gardening traded grains for textiles from the best weavers.  But it is always hard to compare apples to oranges.  How much grain equals a fresh caught fish?  How many garments are worth a well thatched roof?  Can you find someone who needs your bread at the same time you need their pottery?  Bargaining requires what economists call a “coincidence of wants.” 

            This problem was partially solved by trusting in the promise of a commodity. 

Alpha says: “It takes three days to knapp an arrow point but I need meat today.  If you provide my family a fish, bird or rabbit each day this week I will give you two beautiful arrow points.”

Beta replies: “For that much meat I will need two arrow points and a knife blade.”

Alpha: “That’s a deal.”

Now work is being made for a promise accepted by both parties.  Suppose that Beta, knowing he is getting two arrow points and a blade, now decides he needs some moccasins.  Beta goes to Gamma and promises him a knife blade on Tuesday for a moccasin today.  If Gamma trusts Beta, he gives him the moccasins. 

But the world became more populous and less personal.  Just as barter was insufficient even for a small group, oral and written promises became insufficient for larger communities.  As people transferred their trust in family to clan…to town…to region…to country, they also transferred their trust to a commonly accepted medium of exchange.  Currency came to represent a store of universal wealth.

            Originally money was representative of a commodity, traditionally gold or silver.  But a gold standard makes inflation more inflationary and depression deeper.  Such a monetary choice makes as much sense as “bleeding” someone who has lost too much blood.  In modern times, we use fiat money.  That is, it is money because the government says it is money. 

            We, as a society, trust (there is that word again) that our currency is a predictable store of exchangeable wealth.  We trust that the government which created this currency will guard its value, husband its growth and treat it with the respect that assures its integrity.  It is hard enough to control one government in this incredible task of trust-based management, let alone multiple governments each with its own history, goals and governing personality.  That makes the Euro a canary in the coal mine. 

            Learn a little economics and keep the faith.