Currencies, Exchange Rates and the Gold Standard

Posted by PITHOCRATES - June 17th, 2013

Economics 101

Money is a Temporary Storage of Value that has no Intrinsic Value

Giant container ships ply the world’s oceans bringing us a lot of neat stuff.  Big televisions.  Smartphones.  Laptop computers.  Tablet computers.  The hardware for our cable and satellite TVs.  Toasters.  Toaster ovens.  Mixers and blenders.  And everything else we have in our homes and in our lives.  Things that make our lives better.  And make it more enjoyable.  These things have value.  We give them value.  Some have more value to one than another.  But these are things that have value to us.  And because they have value to us they have value to the people that made them.  Who used their human capital to create things that other people wanted.  And would trade for them.

When we first started trading we bartered with others.  Trading things for other things.  But as the economy grew more complex it took a lot of time to find someone who had what you wanted AND you had what they wanted.  So we developed money.  A temporary storage of value.  So we could trade the valuable things we created for money.  That money held the value of what we created temporarily while we looked for something that we wanted.  Then we exchanged the money we got earlier for something someone had.  It was just like trading our thing for someone else’s thing.  Only instead of spending weeks, months even years meeting hundreds of thousands of people trying to find that perfect match we only needed to meet two people.  One that exchanges money for the thing we have that they want.  And another who has what we want that they will exchange for our money.  Then that person would do the same with the money they got from us.  As did everyone else who brought things to market.  And those who came to market with money to buy what others brought.

Money is a temporary storage of value.  Money itself doesn’t have any intrinsic value.  Consider that container ship full of those wonderful items.  Now, which would you rather have as permanent fixtures in your house?  Those wonderful things?  Or boxes of money that just sit in your house?  You’d want the wonderful things.  And if you had a box of money you would exchange it (i.e., go out shopping) for those wonderful things.  Because boxes of money aren’t any fun.  It’s what you can exchange that money for that can be a lot of fun.

Devaluing your Currency boosts Exports by making those Goods less Expensive to the Outside World

So there is a lot of value on one of those container ships.  Let’s take all of that value out of the ship and place it on a balancing scale.  Figuratively, of course.  Now the owner of that stuff wants to trade it for other stuff.  But how much value does this stuff really have?  Well, let’s assume the owner is willing to exchange it all for one metric ton of gold.  Because gold is pretty valuable, too.  People will trade other things for gold.  So if we put 1 metric ton of gold on the other side of the balancing scale (figuratively, of course) the scale will balance.  Because to the owner all of that stuff and one metric ton has the same value.  Of course moving a metric ton of gold is not easy.  And it’s very risky.  So, instead of gold what else can we put on that scale?  Well, we can move dollars electronically via computer networks.  That would be a lot easier than moving gold.  So let’s put dollars on the other side of that scale.  Figuratively, of course.  How many will we need?  Well, today gold is worth approximately $1,380/troy ounce.  So after some dimensional analysis we can convert that metric ton into 32,150 troy ounces.  And at $1,380/troy ounce that metric ton of gold comes to approximately $44.4 million.  So that container ship full of wonderful stuff will balance on a scale with $44.4 million on the other side.  Or 1 metric ton of gold.  In the eyes of the owner they all have the same value.

Moving money electronically is the easiest and quickest manner of exchanging money for ships full of goods.  These ships go to many countries.  And not all of them use American dollars.  But we can calculate what amounts of foreign currency will balance the value of that ship.  Or one metric ton of gold.  By using foreign exchange rates.  Which tell us the value of one currency in another currency.  Something that comes in pretty handy.  For when, say, an American manufacturer sells their goods they want American dollars.  Not British pounds.  Danish kroner.  Or Russian rubles.  For American manufacturers are in the United States of America.  They buy their materials in American dollars.  They pay their employees in American dollars.  Who pay their bills in American dollars.  Go shopping with American dollars.  Etc.  For everyday American transactions the British pound, for example, would be un-useable.  What these American manufacturers want, then, are American dollars.  So before a foreigner can buy these American exports they must first exchange their foreign currencies for American dollars.  We can get an idea of this by considering that container ship full of valuable stuff.  By showing what it would cost other nations.  The following table shows a sampling of foreign exchange rates and the exchanged foreign currency for that $44.4 million.

foreign currencies and exchange rates

If we take the US dollars and the Exchanged Currency for each row and place them on either side of a balancing scale the scale will balance.  Figuratively, of course.  Meaning these currencies have the same value.  And we can exchange either side of that scale for that container ship full of valuable stuff.  Or for that metric ton of gold.  Why are there such large differences in some of these exchange rates?  Primarily because of a nation’s monetary policy.  Many nations manipulate their currency for various reasons.  Some nations give their people a lot of government benefits they pay for by printing money.  Which devalues their currency.  Some nations purposely devalue their currency to boost their export sector.  As the more currency you get in exchange for your currency the more of these exports you can buy.  Most of China’s great economic growth came from their export sector.  Which they helped along by devaluing their currency.  This boosted exports by making those goods less expensive to the outside world.  But the weakened yuan made domestic goods more expensive.  Because it took more of them to buy the same things they once did.  Raising the cost of living for the ordinary Chinese.

The Gold Standard made Free Trade Fair Trade

Some economists, Keynesians, approve of printing a lot of money to lower interest rates.  And for the government to spend.  They think this will increase economic activity.  Well, keeping interest rates artificially low will encourage more people to buy homes.  But because they are devaluing the currency to keep those interest rates artificially low housing prices rise.  Because when you devalue your currency you cause price inflation.  But it’s just not house prices that rise.  Prices throughout the economy rise.  The greater the inflation rate (i.e., the rate at which you increase the money supply) the higher prices rise.  And the less your money will buy.  While the currencies at the top of this table will have exchange rates that don’t vary much those at the bottom of the table may.  Especially countries that like to print money.  Like Argentina.  Where the inflation is so bad at times that Argentineans try to exchange their currency for foreign currencies that hold their value longer.  Or try to spend their Argentine pesos as quickly as possible.  Buying things that will hold their value longer than the Argentine peso.

Because printing fiat money is easy a lot of nations print it.  A lot of it.  People living in these countries are stuck with a rapidly depreciating currency.  But international traders aren’t.  If a country prints so much money that their exchange rate changes every few minutes international traders aren’t going to want their currency.  Because a country can’t do much with a foreign currency other than buy exports with it from that country.  A sum of highly depreciated foreign currency won’t buy as much this hour as it did last hour.  Which forces an international trader to quickly spend this money before it loses too much of its value.  (Some nations will basically barter.  They will exchange their exports for another country’s exports based on the current exchange rate.  So that they don’t hold onto the devalued foreign currency at all.)  But if the currency is just too volatile they may demand another currency instead.  Like the British pound, the euro or the American dollar.  Because these stronger currencies will hold their value longer.  So they’ll buy this hour what they bought last hour.  Or yesterday.  Or last week.  There is less risk holding on to these stronger currencies because Britain, the European Central Bank and the United States aren’t printing as much of their money as these nations with highly devalued currencies are printing of theirs.

This is the advantage of gold.  Countries can’t print gold.  It takes an enormous expense to bring new gold to the world’s gold supply.  It’s not easy.  So the value of the gold is very stable.  While some nations may devalue their currencies they can’t devalue gold.  A nation printing too much money may suffer from hyperinflation.  Reducing their exchange rate close to zero.  And when you divide by a number approaching zero the resulting amount of currency required for the exchange approaches infinity.  Weimar Germany suffered hyperinflation.  It was so bad that it took so much money to buy firewood that it was easier and less expensive to burn the currency instead.  This is the danger of a government having the ability to print money at will.  But if that same country can come up with a metric ton of gold that person with the container ship full of wonderful stuff would gladly trade it for that gold.  Even though that person will not trade it for that country’s currency.  This was the basis of the gold standard in international trade.  When nations backed their currencies with gold.  And kept them exchangeable for gold.  Forcing nations to maintain stable currencies.  By maintaining an official exchange rate between their currency and gold.  If that nation devalued its currency the market exchange rate will start to move away from the official exchange rate.  For example, say the official rate was $40/troy ounce.  But because they printed so much of their currency they devalued it to where it took $80 to buy a troy ounce on the open market.  So a nation could take $80 dollars of that devalued currency and exchange it for 2 troy ounces of gold from that nation.  The official exchange rate forcing the nation to give away 2 troy ounces of gold for $80 when the real market exchange rate would only have given them 1 troy ounce.  So devaluing your currency would cause gold to flow out of your country.  And the only way to stop it would be to decrease the size of your money supply.  Undoing the previous inflation.  To bring the market exchange rate back to the official exchange rate.  Which is why the gold standard worked so well for international trade.  Nations could not manipulate their currency to get a trade advantage over another nation.  Making free trade fair trade.  Something few say today.  Thanks to currency manipulators like China.

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Dow Jones Industrial Average

Posted by PITHOCRATES - May 6th, 2013

Economics 101

The Dow 30 is a Selection of Companies that gives an Idea of how the Economy is Doing as a Whole

The stock market rallied on Friday thanks to what investors viewed as a favorable jobs report.  Sending the Dow Jones Industrial Average into new territory.  Above 15,000.  But it couldn’t hold on to close above 15,000.  Instead, closing at 14,974.  Close but no cigar.  It even fell a little on Monday.  Reaching only 14,968.89 at the close of trading.

No doubt many wonder 14,968.89 of what?  Is it dollars?  After all, they call it the Dow Jones Industrial Average (i.e., the Dow).  And most know it has something to do with the stock prices of some group of companies.  Thirty, to be exact.  The Dow 30.  A selection of companies that gives an idea of how the economy is doing as a whole.  By looking at stock prices from all sectors of the economy.  So is the average price of these 30 stocks $14,968.89?  Well, let’s take a look at those 30 stocks and their closing prices at the end of trading today.

Bow Jones 30 Stocks and Closing Prices 5-6-2013

Hmmm.  Looks like IBM is the most expensive stock in the group at $202.78.  But an average can’t be higher than the highest price.  It has to be somewhere in the middle of the pack.  In this case the average is $64.97.  So the Dow certainly isn’t the average stock price of these 30 companies.   Is it the sum of these stock prices?  Well, if we add all of the stock prices in the above table we get $1,949.19.  That’s closer to 14,968.89 than 64.97.  But it sure isn’t 14,968.89.  So what exactly is this number?

A Company wants a Rising Stock Price and a High Trading Volume

The Dow Jones Industrial Average (DJIA) dates back to 1896.  Then it included 12 industrial stocks.  American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling & Cattle Feeding, General Electric, Laclede Gas, National Lead, North American, Tennessee Coal & Iron, U.S. Leather preferred and U.S. Rubber.  (General Electric has been a part of the DJIA for all its 117-year history except for the periods September 1898 – April 1899 and April 1901 – November 1907.)  And the DJIA was just that.  The average price of these 12 stocks.

To simplify this let’s look at three fictitious companies and their stock prices.  ABC at $300/share.  XYZ at $200/share.  And 123 at $100/share.  If you add these three stock prices together you get $600.  And if you divide this number by three you get the average stock price ($200).  This is how they calculated the first DJIA.  Only with those 12 stocks.  Which gave a good idea about the market.  If companies were doing well their stock prices went up.  Raising the average price.  Telling us the economy was doing well.  Doing this today, though, would give you a distorted view of the economy.  Why?  Because of stock splits (as well as the changing of companies in the Dow 30).

When a company has growing sales and growing profitability the value of the company increases.  Which the stock price reflects.  As people bid up the price of the stock.  Because everyone wants to buy it.  So the laws of supply and demand raise the price.  But a higher price will reduce the number of shares an investor can buy.  Which will reduce the trading volume.  Showing a falling interest in the stock.  Which may cause the stock price to fall.  Something a company doesn’t want.  What they want is a rising stock price AND a high trading volume.  Two seemingly contradictory things.  Which is where the stock split comes in.  Which works like this.  If there are 1 million shares outstanding at $300/share that’s a market capitalization of $300 billion (1 million shares X $300/share).  To increase the trading volume the company may announce a 2-1 stock split.  That is, they will cut the stock price in half and double the shares outstanding.  So after the stock split there’s a market capitalization of $300 billion (2 million shares X $150/share).  The value of the company is the same BEFORE and AFTER the stock split.  But the stock price is lower which encourages investors to buy and sell more of the stock.  Thus increasing the trading volume.  While the stock price can continue to rise.  Thus meeting those two contradictory objectives.

They divide the New Sum of the Closing Stock Prices for the Dow 30 by the Current Divisor to get the DJIA

The DJIA shows the relative strength of the economy.  As companies grow more valuable their stock prices rise.  If they rise a lot the company may announce a stock split.  Anyone holding stock at the time of the stock split will be very happy.  As the number of their shares may double.  Triple.  Even quadruple.  And even though the market capitalization remains the same before and after the stock split the split itself is a sign of a strong and growing company.  Which tends to drive the stock price—and the market capitalization—higher.  So stock splits are good things.  Which is why they had to change the way they calculated the DJIA.  For the average of stock prices after a split will fall even though the economy as a whole is getting stronger.  As we can see with our three sample companies.

Adjusting Index after Stock Split

This is the problem of using a straight average of stock prices.  It would show a weakening market when it was, in fact, growing stronger.  So they had to add a little math.  To make the market capitalization before and after the stock split the same.  And they do this with a divisor.  They divide the sum of stock prices after the split by the sum of stock prices before the split (450/600=0.75).  So if we divide the sum of stock prices after the split by 0.75 the ‘DJIA’ equals 600.  Just what it was before the stock split.  Which makes the market capitalization before and after the split the same.  As it should be between the close of one day’s trading and the beginning of the following day’s trading.  As there are more and more stock splits this divisor gets smaller.  As the sum of stock prices gets smaller with each stock split.  Which makes the divisor grow smaller with each stock split.  And as we divide the sum of closing stock prices in the Dow 30 by a divisor that is continually getting smaller the resultant ‘DJIA’ gets larger.  As we can see here.

Adjusting Index after Stock Split 2

These companies are doing exceptionally well.  So well that they all announced stock splits.  ABC and XYZ quadrupled the number of shares outstanding and divided their stock price by 4.  123 tripled their outstanding shares while dividing their stock price by 3.  The average stock price fell by 73%.  If this was reported as the ‘DJIA’ it would probably cause a stock market crash.  Which is why the DJIA is no longer an average of stock prices.  Because an average of stock prices does not show the true economic picture.  But adding a divisor into the mix does.  And every time there are stock splits (or new companies replace old companies in the Dow 30) they calculate a new divisor.  They divide the new sum by the old sum of stock prices.  Then multiply this number by the old divisor to get the new divisor.  Which they divide into the new sum of closing stock prices in the Dow 30 to arrive at the DJIA at the close of each trading day.

At the close of trading today the DJIA was 14,968.89.  While the sum total of the closing stock prices for the companies in the Dow 30 was $1,949.19.  If we divide 1,949.19 by 14,968.89 we get 0.130216081.  This is the divisor.  Which they publish every day.  Showing any revisions in the divisor whenever there is a stock split or a change in the companies in the Dow 30.  And every day at the close of trading they divide the new sum of the closing stock prices for those companies in the Dow 30 by the current divisor to get the DJIA.  And today they divided 1,949.19 by the current divisor to get 14,968.89.  The Dow Jones Industrial Average at the end of today’s trading.

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FT125: “Welfare states fail because economic systems based on slavery don’t create enough stuff.” -Old Pithy

Posted by PITHOCRATES - July 6th, 2012

Fundamental Truth

In the Barter System the Only Way to Get Something you Wanted was to create Something of Value Yourself

What’s more important?  Money?  Or stuff?  Stuff, of course.  Because people work to earn money to buy stuff.  They don’t work just for the money.  Because you can’t eat money.  You can’t drink money.  You can’t smoke money.  You can drive money.  You can’t watch or listen to money.  You can’t live in money.  You can’t surf the Internet with money.  No.  The only thing money is good for is buying stuff.  It’s the stuff we buy that makes our lives more enjoyable.  Having money helps.  But it is only a means to an end.  That end being stuff.  And someone has to make that stuff.  For if no one does then all the money in the world is worthless.

Early economies were barter economies.  People traded stuff.  Stuff they created, dug up, grew, manufactured, etc.  Instead of working to earn money to buy stuff they created stuff and traded it for other stuff.  So the only way to get something you wanted was to create something of value yourself.  Money didn’t change this.  Money just made trading with other people more efficient.  By being a temporary storage of wealth.  Because the barter system had a serious flaw.  High search costs. 

It took time to bring two people together to trade their stuff.  If a toolmaker wanted a pottery vase he had to find a potter who wanted a tool the toolmaker made.  This could take awhile.  Hence the high search costs.  Because while these people were seeking each other out they couldn’t make anything else of value.  With money, though, you could accept money in trade.  And then go and trade that money for what you wanted.  This greatly reduced search costs.  Because all you had to do was find the things you wanted.  And trade your temporary storage of wealth (i.e., money) for them.  Allowing them to spend more time creating value.  And less time searching.

The North won the American Civil War because the North practiced Free Market Capitalism while the South Didn’t

Advances in agriculture allowed larger and larger food surpluses.  Which, in turn, allowed more and more people to do something other than farm.  This unleashed human capital.  Allowed people to think about other things.  Create new things.  And improve existing things.  This created a middle class of artisans.  Craftspeople.  The people that created goods and services and brought them to the market place.  Creating the complex economy.  These people became entrepreneurs.  They efficiently used resources and sold things in the market place the people were demanding.  Not out of the goodness of their hearts.  But because they were pursuing profits.

This is free market capitalism.  The economic system that ushered in the modern world.  Free people thinking freely.  Creating.  Bringing their bold new ideas into reality.  Giving us the steam engine.  The railroad.  Machine tools.  Electric power.  The assembly line.  Free market capitalism brought us these things and improved our standard of living.  Because they were free to enter the market place.  And make profits.  Providing a powerful incentive to make the world a better place for everyone else.  Because when they took risks and worked hard to make the world a better place they could get rich in the process.

This is why the North won the American Civil War.  Because the North practiced free market capitalism.  While the South did not.  Their economy was a slave economy.  Instead of an expanding middle class working and contributing to the economy they had an expanding slave population.  That didn’t contribute to the economy.  They worked in the fields.  With all the proceeds from their labors going to a few plantation owners.  Slaves in general didn’t tinker or bring new things to market to enrich their masters.  For they had no incentive to do so.  They did have an incentive to do as they were told and work the fields.  To avoid punishment.  And they had no wages to spend in the market.  So there was less demand for manufactured goods in the South (in some states of the Deep South slaves made up to a third to half of the population).  So there was less manufacturing in the South.  Far less.  This is why the North exploded in manufacturing.  Entrepreneurs could bring things to market.  And the manufacturing workers earned wages they could use to buy those things.  As well as mass-produce the implements of war.  Unlike they could in the South.  Because of the economic superiority of the North it was just a matter of time before the South was overwhelmed.  And lost. 

When the Roman Empire turned into a Welfare State they had to Force People to Make Stuff Against their Will

Governments can print money.  They can tax people.  They can borrow money.  But the one thing they can’t do is create stuff.  If they could create stuff (i.e., economic activity) simply by printing money then the South would have matched the North in economic output.  But they did not.  Which is why they ultimately lost the war.  Because they could print Confederate dollars.  But that didn’t make muskets, bullets, canon, shoes, food, ships, steam locomotives or railroad track.  Creative people had to make these things first before the Confederate government could procure them.  Which is why the government didn’t procure them.  Because no one made them.

This is why governments just can’t print money and give it to the people.  They could.  But it would be pointless.  Let’s say they gave everyone $100,000 a year.  So no one would ever have to work again.  A lot of people would vote for the politician that promised that.  Of course if no one works who will create all the stuff to buy with that $100,000?  Having money is one thing.  But if there is nothing to buy with it then that money is worthless.

This is why the welfare state will ultimately fail.  As more people collect welfare benefits instead of creating stuff there will be less stuff to buy.  When supply shrinks while demand increases prices rise.  Higher prices that everyone has to pay.  People who create.  And people who don’t.  So they will raise taxes on those who work to pay for the benefits for those who don’t.  So those who don’t work can afford the higher prices, too.  Higher taxes are a great disincentive to create.  Or to become an entrepreneur.  Some may just choose the easier path.  Stop creating.  And start collecting that government money, too.  Further reducing supply and increasing demand.  Raising prices further.  Reducing overall economic activity.  And reducing the standard of living.

This happened in the Roman Empire as they kept raising taxes and debasing their coin to pay for their excessive government spending.  It got so bad that people quit their jobs because they couldn’t make any money.  Creating great shortages of goods.  And food.  So the Romans passed laws forbidding people from leaving their jobs.  Even tied people and their descendants to the land they farmed.  Which grew into European feudalism.  And Russian serfdom.  Economic systems little better than the slavery of the Deep South.  Which stunted innovation.  Lowered the standard of living.  And led to the fall of the Western Roman Empire.  But it was the only way the Romans could get the stuff they needed.  By forcing people to make it against their will.  Which is what they had to do when the Roman Empire turned into a welfare state.  And the creators quit creating.

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Market Economy, Command Economy and Market Failures

Posted by PITHOCRATES - April 30th, 2012

Economics 101

Money replaced the Barter System making it Easier to Trade Freely and Voluntarily

We did our first economic exchanges in a market economy.  Agricultural advances gave us our first food surpluses.  These food surpluses gave people free time.  To do other things besides growing food.  Like developing an alphabet and writing.  Mathematics.  A code of laws.  And we made material goods.  Like pottery.  Farming tools.  Processing olive oil for lamps.  People who were good at making one thing made a lot of that one thing and traded with other people.  Who were good at making one thing themselves.  These people met.  And traded.  Freely and voluntarily.

Free trade.  A key element of the market economy.  Where people freely met and traded the things they made.  With other people who are freely trading the things they made.  Free trade came before money.  We bartered our first trades.  Trading goods for goods.  We then created money to make our trades easier.  Reducing the search time to find people to trade with.

Money is something that can store value.  Which allowed people to trade their goods for money.  Then they took that money and traded it with someone else.  To get something they wanted.  Money allowed people to spend less time finding people to trade with.  Because you didn’t have to find that one person that had what you wanted AND was willing to trade it for what you made.  Money allowed us to advance beyond the barter system.  Which proved more and more inefficient as we produced more and more goods.

Because of Market Failures the Government taxes to Provide Public Goods and Eliminate the Free-Rider Problem

As we produced more and more goods our standard of living rose.  We had more things in our lives that made that life easier.  More comfortable.  And more enjoyable.  Civilizations with a bustling market economy were great places to live.  Because there were a lot of nice things to make life better.  Which other people saw.  From beyond the civilization.  And they wanted what they saw.  And they took it.  By force.  Raiding parties would enter a developed civilization and rape, murder and plunder.  So to enjoy the amenities of an advanced civilization required the ability to protect your civilization.  Which led to one of the first market failures.  The failure of the market to provide city defenses through the free and voluntary trading of people engaged in economic activity.

We call it a market failure because building city defenses and creating an army are things the market economy can’t provide.  One person can’t make a fort or an army.  And trade it with someone else.  It’s too big.  It takes a lot of people and a lot of effort to make these things.  But it doesn’t take everyone.  If everyone else is contributing one person could skip contributing.  That person would still be able to enjoy the benefits of that fort and army.  Living in safety.  And enjoy living in safety for free.  Something we call the free-rider problem.  The fort and army are examples of public goods.  Things the free market can’t provide.  Or that the free market fails to provide.  Not that the market is broken or operating poorly.  It’s because people rarely act freely and voluntarily to benefit other people.  Because any time and money spent doing this is time and money taken away from their own families.  Which would bring hardship to them.  So the government provides these things that are necessary AND cause personal hardship to individuals to provide.  The government forces everyone to contribute.  Which minimizes the hardship each individual must bear.

Some in power like to take this further.  And call things that people can provide for themselves that benefit only themselves public goods, too.  Such as health care.  Higher education.  Housing.  Food.  Everything the people can buy for themselves by working to earn the money to buy these things.  And when they do they alone enjoy the benefits of these goods.  These goods they incurred hardships to obtain.  By working to earn a paycheck.  Or sacrificing other things to have these things instead.  It’s their call.  Their choice.  A choice they enter freely and voluntarily.  Therefore these things are not public goods.  But that doesn’t stop some people from acting like they are public goods.  Usually to help them win an election to office.  Or to overthrow the government.

A Command Economy reduced Economic Activity and Introduced a Police State

Civilizations with a bustling market economy were great places to live.  If you had talent and ability.  If you did then you could work hard and trade your talent and ability for a paycheck.  That you could use to trade for other things in that bustling economy.  Those with great talent and ability would be able to trade these for great paychecks.  Those with less talent and ability would be able to trade these for lesser paychecks.  Which, of course, caused income inequality.  Which is a handy thing to exploit if you want to seize power.  So you can enjoy the best things the civilization has to offer.  When your talent and ability only can trade for one of those lesser paychecks.

History is full of people trying to seize power.  So this is nothing new.  What was new was the way these people seized power.  By using the teachings of Karl Marx and Friedrich Engels.  As they wrote in the Communist Manifesto.  Who attacked market economies.  And capitalism.  Saying that the new middle class, the bourgeois, maximized profits by exploiting the working class.  The proletariat.  Which they said was unfair.  And that the only way to make things fair was to destroy the very concept of private property.  Because only the bourgeois accumulated private property.  The proletariat had none.  And only got poorer and poorer while the bourgeois got richer and richer.  Under their system, then, nothing belonged to the person.  Everything belonged to the state.  If you created something with your talent and ability it belonged to the state.  And then the state determined how to distribute the fruit of your labors.  Basically according to the rule ‘from those according to ability to those according to need’.  Those with the greatest need got the most stuff.  And those with the most ability worked the hardest.  Well, you can just guess how that worked out.  Everyone tried to show as little ability as possible and the greatest need as possible.

Because people weren’t the masters of their talent and ability anymore they couldn’t trade freely and voluntarily.  Which meant there was no longer a market economy.  Instead there was a command economy.  Where the government made all the decisions.  What to make.  How to use resources.  Where people lived.  Where they worked.  And what prices they paid for the things in the state-run stores.  Which had shelves full of things no one wanted to buy.  And empty shelves where the staples went (soap, toilet paper, etc.).  Because the government decided what to bring to the state-run stores.  And in what quantity.  Not people trading freely and voluntarily.  Which reduced economic activity.  Reduced living standards.  And introduced a police state.  Because anyone who had a chance to escape to a market economy did.  Which is why the East Germans built a wall in Berlin.  To keep their people from escaping their command economy.  And going to the market economy across the street.

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Money

Posted by PITHOCRATES - November 7th, 2011

Economics 101

The High Search Costs of the Barter System Hindered Trade

Agriculture advances gave us food surpluses.  Food surpluses gave us a division of labor.  The division of labor gave us trade.  And trade gave us an advanced civilization.  By allowing more specialists to live together in crowded urban settings.  Creating a rich surplus of goods for trade.  That people traded.  With other people.  Near.  And far.

As trade grew civilizations got better.  The division of labor grew larger.  And more complex.  Producing more things.  Soon there was a rich variety of goods to trade with for other goods.  From civilizations in distant lands.  Which made life more interesting.  And enjoyable.  During that brief time when you weren’t working.  Or trading.  Which was taking more and more time.  To find someone to trade with.  That had something you wanted.  And who wanted something you had.

This is the barter system.  Trading goods for goods.  Producers took their goods to other producers.  And asked, “What will you take in trade for that?”  Often the response was, “Nothing that you have.”  To which the trader replied, “Very well.  I shall keep looking.”  And sometimes would spend days, weeks and even months looking.  And that was time spent not making anything new.  This was the high search cost of the barter system.  And it hindered trade.  We needed something better.

Money made Trade more Efficient and Unleashed the Human Capital of the Middle Class

For civilization to advance further we had to make trade more efficient.  We had to reduce these search costs.  What we needed was a temporary storage of value.  Something we could trade our valuable goods for.  And then trade the value of our goods, held temporarily in this temporary storage of value, for something else of value later.  And we call this temporary storage of value money.

Money greatly simplified things.  Allowed a more complex economy.  A greater division of labor.  And it allowed wages.  Allowing more people to work on more narrow specialties.  These producers could then take their wages to market.  And buy what they needed.  Instead of spending days, weeks or even months traveling to find people to barter with.

Money made trade more efficient.  It allowed cities to grow in size.  And become even more advanced.  It unleashed the human capital of the middle class.  For they could spend more time creating and building new and better things to trade.  And this economic activity allowed more people to live together peacefully.  As producers produced.  And traded with other producers.  All made easier by money.  A temporary storage of value.

Money doesn’t Create or Produce, it just Temporarily Stores the Value of what we Create and Produce

Please note what came first here.  First there was trade.  Then there was money to make that trade more efficient.

At the heart of all economic activity is our human capital.  What we use to create and produce.  Money doesn’t create or produce.  It just stores the value of what we create and produce.  Which is why Keynesian economic stimulus doesn’t work.  Making money to give to people to spend simply does not create new economic activity.

Our skills create economic activity.  That ability to create things other people value.  And wish to trade for.  Because we are traders.  Not spenders.  We trade things of value.  And to trade things of value someone has to create them first.  If you just take things of value without offering something of value in trade it is not trade.  It’s plunder.  And little different from the uncivilized barbarians on the frontier of the civilized world.

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FUNDAMENTAL TRUTH #41: “The want of unearned money is the root of most evil.” -Old Pithy

Posted by PITHOCRATES - November 24th, 2010

Survival of the Fittest is not a Pleasant Way to Live

Whoever said that ‘money is the root of all evil’ got it wrong.  Money gives us peace.  It gives us safe societies to live in.  It’s money that has civilized us.  Differentiated us from the animals. 

Which kingdom is crueler to live in?  The animal kingdom?  Or the human kingdom?  Most will say the human kingdom.  They will point to the Nazis and World War II.  The death camps.  The horrors of the Eastern Front as the Soviets and the Germans waged perhaps the cruelest war of attrition known to history.  And then say check and mate.  Man is worse than animals when it comes to acts of cruelty.  As World War II so clearly demonstrates.

Well, yes, World War II is probably the greatest tragedy man has ever perpetrated against his fellow man.  But a lot of those who suffered and perished were doing so to end the tyranny of fanatical state socialism (Italy’s Fascists, Germany’s National Socialists and Japan’s militarists).  It was a struggle of good versus evil.  Where the evil were behaving like animals.  Using military power, ideology and cruelty in a pure Darwinian survival of the fittest.

Welcome to the Animal Kingdom where the Lame and Young are Eaten

Yeah, you didn’t see that coming, did you?  Only man sacrifices for the good of others.  Animals don’t do that.  That’s why they have so many babies.  Because animals prey on the most defenseless.  They don’t help them.  Babies are easy food.  So they have a lot of babies because so few make it to adulthood.  Because others eat them. 

When a soldier falls in combat, others will risk their own life to drag him to safety.  So many do this.  And the few we see we recognize for this extraordinary act of bravery that is above and beyond the call of duty.

Our nation recently awarded Staff Sgt. Salvatore Giunta the Medal of Honor.  Our highest decoration.  While serving in Afghanistan.  He is the first living recipient of the Medal of Honor since the Vietnam War.  This is what men do.  Perform selfless acts of bravery to help others.  And people like Staff Sgt. Salvatore Giunta make the world a better place.

You know what a hurt animal is?  Easier food.  While the other animals run away, predators eat the slower and lame.  Another reason why animals have so many babies.  They’re still food as they grow up.  And they never stop being food.  This is the animal kingdom.

We Used our Brains more than our Brawn

Say what you want about the cruelty of man, but we don’t eat our babies.  Or our lame.  Most of us live out of the elements.  Many in a warm and cozy house.  The necessities of life come rather easy for most.  Whereas lots of animals perish from the lack of food and water, in America even the poor are obese.

So how did this happen?  How did life get so easy for man compared to the animals?  Yes, our opposable thumbs helped.  And our big brains.  But even with these we were still hunters and gatherers.  And when you hunt and gather, you need a lot of land to hunt and gather on.  Because food just isn’t that plentiful in convenient small areas.  So they traveled.  And came into contact with other hunter and gatherers.  Who they then fought for the limited food supply to survive.

This all changed when we used our brains more than our brawn.  Instead of gathering food, we farmed.  Instead of hunting, we raised cows, pigs, chickens, etc.  As our food supply became steadier, we could do other things besides tending to our food supply.  We thought.  We innovated.  We improved.  We created.

The Barter System was Good but Inefficient

Of course, we were able to do these other things why?  Because not everyone had to be farmers.  But these people still needed food.  So what did they do to get food?  Steal it at every opportunity like in the animal kingdom? 

No.  In the beginning, they traded for food.  A tool maker traded his tools to a farmer for some of his food.  We call this kind of trading the barter system.  It’s an improvement over stealing what you want but it has its problems.  What if the tool maker only makes one kind of tool?  And the farmer already has three?

This is the big downfall of the barter system.  Searching for someone that has something you want AND wants what you have.  The longer it took to find these people to trade with the more time you spent searching than making something.  These ‘search costs’ became costly and made barter inefficient. 

If only we could find something that would make this trading process more efficient.  Something that would allow me to spend less time searching and more time making things.  Something that could temporarily hold value that I can trade for.  That I then could trade with other people for what I wanted.

Money Made Trade Efficient.  And Allowed us to Live Together in Peace and Harmony

We call that ‘something’ money.  And it has exploded the efficiency of trade.  It made it very easy to buy the things you wanted by using the money you made selling the things you made.  Markets where all this buying and selling took place became cities.  Living standards increased.  We were able to live in peace and harmony with each other like never before.

It is our creativity and the things we make or do that allowed this to happen.  Money just made this ‘human capital’ more efficient.  And the more money we accumulated from our human capital, the better everyone lived.  Because we produced more things that people wanted.

But there are those without this human capital.  The lazy.  The shiftless.  Criminals.  Lawyers.  And politicians.  They don’t create anything.  They just want to profit from the human capital of others.  To steal, if you will.  And it is this want of unearned money that is the root of most evil.

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