What is money? Part 1

I’ve been reading a lot about the nature of money lately, and with some of the geopolitical stuff that’s coming down, I think it’s becoming a subject that a lot of people are getting concerned about for the first time in ~70 years or so. A lot of times, writing about an idea helps me to understand it better than just reading an idea, so here goes.

What is money?

Let’s say I have a sack of potatoes, and you have a pair of shoes. I need shoes, and you need potatoes. We each value what the other person has more than what we already have, so we trade them. If I value my potatoes more than I value your shoes, I wouldn’t trade for them. And vice versa in regard to you and your shoes. So we each conclude the transaction believing that we’ve gotten the best end of the deal at that point in time. If I had waited a week, it might have turned out that my food supply was running low, and I might value my potatoes more and would not have made the trade. So the value of something changes based on the conditions of the moment, and we take on some measure of risk whenever we engage in a transaction.

Anyway, having to find a specific somebody with shoes who also happens to want potatoes can be complicated and time-consuming. So enter money. Money is an abstraction that represents something of value in order to streamline the process of trade. If there are a lot of people who want potatoes, then it’s easier for me to trade my potatoes for money, and then use that money to negotiate with anybody who happens to be selling shoes. Money is a medium of exchange. Money is a tool. But it only works if people think it’s worth something.

So let’s back up again. How do you know what a sack of potatoes is worth? That’s easy. A sack of potatoes is worth whatever someone is willing to give you for it. I may feel that it’s worth $10, but if nobody will give me more than $5 for it, then it’s only worth $5. If I still value those potatoes more than what someone is willing to give me for them, then it’s in my interest to keep them and eat them myself. On the other hand, if those potatoes are going to rot before I get around to eating them, then it’s in my interest to settle for the $5.

So given the above, we know that something only has value as long as someone values it. This is tough to wrap your head around at first, because in real life we assume that the price tag on items at the grocery store represent a solid commodity price. A gallon of milk is $3 because if they charged more, people would buy less of it, and if they charged less, people would buy more of it. Since the total quantity at a given time is limited and known, the milk producers can maximize what they earn from it by selling it at an optimum price while it’s fresh. That price is the one at which milk producers value dollars more than their milk, and where milk buyers value the milk more than the dollars in their pockets.

Therefore, the value of something is determined by what someone is willing trade for it.

Which brings me to the next layer of confusion: the statement above applies not only to products and services we spend money on, but to the money itself. In our financial system, the dollars that represent value don’t have a fixed value themselves. They’re subject to the same effects of supply and demand as any other commodity. But I’m gonna split that to another post. Coming soon…