Why money requires trust and cooperation in order to function. What happens when trust disappears.
In this episode you’ll learn:
- Why money requires trust and cooperation to function.
- How much money is there above and beyond coins and bills.
- What happens when individuals lose trust in digital money.
- Why countries must balance personal security against personal liberty.
- Why we need pockets of independence away from the financial system.
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Money Is Trust
Kabir Seghal, author of the book “Coined,” relates the story of a taxi ride in Jakarta, Indonesia.
Seghal sat in the back of the cab that stopped for a red light. A barefoot beggar holding a baby approached the cab. The light turned green, and Kabir urged the driver forward, but the taxi stayed put.
The cars behind the cab honked, but the taxi still didn’t move as the beggar woman approached. Kabir looked away as he expected an inevitable knock on the window asking for a handout.
Then the front passenger door opened and to his surprise the woman and baby got into the taxi. She fiddled with the air conditioning as the driver took off and got on the expressway. Kabir, confused by this turn of events, thought it might be a kidnapping.
When the taxi driver entered the carpool lane, Kabir finally realized what had happened.
The woman with her baby allowed the taxi driver and his paying passenger to use the fast lane and get to the destination quicker.
The woman didn’t need to go where the cab went. What she needed was food. By agreeing to join the taxi ride, she would receive money to buy food.
Prior to the invention of money, this type of transaction could not have occurred.
Individuals instead traded directly with each other, exchanging the goods and services they had for something they wanted from someone who wanted what they had. This is called bartering. Bartering works only if both parties want what the other is offering.
I know a man who started one of the first national bartering networks in the early 1980s. I was still a teenager, and I remember how impressed I was that he had acquired a motor home as part of a bartering transaction.
The challenge with bartering is you can end up trading for something that eventually people don’t want. That’s what happened to this man. For decades, he had a warehouse full of vinyl records that he couldn’t trade or sell. Only in the last few years as vinyl albums have come back into vogue has he been able to liquidate some of his record holdings.
Money Is Symbolic
Money facilitates exchanges that would not have occurred in a bartering economy because money acts as symbol or token of value.
Money requires cooperation and trust for it to function properly and facilitate transactions.
Trust is required because money has no intrinsic value. It has only symbolic value.
Money cannot be used in its physical form to make something productive. You can’t eat it. You can’t build shelter out of it. You could use paper money for heat by burning it in your fireplace, but it would be far more effective to exchange the money for firewood.
Money has value because we and others believe it is worth something in that it can be exchanged for something of value.
Initially money was physical—a gold or silver coin, and later paper bills and coins made of less precious metals.
Today, most money doesn’t exist as paper bills or coins. Most of it resides as bits on computer networks. The balance in your bank account is simply a digital record.
In the U.S. there is $3 trillion of money comprised of physical bills and coins, checking account and other demand deposits at banks, including balances banks hold at the Federal Reserve, the U.S. central bank.
Just over 40% of that $3 trillion consists of U.S. coins and bills.
The rest is electronic records.
Money Is Abstract
Over the centuries, money has became more and more abstract as human cooperation and trust increased.
When households and businesses lose faith in the institutions holding their money, they demand to hold it as physical coins and bills, or they convert those coins and bills to something they believe is a better store of value, such as gold.
This is what occurred during the Great Depression. Households and businesses hoarded their physical money and were afraid to part with it. The result was the value of money went up relative to the value of other goods and services, causing the prices of those goods and services to fall. That is called deflation.
Money Is Mostly Electronic Records
There are other forms of money besides dollars that exist mostly as electronic records.
For example, the financial claims on gold (sometimes called paper gold) on the COMEX commodity change are about 200 times greater than the amount of registered physical gold that could be delivered to gold contract holders should they request delivery.
This is no different then the amount of financial claims for dollars being significantly higher than the amount of physical coins and bills.
If investors lose trust in paper gold, then the value of physical gold will skyrocket relative to other goods and services.
Paper Assets Versus Physical Assets
Most paper assets are denominated in a particular currency such as the dollar, but the assets themselves are not money. Most of those assets are someone else’s liability.
The same holds true for mutual funds, ETFs and other paper assets.
Cooperation and trust are required for our financial system to function.
Still, prudent investors will keep some physical assets that they own outright and have direct access to in case trust breaks down, threatening the financial system.