Money

Understandings and Misunderstandings

Mohammad Ashraf

• Publisher: Palgrave Macmillan
• Year: 2020
• ISBN:
  9783030503789
• Topic: Economics
• Subtopic: Macroeconomics
• Index: Economics

This book clarifies some misunderstandings about money by tying the concept of money to the goods and services sector of the economy. In addition, it demystifies the process of money creation on the part of central banks.

The phenomenon of money is ubiquitous; it has been around for tens of thousands of years, if not longer. Indeed, no modern economy could function without money. For many, however, the concept of money remains elusive. Worse still, misinformation abounds, which leaves the uninitiated vulnerable to fraud. This lack of understanding has serious policy implications as well. When policymakers lack a firm grasp of the concept, policy is likely to be flawed and its effects are likely to be detrimental to the body politic.

After providing a brief history of money, the author details the role of money in the division of labor and specialization, in economic growth, and in an interconnected world. Throughout the book, he points out the pitfalls of fallacious thinking. In recent policy debates, such thinking has led to proposals ranging from the re-institution of the gold standard to supplying limitless money as suggested by Modern Monetary Theory.

© The Author(s) 2020

M. AshrafMoneyhttps://doi.org/10.1007/978-3-030-50378-9_1

Begin Abstract

1. Why Another Book About Money?

Mohammad Ashraf¹

(1)

Department of Economics and Decision Sciences, The University of North Carolina at Pembroke, Pembroke, NC, USA

Mohammad Ashraf

Email: [email protected]

End Abstract

In 1787, John Adams, who later served as the 2nd President of the United States, wrote in a letter to Thomas Jefferson, who later served as the 3rd President of the United States:

All the Perplexities, Confusions and Distresses in America arise not from defects in their Constitutions or Confederation, not from a want of Honour [sic] or Virtue, So much as from downright Ignorance of the Nature of Coin, Credit and Circulation.¹

Why another book about money? Because misunderstandings remain. While the phenomenon of money is ubiquitous and has been for tens of thousands of years—we all use money to buy and sell goods and services, as did our ancestors in one form or another—for many, however, the concept of money remains elusive. These misunderstandings are not benign. On the one hand, this lack of understanding unfairly treats the professionals who deal with money, underestimates the value of their services, and undermines the institutional setup that a modern economy needs. On the other hand, this misunderstanding leaves us all exposed to frauds by those who see room for exploitation. Lured by the promises of getting rich overnight, the uninitiated are robbed of their savings by the likes of Bernie Madoff to Jim Cramer of the TV show “Mad Money” on CNBC, to the purveyors of the Prosperity Gospel, to the self-help gurus like Tony Robbins. The list goes on. This introductory chapter provides an overview of the topics covered in the rest of the book.

1.1 From Bands of Hunter-Gatherers to Farmers

Researchers have found artifacts in the Chinese Loess Plateau that date back to about 2.12 million years ago. These findings were reported in an article published on July 11, 2018, in the journal Nature.² The authors of the article reported that an earlier branch of human ancestors that separated from those of modern-day chimpanzees from our common ancestor, called Hominin, used stone tools. These findings indicate that these ancestors of modern-day humans knew how to make flint blades, attach them to wooden handles to hunt, and knew how to make fire. These ancestors of modern humans lived in bands of hunter-gatherers and ventured out for miles in search of food. It is not too much of a stretch of imagination to suggest that while they shared food and exchanged favors with their band members, they probably also exchanged food and favors with other bands. Banding together against a common enemy is certainly a good survival strategy, and exchanging food and favors is a good strategy to form bonds.

Our human ancestors domesticated maize and other varieties of cereals and became sedentary around 70,000 years ago. They learned to farm around 10,000 years ago. Farming “emerged in seven or eight regions across the world, almost simultaneously at the beginning of the Holocene: in the Levant, in North and South China, in New Guinea and Ethiopia, and in eastern North America, Mesoamerica, and South America, all during the chronological window from 11,500 to 3500 years ago,” writes Jean-Pierre Bocquet-Appel. With this agricultural revolution, known as the Neolithic Revolution, population density also increased and “the number of potential mouths it was possible to feed,” from “0.05 people per [kilometer] with the foraging system as against 54 today.”³ Farming provided relatively safer environment better suited for survival. Group sizes increased. With the advent of farming, the need for exchanging food and favors increased further.

In order to take advantage of a larger group size, and the social complexities that accompany, our ancestors needed larger brains. There is evidence of a positive correlation between the brain-sizes (especially the size of neocortex) of primates and group sizes.⁴ Evidence further suggests that as the group size increases, time constraint puts a limit on social activities an individual can partake. Along with grooming, which creates social bonding, other social activities may include “play, courtship and mating, agonistic interactions, territorial behaviour [sic].”⁵ Studies show that once group size reaches about 40, complexities of social life reach to the point where social cohesion suffers and fission takes place.⁶ One band is divided into two, or more.

Division, however, has costs as well—fewer bodies to lend a hand. A larger band is better suited, not only to hunt and find food but also to fend against attacks by rival bands as well. A way to deal with the chaos resulting from a larger group size is to come up with rules.

Among one group of social animals—the human species—social interaction advanced far beyond that possible among any other animal groups. This occurred through the rise of culture, which permitted coordinated behavior more varied and precise than anything previously known. Through the cohesiveness of social structure that culture made possible, the genus Homo grew, spread, and prospered as no other. [italics original] (p. 112)

Writes Robert Carneiro.⁷ “[W]e might say that social evolution is largely the struggle to increase structure in proportion to size,” [italics original] argues Carneiro (p. 115).⁸ He goes on to write that, “[W]e might say that autonomous villages … become increasingly unstable as they grow larger but fail to develop their structure accordingly” (p. 122). Because larger group sizes offer economic and survival benefits at the cost of social cohesion, the cost-benefit analysis has to have been the source of decision that led to the invention of some means of remembering favors received and rendered.

1.2 The Need to Invent a Numeraire: The Functional Limits of Barter Exchange

It is not a fanciful speculation to suggest that as the band members increased in number, and the number of favors rendered and received, inter-band and intra-band, increased, they had to come up with some way to keep track of transactions; they had to use a numeraire. The reason? Barter—exchanging goods and services for other goods and services—can become infeasible in a short order. Let me give an example.

Suppose that there are two goods. Call them Good A and Good B. To make things simple, suppose also that both Good A and Good B are of only one kind and quality. How much is Good A worth in terms of Good B? Simple. Compare Good A with Good B and one gets the value of Good A in terms of Good B, and vice versa. If the producer of Good A wants to exchange Good A for Good B, all she has to do is to offer a quantity of equivalent value of Good A to the producer of Good B and the exchange can take place. Of course, I am assuming here that the producer of Good B wants to make the exchange. This is what economists call “double co-incidence of wants.” That is, for this exchange to take place, the producer of Good A has to want Good B, and the producer of Good B has to want Good A. This is important. If either of them does not want what the other has to offer, the exchange does not take place.

Make the situation just a bit more complicated. Suppose that there are four goods—Good A, Good B, Good C, and Good D. Continue supposing that each good is produced only in one kind and quality. If one wants to exchange one good for the other one has to come up with a value of one good in terms of the other good or goods. Add another little wrinkle. Suppose that the producer of Good A wants Good B, but the producer of Good B wants Good C. The producer of Good C, however, wants Good D, and not Good B. But the producer of Good D does not want Good B. She wants Good A. The coincidence of wants does not exist—each wants what the other does not have to offer.

All is not lost, however. The producer of Good A can exchange Good A with the producer of Good D. Take Good D to the producer of Good C. Get Good C, take it to the producer to Good B, and exchange Good C for Good B. Notice that we are supposing away the possibility that the producer of each good want the other good in a whole unit, and not a part of one good and a part of another good or goods. We are assuming away the possibility that the vintner wants stake for dinner and not the whole cow. Even with this extreme simplification, the level of complication seems head spinning. We need to know how much is Good A in terms of Good D. We also need to know how much is Good B in terms of Good C, and we need to know ho...

Table of contents

• Cover
• Front Matter
• 1. Why Another Book About Money?
• 2. Imagine a World Without Money
• 3. A Brief History of Money
• 4. Saving, Lending, Borrowing, and the Banking Sector
• 5. Central Banks, Monetary Policy, and the Economy
• 6. The Financial Crisis of 2007–2009 and the Great Recession
• 7. Economic Growth and the Role of Money
• 8. Money in an Interconnected World
• 9. Some Concluding Thoughts
• Back Matter