Exchange

On the Utitility of Money

Hans in Luck

If you have children, you must read them 'Hans in Luck' by the Grimm Brothers. It is probably the most underrated tale in their collection. Here is how it goes:

While returning home after his apprenticeship, Hans trades his hard-earned gold lump again and again, for a horse, cow, pig, goose, and finally a whetstone. Each time he feels better off. At last, he loses even the heavy whetstone and feels ... unburdened. He arrives at home, believing himself 'the luckiest of all'.

When I heard this tale first, I hated it. Hans seemed incredibly gullible, a fool. So, why do I now think it important?

Some claim it shows that happiness does not always come from wealth, that sometimes it comes from letting go. You'll own nothing and be happy!

I think this degrowther framing misses the point. In truth, 'Hans in Luck' is a valuable lesson on the inefficiency of barter trade. Imagine if Hans had not received a lump of gold but gold coins.

Hans in Luck exchanging a swine for his cow

The value of money

If we want to understand money, we must ask ourselves:

Why does money have economic value at all?
Why does money command a 'monetary premium'?

The first answer is given by a simple economic law: anything scarce, any good in demand but with a limited supply has economic value, thus warranting production cost to make a profit. The second answer stems from a duality, the difference between the value for non-monetary use cases of a good and the higher value after its monetisation into a base money. The value of Bitcoin, while it remains a proto-money prior to monetisation, expresses the perceived probability of its future monetisation.

The monetary premium for a base money asset stems from the utility afforded to those who use it as a medium of exchange. This is the main utility of money and all other functions, such as store of value and unit of account derive from it. We will revisit these secondary functions later. But without trade, exchange mediated by money, without specialisation and division of labour, a modern highly efficient economy is impossible. With bad money, progress slows down. But without money, mankind would sink back into poverty and modern civilisation would be wiped out.

Inefficiencies without money

When mediating exchange, money works in two dimensions. Base money (gold, silver, bitcoin) facilitates the transmission of value in place, in the present. Whereas, credit money (gold redeemable banknotes, Bitcoin redeemable e-cash) facilitates the transmission of real value in time, in the future. We can think of it as mirroring stores of real goods, ready (or not yet) for sale. These two dimensions are inseparable, as as exchange for money (a sale) must always precede an exchange with money (a purchase).

Purchases and sales seem trivial to modern man, the enormous economic savings afforded by money are rarely given second thought. Two kinds of efficiencies become visible when we compare them to the direct exchange of two goods, barter.

Butler Lechner barters a breakfast egg for Counsellor Geiger

Barter Time - SD 480p.mov

Lost time

Imagine a world without money, like empoverished Austria after the second world war. People had to exchange goods directly for other goods. If they did not produce, they had to exchange some store of value, like art objects, for bread, milk, or ... a breakfast egg.

In such a barter system, everyone must not only find someone who has the good you want but that person must also want your good or store of value. This is rarely the case, so barter can well turn into very roundabout, time consuming chain of exchanges. And you must repeat this inefficient exercise for all items you need.

For producers, the time lost for barter costs production. For workers, this effort eats into their leisure time.

Bonus: Mariandl

Lost value

Hans's actions seem perfectly sensible under his specific circumstances in place and time. Each exchange was rational and purposeful. Hans was tired, thirsty, hungry, in danger and the exchange fixed the problem. And yet, only a short series of exchanges wiped out seven years of savings.

In the simple medieval times of Grimm's fairy tales, these is bad enough. In our modern world, with a high degree of specialisation, with millions of intermediate products in the supply chain, a world runnning only on barter is clearly impossible.

Negotiating terms for each exchange leaves value on the table, this repeats for every step along a chain of exchanges, involving multiple unrelated goods of varying use or production stage. The roundabout way of exchange means that the person or business with the more urgent need is at the mercy of his counterparty.

Value of Money's utility

Clearly, money affords enormous value and time savings in the real economy, when compared to trading on barter. Recently, the total value of money needed to transact the world economy's production and to transmit value along longer supply chains reached about half of world GDP.

Historically, that need was closer to one quarter of GDP, three months' worth.

We conclude that today's fiat system show much higher money holdings. While part of this could be longer production and supply chains, much could also to be just idle liquidity precautionary balances.

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