Category: Pet Topics

Money 2 – an alternative history

In the beginning, there were people….
People have social interactions which have very strong patterns. One of these patterns is the concept of Reciprocity. If someone gives you something you have a strong sense of obligation to give them something back. This forms the basis on many successful marketing strategies (see “Influence” by Robert Cialdini) but also sits at the heart of everyday social interactions.

For example, in the office someone makes coffee for you. This creates an implicit obligation which you will wish to later reciprocate, or perhaps “repay”. In fact, the word “pay” is said to come from Latin “pacare” meaning “to pacify” and later came to mean to settle a debt. You do not immediately barter, need to give something in return at that time. You have a social relationship and there is mutual trust that this obligation will be repaid. This obligation could be called a “debt” or a “liability”. The person who made the coffee now can be seen to be holding an “asset”.


Make it more useful by adding features….
This method of economic organisation works well for small items between tight-knit or homogenous groups. But it would be far more powerful if we could add some other features which allow us to expand it:

  1. Unit of measurement.
    It is handy to be able to quantify the economic value of the transaction so that more complex exchanges can be facilitated
  2. A method of recording ledger items.
    Just remembering that it is your turn to buy doughnuts for office is not sustainable for more complex economic transactions.
  3. Tradability to a 3rd party
    It would be great to be able to have the favour repaid by someone other than the recipient.

A voucher system….
So let’s start a voucher system. Every time you do me a favour such as babysit my kids I will give you a voucher. Every time I do a favour such as mow someone’s lawn I will be given a voucher. I can build up a stack of voucher from doing these jobs and then “spend” them by taking my family to a restaurant for dinner.

This system of money can be seen today in small areas. In the UK, there is the Lewes pound and the Brixton pound. Tight-knit communities can develop all sorts of formal and informal social conventions to regulate exchange. None of them require gold. These are the sorts of systems of money found in ancient, primitive societies. There is no strong archaeological evidence because this kind of money is not physical, however the earliest writing ever discovered was on tablets thought to represent ledger type records. Tokens in the form of Coins are in fact a later discovery and this has commonly been misunderstood as thinking that it was the tokens themselves that were the valuable item. In fact, it was and is the social obligation that matters, coins were simply a means of recording it.


Using a central authority to widen the usage….
But these local currencies or voucher systems have limitations. They rely on trust which is hard to foster with strangers. It would be much more powerful to have some authority or government to issue the money and guarantee its use across a broader area. This is when we see minted coins by a sovereign.

The unit of value can be solidified by collecting taxes in that unit. You will notice that you owe your taxes in US dollars in the US, and in pounds sterling in the UK. The benefit to society is huge, economic activity can be distributed and exchange facilitated on a grand scale. There is also a large benefit to the government, as issuer they get to earn seignorage.


Conclusion

The alternative story of money is still taught, but these days it is mainly in sociology, history or anthropology departments. This version has been eradicated from economics faculties and treated as “fake news”. Economics students are not taught arguments to support their story, it is simply assumed and most are even unaware there are other ideas.

Money 1 – A Creation Myth

In this piece, I take “Macroeconomics” by Greg Mankiw, the bestselling undergraduate textbook, as the source for this story.

A history of money

In the beginning, there was barter…
and a rudimentary economy was based on it. This is extremely inefficient as you have to walk around all day carrying lots of goods, hoping you bump into someone who has something you need who at the same time wants something of yours and will trade you for it.

Efficiency demanded the use of commodities….
Given how poorly organised this world would have been, “it is not surprising that in any society, no matter how primitive, some form of commodity money arises to facilitate exchange”. “Most societies in the past have used a commodity with some intrinsic value for money”. We can see this because archaeologists have found lots of gold, silver and copper coins from previous civilisations.

A really nice example of recent commodity money is the use of cigarettes for currency in a POW camp in WW2. This is an excellent example of why commodity currencies existed and how they operate.

As society evolved thus did “fiat money”….
A modern development in the history of money is the development of “fiat money” which is “money that has no intrinsic value”. This occurs via a process of “evolution from commodity to fiat money”. The process by which this happens is rather mysterious but “in the end the use of money in exchange is a social convention: everyone values fiat money because they expect everyone else to value it.”

Modern money

“Money is the stock of assets that can be readily used to make transactions” and it can be defined by its uses which are:

  1. Store of value
  2. Unit of account
  3. Medium of exchange

Between history and mythology

Unfortunately, as so often is the case with creation myths, none of this is actually true. Understanding what money is and why economists are taught its history in such a strange way is important. In fact, I would say it is central to understanding current economic policy and also how best to invest.

Myth #1 In the beginning there was barter

There is no evidence of any society has ever used barter as their primary means of exchange. This should be unsurprising as it would be horrifically inefficient.

Myth #2 Commodity money was the primary form of money for most of history

This myth is more serious and way more pervasive.
However the evidence from the existence of coins far from backs it up, I think it is good evidence of the opposite.

Imagine we are in ancient Rome and we have a Denarius coin in front of us
(Deni from Latin “containing ten” originally was the value of 10 asses)

It has a nice picture of Hadrian on it, “he” of the wall.
It was made of silver and so has an intrinsic value from its weight in silver
(there are examples of use of gold in coins too – the history is interchangeable)

Consider this, let:

A= intrinsic melt-down value of the coin

B= face value on the coin

Then scenarios are:

A > B the coin would not exist, it would be melted down.

A = B why mint it in first place? Why bother calling it a Denarius at all and put the Emperor’s face on it? It would be simpler just to weigh it. There is no benefit for the government to go to the trouble and expense of minting these things.

B > A Now there is a reason to mint it – a profit! The difference (B–A) is known as “seignorage”. We know this was a main source of income for monarchs for centuries from records. But if B>A then there is no strong link between the intrinsic value of the metal and the value of the money. It sets a lower limit but nothing more.
So what is the difference to fiat money? Not much. History indeed has little evidence for a prevalence of commodity money.

But what about the example of cigarettes in the POW camp?
I love this example because it is correct, and utterly misleading. There is an important reason why a commodity currency was used. It is because there was no way to enforce an obligation as the members of the economy were not in control of their society (see below for why this matters).

Myth #3 Money is an asset

Money is not a thing, or an asset like any other asset in the economy. It is much more special than that. It is a ledger item which always consists of an asset and a liability which come into existence at the same time. There is nothing else like it and it is central to the functioning of the economy. I will delve into this in the following posts.

A common error when struggling with such an abstract concept, it is often much easier and more natural to think in tangible terms. An analogy for this is units of measurement. It is now “obvious” that the concept of measurement is conceptually separate from any physical object. I can separate the concept of “1 metre” from the physical reality of a “piece of metal 1 metre long”. Although it is hard to imagine than this was not always obvious for humans, it was certainly not the case in ancient societies. In fact, it is striking how well these societies were able to operate, before the concept of number being separable from their physical objects, allowed formal arithmetic.

Myth #4 Money can be defined by its uses

This myth is again common but is a non-unique definition for money. There are many, many assets which could be used for the functions:

  1. Store of value
  2. Unit of account
  3. Medium of exchange

For example: dollars, gold, bitcoin, cigarettes, diamonds, canned food, oil etc.
In fact, anything non-perishable as bananas would not store well. The concept that in a mainstream economics they assume that anything can be used for money is important. Economic theories have developed from it, often containing the hidden assumption that money is not special and can largely be ignored. It is an asset like any other asset, is priced in the same way as any other asset. Therefore we should not be surprised that all the output from these models show no important role for money in the economy. I would have hoped the financial crisis would have exposed this as a myth.

Myth 5 Fiat money is a modern development

In fact, it is the oldest form of money.
I would prefer to say that “fiat money” means “money” and that “commodity money” is best defined simply as a “commodity”.


Conclusion

The story of money taught to economics students contains many a myth.
Next, I will tell an alternative story of money. The ideas I will present are not difficult.

But as Keynes said, “The difficulty lies not so much in developing new ideas as in escaping from old ones.”

What is our education system for?

Education plays a big part in every election campaign. But it seems that the only debate is over funding. It is implicitly assumed that the only way to improve our education system is by higher funding levels and that if only more young people could do A levels and get a degree then our economic productivity would rise and they would all be better off.

What I would like to see is some examination of what our education system actually does and reconsider if that really should be its goal.

Learn to write

Education can be seen as the way that students are taught to write and communicate “properly”. In particular, they are taught Standard Written English (SWE). David Foster Wallace’s essay “Authority and American Usage” examines how “rules” in English usage and grammar can be better understood as “norms” more similar to “ethics” than to “scientific laws”. Importantly “a dialect of English is learned and used either because it’s your native vernacular or because it’s the dialect of a Group by which you wish to be accepted”. Therefore, students from less privileged backgrounds have to learn SWE because it is the dialect of “power and prestige.”

You may find this form of education objectionable. My view is that given the structure of our society, it is useful for the individual. Highly paid professions require fluency in this dialect and if we want any social mobility this has to be taught.

If I look at what is taught at a UK university, I quickly conclude that they go much further than this in the enforcement of dialect. Peter Elbow in “Everyone Can Write” discusses the teaching of “academic discourse” which is the language academics use to write to each other. This is the form of writing that is taught and highly valued at university. But as he points out, there is not a single form of “academic discourse”. Historians do not write in the same style as Biologists. Even within subjects, there can be wildly different forms of acceptable dialects.

The purpose of these dialects is to provide a barrier to entry to the discipline. It is how academics can signal to each other that they are part of the same sub-group, and by enforcement of their dialect exclude outsiders. Much of academic writing appears to be deliberately obstructive to the lay reader. Within academia this is irritating, but when it forms a central part of the education of a population it is a lot worse than useless.

Learning to write in this dialect does not prepare the student for the tasks they will face after university. The language of business is very different from the language of English Professors. Hence the common complaint that not only do graduates have to be taught so much, they actually have to “unlearn” what they have been taught.

Learn a subject

In UK universities, it appears that the purpose is to train future academics. The subject matter is very narrow, the syllabus relates to one discipline and the student is encouraged to go deeply into a specific area within that subject. Ask a history student about anything and they will say “not my period”. Talk to an economist and they will refuse to have a conversation without a mathematical model. Lawyers learn the intricacies of Roman Law.

Unfortunately, it is not obvious that excelling at a narrow and specialised area has many transferrable benefits. It does not produce a well-rounded graduate with a range of interests and perspectives. It provides a very highly refined ability to do something they will never be asked to do again, unless they become an academic of course or maybe a macro manager.

 

It is a signal

This is a compelling driver for getting an education. It can be used to give very valuable signals which are important in your life. For example

  1. Getting into a selective university signals that I am intelligent and hard-working
  2. High grades signal that I am intelligent and hard-working
  3. Going to certain universities signals that I have been socialised into a specific culture and am motivated to belong to it. This is why investment banks interview Harvard students.

These signals have numerous costs, not just the financial and time cost of a university education.

Getting good grades at school to gain entry into a top university has become a growing driver of school education. We are obsessed with league tables, and education up to the age of 18 appears increasingly to be a competition. There are many other things that could be the focus of our children’s attention. Teaching to pass an exam necessarily leads to focus on a defined syllabus and the subordination of creativity and imagination to regurgitation of the approved answers.

The desire by students for high grades creates a strong demand for courses which can be graded and for the students to be ranked. To rank students effectively, a syllabus is required which leads to a test with a decent dispersion of results. This leads to a particular kind of subject matter being preferred. In subjects such as economics and finance, what I observe is a lot of time focused on the teaching of complex and rather arcane methods of mathematical and statistical modelling. This creates an exam which even some of the very smart students cannot do well and so it is possible to differentiate between them. But not on a basis which is necessarily meaningful.

If I taught a course, I have lots of things I would like to include. But I have no idea how I would examine it. What I would want to teach are concepts which are not very difficult. Everyone in the class could understand them and get an A. But just because there are not difficult does not mean that they are obvious or commonly understood. Perhaps the most important lesson would be that they should never use any of the sophisticated mathematical techniques they are learning in their other classes. Care and attention in assessing what the characteristics of the data are and what can reasonably be done with it are far more important.

For an individual, this signalling can produce compelling and powerful success stories. In many ways, my personal story can be expressed in this way. Teresa May wants to bring back Grammar schools because she went to one and ended up being Prime Minister. But this type of anecdotal reasoning leads to poor policy and worse outcomes for most children. http://blogs.ft.com/ftdata/2013/01/28/grammar-school-myths/

What should the purpose of education be?

We could add a focus on developing knowledge and skills which are useful for people to have

  1. In the workplace
  2. In their lives
  3. As a member of society

The opportunity is there. I meet many students who enjoy their time at university. I meet very few who enjoy their academic work and even fewer who think their academic work is useful.


My recent experience

I have to admit a tendency to get overexcited in the adoption of new things. I spent a week touring US colleges recently and was overwhelmingly surprised and impressed. I met students who described doing courses that were “not too hard, but really useful”. I never did courses like that.

I do not want to single out any one place as there were so many positive impressions. But this was the best video.

https://www.youtube.com/watch?v=tGn3-RW8Ajk