1. The Value of Money

CHAPTER ONE

THE VALUE OF MONEY

So when the money failed in the land of Egypt and in the land of Canaan, all the Egyptians came to Joseph and said, “Give us bread, for why should we die in your presence? For the money has failed.” (Genesis 47:15)

Daniel Defoe wrote a novel in 1719 about a man whose ship sank, and who wound up on a deserted island for 28 years. It was called Robinson Crusoe. Crusoe faced a hostile world. How was he going to overcome scarcity? He needed food, clothing, and shelter. Fortunately for him, he was able to get a lot of his tools from the ship; if he hadn’t, he wouldn’t have survived even 28 days.

Economists love to use Robinson Crusoe as their example when they begin an introductory textbook on economics. Why? Because he was alone initially. In discussing Crusoe, economists don’t have to begin with the difficult problems of the division of labor and voluntary trade. Only when the economist has explained basic production, saving, and the allocation of time and capital does he introduce Friday, the native partner. That was Defoe’s strategy, too.

The textbook Crusoe initially has to decide what his highest priorities are. What is his order of preferences? Is it fresh water, food, shelter, and clothing? What need does he attempt to satisfy first? The whole point of the illustration is to show that in a world of limited resources, a person has to make decisions about how to achieve his goals. He can’t achieve all of them at the same time. He has to decide what he needs to do—first, second, and so on, down to a hundred and thirty-fifth or more—and then he has to compare this list with his available resources, including his personal skills and time.

One day he may pick berries. But they don’t last forever, and besides, he wants something else to eat. He can climb a tree and pick coconuts, or he can spend several hours to make a sort of poking stick that he can use to knock down fruit or coconuts from trees. But the time he spends locating a suitable stick can’t be used to climb trees and get food directly. The point is that he has to give up income (food) in order to get the time to produce or discover capital (the stick).

He may want to go fishing. That means he needs a fishing pole, some line, a hook, and maybe some bait. Or he needs a net. But unless he finds the net as a free gift (the ship’s warehouse), he has to make it. He can’t become too fancy, or else he will die of malnutrition before he finishes the project.

Decisions on Board

Say that he has a pile of goods to take from the ship. He has put together a crude and insecure raft that he can use to float some goods back to shore. The ship is slowly sinking, so he has limited time. A storm is coming up over the horizon. He can’t grab everything. What does he take? What is most valuable to him? Obviously, he makes his decision in terms of what he thinks he will need on the island. He tries to estimate what tools will be most valuable, given his new environment.

The value of a tool as far as he is concerned has nothing to do with the money it cost originally. He might be able to pick up a sophisticated clock, or an expensive musical instrument, but he probably won’t. He would probably select some inexpensive knives, a mirror (for signaling a passing ship), a barrel (for collecting rain water), and a dozen other simple tools that could mean the difference between life and death.

In short, value is subjective. The economist uses fancy language and says that Crusoe imputes value to scarce resources. He decides what it is he wants to accomplish, and then he evaluates the value to him personally of each tool. In other words, the value of the tool is completely dependent on the value of the tool’s expected future output. He mentally calculates the future value of the expected future output of each tool, and then he makes judgments about the importance of any given tool in producing this output. Then he calculates how much time he has until the ship sinks, how much weight each tool contributes, how large his raft is, and how choppy the water is. He selects his pile of tools and other goods accordingly.

In other words, he doesn’t look to the past in order to evaluate the value to him of any item; he looks to the future. The past is gone. No matter what the goods cost originally, they are valuable now only in terms of what income (including psychic income) they are expected to produce in the future. Whatever they cost in the past is gone forever. Bygones are bygones. The economist calls this the doctrine of sunk costs. In the case of Crusoe’s ship, that’s exactly what they are about to become: sunk. That’s why he has to act fast in order to avoid losing everything.

There are objective conditions on the island, and the various tools are also objective, but everything is evaluated subjectively by Crusoe. He asks the question, “What value is this item to me?” His assessment is the sole determining factor of what each item is worth. He may make mistakes. He may re-evaluate (re-impute) every item’s value later, when he better understands his conditions on the island. He may later wish that he had picked up some other item instead. The point is, it’s his decision and his evaluation that count. Because he is all alone, he and he alone determines what everything is worth. He doesn’t ask, “How much money did this item cost in the past?” He asks instead, “What goods and benefits will it produce for me in the future?” Then he makes his choices. He allocates the scarce means of production. He allocates some to the raft and the rest he leaves on the sinking ship. He loads his top-priority items onto his raft, and floats it back to shore.

He doesn’t ask himself, “I wonder how much money all this cost before it was loaded onto the ship?” Unless he expects to be rescued shortly, thereby enabling him to resell the item, he wouldn’t bother with such a question. What does he care how much money any item cost in the past? All that matters is what actual services (non-money income) it will produce for him in the future.

The Function of Money

What has money got to do with all this? Absolutely nothing. Crusoe doesn’t use money. He simply makes mental estimations of the value of something in terms of what he thinks it will produce for him in the future. If whatever an item will produce isn’t worth very much to him in the future, it won’t be worth very much today.

Assume that he has really little hope of being rescued. The ship is sinking. His raft is almost sinking below the water. The storm is coming. He has to get back to shore fast. As he is about to climb off the ship and onto the raft, he remembers that the captain of the ship was rumored to own a chest full of gold coins. Would Crusoe run back to the captain’s room to try to find this chest? Even if he had enough time, and even if he really knew where it was, would he drag it to the edge of the ship and try to load it onto the raft? Would he toss the tools into the ocean to make way for a chest of gold coins? Obviously not.

But money is wealth, isn’t it? Gold is money. Why wouldn’t he sacrifice some inexpensive knives and barrels in order to increase his wealth (money)? The answer is simple: on a permanently deserted island, money isn’t wealth. Therefore, gold isn’t wealth. It’s heavy. It displaces tools. It sinks rafts. It’s not only useless; it’s a liability.

The value of money is determined by what those who value it expect that it will do for them in the future. A lonely man on a deserted island can’t think of much that money will do for him in the future. If he remains alone for the rest of his life, there is nothing that money can do for him at all.

So the value of money in this example is zero.

Joseph in Egypt

Now let’s take an example in the Bible: the famine era in Egypt. Joseph had warned the Pharaoh of the famine to come, and for seven years, the Pharaoh’s agents had collected one-fifth of the harvest and had stored it in granaries. Then the famine hit. The crops failed. The people of nearby Canaan also suffered. No one had enough food.

And Joseph gathered up all the money that was found in the land of Egypt and in the land of Canaan, for the grain which they bought; and Joseph brought the money into Pharaoh’s house. So when the money failed in the land of Egypt and in the land of Canaan, all the Egyptians came to Joseph and said, “Give us bread, for why should we die in your presence? For the money has failed.” (Genesis 47:14–15)

What did they mean, “the money has failed”? They meant simply that compared to the value of life-giving grain, the money was worth nothing. Why would a man facing starvation want to give up his remaining supply of grain in order to get some money? What good would the money do him? He wanted life, not money, and grain offered life.

Because the money “failed,” it had fallen to almost zero value. Thus, in order to buy food, the people had been forced to spend all of their money. Now they were without food or money.

And Joseph said, “Give your livestock, and I will give you bread for your cattle, if the money is gone.” So they brought their livestock to Joseph: and Joseph gave them bread in exchange for the horses, the flocks, the cattle of the herds, and for the donkeys. Thus he fed them with bread in exchange for all their livestock that year. (Genesis 47:16–17)

Were the Egyptians foolish? After all, all those cattle and horses were useful. But animals eat grain. The grain was too valuable during a famine to feed to animals. All that the animals were worth was whatever they would bring as food, and in Egypt, the meat wouldn’t last long. Dead animals in a desert country don’t remain valuable very long. Why not trade animals for grain, which survives the heat?

The only reason the Pharaoh had any use for the animals and money is that he knew he had enough food to survive the famine. He knew that it would eventually end. Thus, he would be the owner of all the wealth of Egypt at the end of the famine. For him, the exchange was a good deal, but only because he had the food, and the army to defend it, and he also possessed what he believed to be accurate knowledge concerning when the famine would end. Joseph had told him it would last seven years.

Because he had a surplus of grain beyond mere survival, and because he had “inside information” about the duration of the famine, money and animals were valuable to the Pharaoh, even though they were not valuable to the people. Thus, a voluntary exchange became profitable for both sides. The Pharaoh gave up grain for goods that would again become very valuable in the future. The Egyptians gave up goods worth very little to them in the present in order to get absolutely vital present goods. Each side gave up something less valuable in exchange for something more valuable. Each side improved its economic position. Each side therefore gained in the transaction.

Notice here that we are not dealing with any so-called “equality of exchange.” This theory says that people exchange goods only when the goods are of equal value. It is true that in the marketplace, they may be of equal price, but they are not of equal value in the minds of the traders. What we are always dealing with in the case of voluntary exchange is inequality of exchange. One person wants to possess what the other person has more than he wants to keep what he himself already has. Because each person evaluates what the other has as more valuable, a voluntary exchange takes place.

Egypt’s money failed. In fact, grain became the new form of money, although the Bible doesn’t say this explicitly. What it says is that everyone was willing to trade whatever he had of former value in order to buy food. But if some item is what everyone wants, then we can say that it’s the true money.

The Properties of Money

Why would grain have served as money? Because it had the five essential characteristics that all forms of money must have:

1. Divisibility

2. Portability

3. Durability

4. Recognizability

5. Scarcity (high value in relation to volume and weight)

Normally, grain doesn’t function as money. Why not? Because of characteristic number five. A particular cup of grain doesn’t possess high value, at least not in comparison to a cup of diamonds or a cup of gold coins. The buyer thinks to himself, “There’s lots more where that came from.” Normally, he’s correct; there is a lot more grain where that came from. But not during a famine.

Why divisibility? Because you need to count things. Five ounces of this for a brand-new that. Only three ounces for a used that. Both the buyer and the seller need to be able to make a transaction. The seller of the used “that” may want to go out and buy three other used “thats” in order to stay in the “that” business, so he needs some way to divide up the income from the initial sale. This means divisibility: ounces, number of zeroes on a piece of paper, or whatever.

Portability is obvious. It isn’t an absolute requirement. I have read that the South Pacific island culture of Yap uses giant stone doughnuts as money. They are too large to move. But they are a sign of wealth, and people are willing to give goods and services to buy them. Actually what are exchanged are ownership certificates of some kind. Normally, however, we prefer something a bit smaller than giant stone doughnuts. When we go to the market, we want to carry money with us. If it can’t be carried easily, it probably won’t function as money.

Durability is important, too. If your preferred money unit wears out fast or rots, you have to keep replacing it. That means trouble. A barrel of fresh fish in a world without refrigeration won’t serve as money. But there are exceptions to the durability rule. Cigarettes aren’t durable the way that metal is, but cigarettes have functioned as money in every known modern wartime prison camp. Their high value per unit of weight and volume overcomes the low durability factor. Also, they stay scarce: people keep smoking their capital.

Recognizability is crucial if you’re going to persuade anyone to trade with you. If he doesn’t see that it’s good, old, familiar money, he won’t risk giving up ownership of whatever it is that you’re trying to buy. If it takes a long time for him to investigate whether or not it’s really money, it eats into everyone’s valuable time. Investigations aren’t free of charge, either. So, the costs of exchange go up. People would rather deal with a more familiar money. It’s cheaper, faster, and safer.

So what we say is that any object that possesses these five characteristics to one degree or another has the potential of serving a society as money. Some very odd items have served as money historically: sea shells, bear claws, salt, cattle, pieces of paper with politicians’ faces on them, and even women. (The problem with women is the divisibility factor: half a woman is worse than no woman at all.)

Money as a Social Product

We have already seen that Robinson Crusoe has no need of money on his island. From there we went to ancient Egypt, and we found that society did initially need money, but when a famine struck, the older forms of money “failed,” no longer serving as money. Maybe grain took over as the new money. Or maybe nothing replaced money.

These examples should give us some preliminary ideas about what money is, and how it works. It is used in exchange. Because Robinson Crusoe is all alone, he has no use for money. He doesn’t intend to make any voluntary exchanges. Similarly, in a society that is just barely surviving, and almost everyone is a farmer, there will be no reason for money to exist. Nobody buys and sells for money any more. To trade away grain is to trade away life. They all hang onto every bit of food they grow, and nobody trades very much. They may barter goods and services directly, but they no longer trade by means of money. This indicates a very low amount of trade. So, widespread trade ceases. When this happens, money “fails.” It dies. It no longer serves society, so it falls into disuse until the crisis is over.

If people don’t trade, they can’t specialize in production. In the case of Egypt, what had been a rich nation became poor. The Pharaoh was rich, and the people of Egypt survived, but at very high cost: the loss of their freedom. They sold themselves into a form of slavery in order to buy food, for they sold their land and their children’s inheritance to Pharaoh (Genesis 47:19–23). That’s poverty with a vengeance. But they survived the famine. They bought their lives.

Why does money exist? Because it serves people well. If they want to increase their personal wealth by giving up less valuable items (to them) in order to buy more valuable items (to them), they need trading partners. If I have only cattle to sell, and the person I want to sell to doesn’t want cattle, but wants an axe, I have to go find someone who will trade an axe for my cattle, and then I have to try to find the person who wants the axe. I hope and pray he hasn’t found an axe to buy from someone else in the meantime.

But where there’s a will, there’s a way. Where there is a need in society, men have an incentive to find a way to fill the need. As people trade with one another, they voluntarily begin to search out universally desired items in order to hold “for a rainy day.” They sell their surplus goods or services for this universally sought-after good. Why? Because they make the assumption that people will want this good tomorrow and next week, too. So, if they store up a quantity of this good, they will be able to find people who will be willing to sell them all sorts of goods and services later on. In fact, the owner of this good will be able to change his mind next week about what he wants to buy, and he will still be able to buy it.

In short, and most important, money is the most marketable commodity in a particular society. That is the best definition of money that economists have been able to come up with. In Egypt, when the older form of money was no longer marketable, the Bible says that the money failed. “Failed” money is the same as “unmarketable” money. But there is no such thing as unmarketable money. If it’s unmarketable, then no one wants it. If no one wants it, it’s no longer money.

Money allows us to change our minds inexpensively. It allows us to make mistakes about what we need or want, and we can still recover. Money broadens the number of people who will be willing to sell us what we want. The more people who want money, the more people I will be able to deal with.

Furthermore, money makes it possible for people to establish common prices for most goods and services. I don’t have to compute how many axes will buy how many shoes, and then compare shoes with cattle, and sheep with axes, and on and on. All I need to do is to check the Web and see all the things I can buy with money. So, we all make better decisions because we can calculate more effectively. Without money, we can achieve only a primitive economy, because calculating the price of anything, let alone everything, becomes too difficult. In fact, we can define the word “primitive” as “a society without a developed money system.”

Money increases the division of labor. It increases our options of buying and selling. It therefore increases our wealth and our freedom of action. It promotes economic growth. And most interesting of all, to achieve all this, the State doesn’t need to produce it. It is a product of individual economic action, not government legislation.

Conclusion

Robinson Crusoe didn’t need money (except perhaps after Friday showed up) because he had no one to trade with. He had to make his calculations of value directly. “I want this most of all, this over here second, that over there third,” and so forth. He calculated in terms of first, second, third, etc., not by ten units, seven units, five units, etc. He had no units in his head, so he couldn’t use them to make comparisons.

In Egypt, the money failed because everyone wanted the same thing, grain, and nobody was willing to give up any grain except the Pharaoh. Trade either ceased or slowed down drastically. Money ceased to serve as a means of trade. The famine made people poor, and as trade was reduced, they became even poorer. The division of labor collapsed. This means that the specialization of production collapsed.

Money is a social phenomenon. It comes into existence because individuals begin to recognize that certain common objects in society are universally sought after. People then sell their goods and services in order to obtain this sought-after good. They store up this commodity because they expect others to sell them what they need in the future. As in the case of Robinson Crusoe on board the ship, people want to own whatever will provide them with income (goods and services) in the future. People make decisions concerning the present and the future. The past is gone forever. Money offers people the widest number of options in the future, so they sell their goods and services in order to buy money in the present.

Summary

The principles governing the value of money are these:

1. Economic action begins with an ordered set of wants (first, second, third, etc.).

2. A world of scarcity doesn’t permit us to achieve all of our desires at the same time.

3. To increase output, we need capital (tools).

4. We have to sacrifice present income in order to obtain capital.

5. The value of the tool to each person is dependent on the expected value (to him) of the future output of the tool.

6. Value is imputed by a person to goods and services; it is therefore subjective.

7. Past costs are economically irrelevant; present and future income are all that matter.

8. We must allocate our scarce resources rationally in order to achieve our goals.

9. Money isn’t wealth if you’re all alone.

10. Money is a social phenomenon.

11. The value of money isn’t constant (for example, during a famine).

12. There is no “equality of exchange.”

13. Money’s five characteristics are divisibility, portability, durability, recognizability, and scarcity.

14. Money is the most marketable good.

15. Money increases our options.

16. Money allows us to recover more easily when we have made economic errors.

17. Money increases the division of labor.

18. Money therefore increases our productivity.

19. Money increases our freedom.

20. Money makes possible a highly developed economic calculation.

21. The State doesn’t need to create it in order for it to exist.