Sunday, September 29, 2013

I.7: Money

(from the larger project of an introductory approach to Ecological macroeconomics)

No video for this chapter, at least not yet.

But there is a pull quote:
Money, in its pure form, is like chicken for a vegan, in a world where everyone is a vegan.
Here's the text:


With money, we move solidly into the realm where there aren’t directly analogous phenomena in other species or in ecosystems as a whole. The task is the same: there’s still a need to coordinate the actions of multiple individuals within a species, or to mesh the roles of multiple species within an ecosystem. But money as a tool for doing that is a uniquely human approach, with unique attributes.

And yet, to understand it we’re going to start by going back to those pre-human models. Because when we look at money’s role in the context of how ecosystems coordinate their activities, we do two things. First, we shed a particular light on how money works. And second, we develop a way of seeing when money doesn’t work so well.

Animal use value
Use value for humans
Exchange value
Value added
Distributing use value
- What money is
- Roles of money
- Attributes of money
The value spectrum

Animal use value
Start with a familiar picture, one of the stylized versions of an ecosystem from chapter 2. [See Figure I.7.1 below.] The ecosystem is full of species that are doing things that keep the whole thing humming along nicely. But that’s not “why” they’re doing it.

As an example, look at soil organisms decomposing dead stuff that used to be living. If we had to translate the instructions in their genetic code and accompany those instructions with a rationale, their genes wouldn’t be telling them, “Break down that organic matter and make it available to plants for new growth so that everyone in the neighborhood can thrive.” No. Their genetic instructions are, “Eat that, because it’s got energy or other stuff you need in order for you to live.”

That other thing gets done: the soil organisms break stuff down and make it available for plants. But from the organism’s perspective, that’s not why it’s doing it. It’s merely doing what’s useful for its survival. The seemingly magic part is that a coevolutionary process has shaped it such that, when it does what’s good for its own survival, it’s also doing what’s good for the ecosystem.

From an animal’s perspective, the “value” of anything it does is based on how much that thing contributes to the survival of its genes. Animals are shaped by evolution such that behaviors they find useful—behaviors they choose to engage in, behaviors that have “use value” to them—are also behaviors that increase the chance of their genes making it into the next generation and beyond.

So in the animal world, “animal use value” is being created at every stage of the process. [See Figure I.7.2 below.] A squirrel gathers acorns because that helps it get through the winter, but it turns out that that also helps new oak trees grow. A fox hunts squirrels because that gives it energy and protein, but it turns out that that also keeps there from being so many squirrels that the oak trees would be damaged.

Throughout the ecosystem, animals are doing things that are useful for the system as a whole, but those same things are useful for the animals themselves. Nobody has to figure out how to compensate them, because that compensation is built into the acts themselves.

Use value for humans
Now let’s make the jump—a familiar one by this point—from the ecosystem to the economy. [See Figure I.7.3 below.] There’s the same basic structure as with the ecosystem, but here instead of different species playing different roles, you have all one species—us—with different kinds of jobs.

Where do we get use value from? For a person—say, you—a thing has use value if it’s something that you want, in itself, for yourself. That is, you’re not planning to trade it to someone for something else, you just want it.

(Note that this is not a standard definition of use value, but I think it's a helpful concept, together with "exchange value" coming later, for understanding how money works in its coordinating role.)

If you go back far enough, use value for humans must have been grounded in survival: we were genetically built to “like” things that increased our chances of passing on our genes. And those “preferences” are still in us: We still like eating, and sex, and being warm, but we like other things, too. We like friendships, though arguably those contribute to our survival. The further we get from bare subsistence, or the further we go into having more than we need, the more our preferences can become arbitrary. One person likes pop, another likes jazz, a third likes opera; none of those preferences is better for your survival than another.

So in terms of our preferences, we can be thought of as an animal that’s rich enough to have whimsical desires. But here’s a key difference. Animals occupy different parts of the ecosystem, contributing in different ways to the functioning of the whole, and each animal gets use value from its own activities. Humans occupy different parts of the economy, contributing in different ways to the functioning of the whole, but use value comes exclusively from the act of consumption.

And so a human economy faces a challenge that doesn’t exist for an ecosystem: How do you provide use value to people doing important jobs that don’t involve producing items of use value, or don’t involve more than a fraction of the items of use value items they need and want?

Some social insects do actually face a similar problem, such as the leaf-cutter ants. Soldiers guard members of the nest on leaf-gathering expeditions; the next-largest ants cut pieces of leaves and bring them back to the nest. Ants of a still smaller size chew up the leaves. The next smallest add them to the fungus farms the colony grows. And the smallest ants of all move through channels in the fungus farm, bringing out tasty morsels of fungus for everyone to eat. All the ants play vital roles in the production of food, but only the smallest ants have actual ant food when they’re done with their part of the job.

The ants’ solution has to do with genetically driven behaviors that cause the ants to function together. But the diversity of roles in a human economy is far greater than the diversity of roles in an ant colony. In fact, it’s more like the diversity of roles in an entire ecosystem, and then we’re back to a comparison with a structure where everyone gets use value along the way.

On top of that, change in human technology is analogous to biological change through evolution, except that human technological change happens much faster, particularly when you measure times in terms of generations. It can take a hundred generations for a new biological “technology” to take shape, whereas human technologies can go through many changes within a single person’s lifetime.

As discussed in chapter 6, norms and hierarchy are other solutions to this coordination problem, at least some of the time, but a vital tool for a modern economy is money, and to understand what it is and how it works, we’re going to need to look at the distinction between use value and exchange value.

Exchange value
I said above that a thing has use value if it’s something that you want, in itself, for yourself. In contrast, a thing has exchange value if someone is willing to give something up to get it—they’re willing to exchange something for it.

Let’s start with a loaf of bread. It has use value, because if I’m hungry, bread would satisfy me. It also has exchange value, based on its use value: because it would provide use value for me, I’d give something up to have some bread—I would exchange something for it. If we take a step back, flour has no use value in the sense that I’m using that term; the flour is obviously useful, but I can’t eat it, it doesn’t contribute in any direct way to satisfying my wants. On the other hand, it does still have exchange value, because if I’m a baker, I can use the flour to make bread to sell, so I’m willing to give something up to get flour. But the flour must have less exchange value than the bread: the bread provides use value directly, whereas the flour only contributes to use value after we do the work of turning it into bread.

Taking another step back, the wheat is like the flour: it has no use value, but it has exchange value, because the miller can turn the wheat into flour that she can sell, so she is willing to give something up to get the wheat. But again, just as the exchange value of the flour was less than the exchange value of the bread, it’s also true that the exchange value of the wheat must be less than the exchange value of the flour, and for the same reason: you can turn wheat into flour, but you have to do some work for that to happen.

The closer we get to the bread—the closer we get to the thing that actually has use value—the higher our exchange value goes. Looking back at Figure I.7.3 (the basic physical flow diagram of the economy), we can follow a product through the production process, from raw materials at the left to finished consumption good on the right. Use value is zero over at the left (you can’t drive iron ore), and use value stays zero all the way along, until we get to a consumption good on the right (you can drive a car). But exchange value is increasing at each step of the way: the iron ore at the mine mouth is worth more than the ore still in the ground; the steel is worth more than the ore; the car at the factory is worth more than the steel; and the car at the dealership is worth more than the car at the factory.

This sets up the idea of “value added,” which we’ll get to in the next section, but first we have to tidy up the concept of exchange value.

As mentioned earlier, and as the name implies, a thing has exchange value if people are willing to give something up to get it. And it turns out that this requires excludability, plus some degree of scarcity.

Excludability is crucial because if I can't keep you from having something, your willingness to give up something to get it should be zero. But that's not enough either. If you pick up a beautiful autumn leaf, that specific leaf becomes excludable (you can keep me from having it), but in Vermont in early October, there'd have to be something really unusual about that leaf for me to put any exchange value on it, since leaves that are merely pretty are not even a dime a dozen.

Scarcity can also come from the need to draw on human time or effort (i.e., labor), and from differences in how well we're able to do that. You and I may both be capable of harvesting wood and of making it into furniture, and there may be a forest commons to which we both have access, so neither of us can stop the other from obtaining wood or from making furniture. But say I'm particularly skilled at felling trees and turning them into lumber, and you're particularly skilled at turning lumber into furniture. You will attach exchange value to the lumber I offer you, even though you don't need to pay me, and I'll attach exchange value to the furniture you offer me, even though I don't need to pay you. In these cases, the use value of the furniture combines with our differences in skills and with the excludability of the products of our labor to give rise to exchange value in both the lumber and the furniture.

We’ll come back to the relationship between exchange value and use value at the end of the chapter, but our job right now is to delve into the idea of value added some more.

Value added
Value added can happen with use value. Let’s say you paint your house a color that you happen to like. You’ve just increased the house’s use value from your perspective. But if potential buyers don’t care about the color, then you’ve done nothing to the exchange value. In the extreme, if you’ve put on a color that most people dislike, then you’ve actually reduced the house’s exchange value, even as you increased its use value for you.

But that’s a rare example. Almost all the time, value added has to do with exchange value. Look at Figure I.7.4, which shows the bread transaction described above, but with a little more detail, and some dollar signs attached.

We start at the right with a consumer spending $23 on bread (maybe it’s a whole month’s supply). The grocery store receives the $23 and the consumer gets the bread.

$18 goes from the grocery store to the bakery, because it had to buy the bread. The store also has energy costs (heat, light, refrigeration, cash registers), and let’s say $1 of those costs can be attributed to the $23 worth of bread. There are also labor costs (stocking the shelves, running the cash registers, gathering carts in the parking lot), and some amount (say $3) of the bread purchase can be assigned to labor expenses. $23 minus $18, minu $1, minus $3, leaves $1, which is profit.

If you keep reading leftward on the figure, you see the same process play itself out at the bakery and at the mill: some of the revenue goes out the door to buy the inputs (the bakery buys flour from the mill, and the mill buys wheat from the farm); some of the revenue covers energy costs; some covers labor costs; and what’s left is profit.

Each business buys inputs (bread and energy at the store; flour and energy at the bakery; wheat and energy at the mill). And each business sells its product for more than the cost of the inputs that went into it. The difference is the value added.

As the diagram shows, the value added is partly labor income (wages and other compensation paid to employees) and partly capital income (profits). Of the $23 the consumer spent on bread, $15 has ended up as value added ($3 in profits, $12 in labor income).

And though it doesn’t fit on the diagram, the $4 paid for wheat and the $4 paid for energy will also turn into value added: if you go back far enough, the farmer will get profits and the farm-hands will get wages; the owners of the oil wells and refineries will get profits, and the roughnecks and refinery workers will get wages.

Value added and gradients
Going back to Fig. I.7.3 again, we see that we add value by moving an item along the production process from left to right. But remember what that means physically. On the one hand, matter is being rearranged, being moved closer and closer to a form that people want, a form in which it will have use value (something we want in itself, for ourselves). On the other hand, each of those transformations involves us with the Second Law of Thermodynamics: none of the value-adding transformations can happen without access to a gradient of some sort; and once the tranformation has happened, the gradient will have been used up.

In other words, adding value (creating value) is a physical process tied up with the First and Second Laws of Thermodynamics. It’s not simply a physical process, where you can map a particular amount of energy use onto a particular amount of value created, since value is also tied up with human preferences, and when you’re comfortably away from the edge of survival, human preferences can be fairly arbitrary. But what we can say is that you can’t create value without reducing a gradient.

Distributing use value
After our detour through exchange value and value added, it’s finally time to answer the question of how we distribute use value, and the answer is summed up in Figure I.7.5.

Start over at the right, with final use. Notice that part of this is expenditure on consumption; that includes the $23 on bread in the example above, but also pretty much everything else a household buys, as well as some of the stuff that government spends money on (such as salaries for teachers and police officers). It also includes investment expenditure, everything from Ford installing a new assembly-line robot or a coal company buying a new excavator, to government building a road or an aircraft carrier.

Taking those consumption expenditures and investment expenditures together, we have aggregate expenditure. That expenditure goes to firms in the manufacturing sector (the robot, the excavator, the road builders, the shipbuilders) or to the service sector (the stores that sell the things you buy, which in turn buy stuff from the manufacturing sector).

Those businesses have to buy inputs (those are the black arrow that continues toward the left), but they also have added some value, which shows up as labor income and capital income (the green arrows curving downward).

If you keep following the arrows to the left, you keep having firms buying inputs from businesses earlier in the production process, and that expenditure keeps getting split into wages, profits, and further inputs. If you follow all the way back, the entire amount of aggregate expenditure that we started with on the right has turned into value added in somebody’s pocket.

Looking at the green value-added arrows and starting at the left, we have wages and profits in the extraction sector, then wages and profits in the processing sector, and finally wages and profits in the manufacturing and services sector. When you add those all up, those are the flows of people’s incomes, which are shown as the blue arrows flowing rightward along the bottom of the diagram.

As we follow that blue arrow to the right, there are three things that can happen to income.
  • First, some of it gets collected by governments in the form of taxes.
  • Of what’s left after taxes, some gets saved, and goes to financial markets (banks ,stock exchanges, etc.).
  • And what is left after taxes and saving is the unsaved after-tax wages and dividends.
That last category pretty obviously gets spent: If there’s some money that wasn’t paid in taxes, and wasn’t put in savings, then it must have been spent.

But the other two categories also get spent. Government collects taxes in order to pay for things, and financial markets collect savings in order to make loans, and people take out loans in order to pay for things.

So our blue income arrow splits into three categories, but they all end up feeding some kind of expenditure on final use, so the three black arrows at the right come back together to make up the next period’s demand for final use, the aggregate expenditure.

But all of this has simply been the background to understand the essence of money, which is that it is a carrier of exchange value. But it has other roles and attributes, so we’ll step back and build it up along a different path, comparing its use to a barter transaction.

What money is
Start by thinking about a simple act of barter.
I have chickens, you have flour. We work out how much flour you’ll give me if I give you a chicken (we exchange one good for another one).
In this trade, as in any barter example you could construct, there’s an exchange of value for value. More precisely, there is a swap of goods and/or services that have exchange value—that must be true, since the essence of barter is that you get one thing by giving up another.

In the case of this particular trade, we could also construe it as a swap of use value for use value. If you know how to butcher a chicken yourself, and I know how to bake bread myself, then we could be planning to use the chicken and the flour to satisfy our own wants, rather than making something and selling it on to somebody else. But it could also be that you’re engaging in some rudimentary commerce.

Say you’re a vegan, so my chickens are of no use value to you. But you have no objection to other people eating chicken (apparently you’re a vegan for reasons of personal health). You’ve brought your flour into town, and you find I’m willing to exchange chickens for flour. And you know that back in your village there’s a neighbor with an apple orchard and a taste for chickens. So you can barter with me to turn your flour into chickens, then barter with your neighbor back home to turn the chickens into apples.

You’re no longer exchanging what you have for something that has use value for you. Instead, you’re giving up your wheat for something that you think will have use value for someone else. The fact that the chickens have use value for your neighbor is enough to cause them to have exchange value for you: the chickens interest you because you’re confident you can use them to get something that does have use value for you.

In the case of money, we start with this distinction between exchange value and use value and take it to its logical conclusion. The chickens don’t have use value for you, but they must have use value for someone, or else they wouldn’t even have exchange value for you. No matter how many times the chicken changes hands, it’s accepted as payment because many people like to eat chickens.

Money, in its pure form, is like chicken for a vegan, in a world where everyone is a vegan. Unless you’re Scrooge McDuck and get pleasure from rolling around in a pile of greenbacks, money has no use in itself. It is pure exchange value. In an exchange involving money, I give up a thing that has use value (a chicken) or a thing that can be an input to a thing with use value (wheat that can be made into flour) in return for money, something that has no use value nor can ever be physically converted into something that does have use value. I do this because I expect that someone else will take the money and give me a thing that has use value, or that can be an input to something that has use value. Unlike the chicken, there’s no end-of-the-line step of these exchanges; there’s no point where someone slaughters the money and eats it.

(Well, in the wake of Germany’s hyperinflation in 1923, money became so worthless that people did actually use it for itself, fueling their kitchen stoves with it or stacking up bricks of money in toy structures, but that’s an exceptional case.)
There are what you can think of as “intermediate” cases, where something is acting like money but is also still a commodity. A famous case is prisoner-of-war camps in World War II, where prisoners exchanged all sorts of goods for cigarettes, and quoted the price of everything else in terms of cigarettes. You might ask how this is different from the case of a vegetarian who accepts payment in chickens because she knows that someone else is interested in a chicken dinner. To some extent, it’s not: as this article mentions, the ban on smoking in federal prisons has essentially elminated the use of cigarettes as money. Non-smokers accepted them because of their exchange value, but their exchange value was supported by their use value.

Still, they did have some money characteristics. They were the common medium of exchange. It wasn’t a situation of some people circulating sandwiches, other people circulating books, and still others circulating beverages. Cigarettes were the one thing for which anything else could be exchanged. Also, they were the unit of account: you wouldn’t quote the price of a sandwich in terms of books, or the price of a book in terms of beverages. All those things were quoted in terms of cigarettes.

Perhaps a more familiar intermediate case is precious metals, typically gold and silver. These things have some use value: in the ancient world they were desired for ornamental purposes, and they have modern industrial applications (though silver lost a big one when film photography was eclipsed by digital). So it’s more a matter of degree: most people accepting gold and silver as payment were taking them for their exchange value, not for their use value.

Here’s a way to think about the difference. It’s ludicrous to think about a chicken changing hands from Frank to Jenny to Adnan to Hiroko and back to Frank. Someone along that chain is going to actually eat the bird. A gold coin is different. It could easily keep circulating among those four people endless times, as they keep producing things and providing services to each other. Money can be useful without being used for anything other than exchange.

So what is money, anyway? Distilling the common elements out of the examples above, we can say that it’s:
Anything that is used regularly and widely as a medium of exchange, and if it has a use value, there are at least some settings in which it is used primarily for its exchange value.
That’s a fairly general description. We still need to look at money’s roles in more detail, and then consider the attributes that makes something suitable as money.

The roles of money
Medium of exchange: As the loose definition suggests, money is the thing we use by default in any transaction; we exchange everything for money, and money for everything.
Unit of account: As the cigarette-money examples bring out most clearly, another important function of money is that it is the unit of account, the way of expressing the value of everything else in common terms. In the prison camp, everything has a price in cigarettes, while in a normal economy everything has a price in dollars, or euros, or …
This is actually different from saying that money is the medium of exchange, used for actually buying and selling all things, because the unit-of-account function can come into play even if we’re not directly using money. Let’s say you have sandwiches and I have packs of cards, and we’re interested in making a trade. If there’s no unit of account, we look first to our own preferences (How much do I like that sandwich? How much do I like playing cards?), and then to our best guess of what someone else might be willing to give up for a sandwich, or a pack of cards. But if sandwiches and cards have known prices in cigarettes, then we can trade on that basis. If a sandwich is worth two cigarettes and a pack of cards is worth four, then we should be happy to trade two sandwiches for one pack of cards, even if no cigarettes change hands.
A store of exchange value: This one is usually written as “store of value,” without specifying that what’s involved is specifically exchange value. Let’s say I raise some chickens and sell them; I give up the use value of the chickens for the exchange value of the money. I could turn around and use the money to buy something, but I don’t have to. I can hold onto it, or put it under my mattress, or deposit it in a bank. I can store up exchange value, and then at a later time take my exchange value out of storage and go buy stuff with it—turn my exchange value back into some sort of use value.
What I can’t do is store use value. I can store things that have use value: wheat, land, oil, paint, metal, … But storing use value itself in some abstracted form would be a bit like storing time.
The attributes of money
There’s a conventional list of attributes that make something a good candidate as money. In examining them, I will refer repeatedly to the chicken of our initial barter transaction.
Storable: You don’t want the money to melt away in your pocket between the time you receive and when you want to spend it. The chicken does poorly by this standard, since you have to feed it—and it smells. The cigarettes do much better, as long as you keep them away from water and fire—though their exchange value does depend ultimately on their use value, which you take advantage of by using fire. Precious metal performs well on storability. Paper money does too, with the exception of fire.
Transportable: It should be easy to move your money from one place to another. Chickens again are not ideal in this regard. Cigarettes are fine as long as you’re not trying to buy anything very expensive. Silver and gold give you a lot more purchasing power than cigarettes before their weight becomes problematic. Paper money is even more transportable than metal, and we can make paper money with however large a value we find useful.
Hard to produce: There has to be some aspect of scarcity about money. The reason I give you a chicken, a real thing, in exchange for money, is that, 1) I want to have money for purchases of my own; and 2) I can’t get my hands on money without giving up something of value—an object that I own, or my time. What if we were to use autumn leaves as currency, in October? If I needed money, I could just stoop down and pick up as much as I wanted. But then I wouldn’t be able to buy anything with it, because nobody would accept it from me: why should someone go to all the work of raising a chicken to get money when they can just stoop down and pick up as much as they want?
Or think about it this way: exchange value requires some degree of scarcity, and money is pure exchange value. If you make money obtainable with no effort, you destroy its exchange value.
Looking at our money forms, the chicken does reasonably well on the “hard to produce” scale, since some time and feeding went into it. Cigarettes require the land and time to grow the tobacco, plus the labor and machinery to turn the tobacco into cigarettes; in prison, there’s the added constraint that the prison officials can control the quantity that gets in from the outside. Precious metals require a mine with ores of gold or silver, and the labor to pull out the ore and extract the desired metal from it.
With paper money, there’s very little inherent difficulty to produce it, so governments make it hard to reproduce their currency, with fancy engraving, watermarks, little strips of metal embedded in the paper, and so on. And then they go after anyone who tries to overcome those hurdles.
Easily divisible: Let’s say you get your salary every two weeks, and you get $2,000. If you received your salary as a single, very valuable coin, you’d find it very inconvenient when you went to the sweet shop and wanted to buy a mini donut for $0.50. Paper money is, in principle, infinitely divisible; just as we could create a piece of paper money with as large a value as we find useful, we could also create one with as little value as is worth doing, though obviously we generally use coins for the smallest amounts.
Cigarettes bulk up pretty well, since we can trade packs, or cartons, or boxes. Going the other way, we can break open a pack and trade a few cigarettes, or even a single one, but that’s about the limit of its divisibility, since two half-cigarettes are worth less than a single whole cigarette.
Precious metals don’t do too well in this regard: if you want half a dozen eggs, there’s probably no silver coin small enough for the purpose, and certainly no gold one.
The divisibility of the chicken is left as an exercise for the reader.
Widely accepted: Remember that the important thing about money is that it stands for exchange value in general, not for any particular thing. You accept it and give someone else a real thing because of your confidence that someone else will in turn accept it and give you a real thing. That confidence can only last so long as it is regularly reinforced; it doesn’t take too many instances of people turning down your money before you decide that it’s not actually money.
At one level it doesn’t matter why a particular form of money enjoys wide and dependable acceptance, as long as people do accept the money. But the historical development is interesting, and also relevant for understanding banking in the next chapter, and monetary policy in Part IV.
The short story is that money is a kind of a promise. Back in the priest-kingdoms of ancient Mesopotamia, people would bring grain to be stored in the temple granaries, and they would get a receipt for their grain. Then they could go out into the marketplace and make trades.
If you think in terms of a barter transaction, a person who owned grain could bring some of that grain to the market and trade it to another person for some chickens, or a rug. But why should he lug around the grain itself? He’s got a receipt for the grain, proof that the grain exists in the granary and that he owns it. So instead of handing over his grain to buy a rug, he can hand over the receipt for the grain.
The rug merchant accepts the grain receipt as payment for the rug, because he knows what it represents, and he knows that he can, at his leisure, go to the granary and collect the grain, which now belongs to him.
But he also knows that he doesn’t have to go get the grain. The receipt is now his, and he can do just what the first man did and use the receipt as a form of payment, perhaps for some wool.
The receipt has started to act as a form of money, and it was able to do that because it represented a credible promise. Everybody knows what those grain receipts represent, and everybody expects that, when someone finally takes one to the granary to pick up his grain, the receipt will be honored.
There are other similar examples, where a record of ownership or a record of debt comes to act as money, as long as people believe the ownership, or believe that the debt will be paid. But we’re going to pass over them and skip right to state-issued money.
This is also based on a credible promise, but it’s an odd one. First, the state imposes taxes. Second, the state issues some form of money. Third, the state declares that if you bring in the appropriate amount of state-issued money, you will have satisfied your tax obligations for the year. That’s the promise: not, “Bring the money and I’ll give you something,” but, “Bring the money and I’ll check you off as having fulfilled that obligation I imposed upon you.”
Every modern country operates essentially this kind of money system: a tax obligation, plus a state-decreed form of money that is valid for paying taxes.
So we have our loose definition of money (it’s what’s usually used in exchange, and used primarily for its exchange value, rather than its use value). We have our functions of money (medium of exchange, unit of account, store of exchange value). And we have our attributes of money (storable, transportable, hard to produce, easily divisible). What’s left for the chapter is to consider the relationship between exchange value and use value.

The value spectrum
In the discussion of exchange value up above, the reason for something having exchange value was that it was connected to use value eventually. Maybe I don’t eat chicken, but I know someone who does, so I might buy the chicken to sell to her. Nobody can drive a piece of steel, but I know a fellow who can turn steel into a car, and the car will have use value, so the steel has exchange value.

In principle, as in these examples, exchange value should be based in somebody's use value somewhere down the line, but it's not the job of each seller to determine who or where that “somebody" is. Neither is it really the job of any of the buyers; as long as they're confident about a subsequent party putting exchange value on an item, they themselves will put exchange value on it, and as long as their expectation was correct, they'll do well as individuals. In the extreme, we can have exchange value that exists without the tether of use value: people want something because other people want it, but nobody wants the thing in itself, for themselves. This would be the essence of a pure bubble. More likely is what could be called a mixed bubble, where use value still exists, but the exchange value is higher than anybody's use value. Perhaps a particular house has use value, but there's nobody who would pay more than $100,000 simply to live in it, and yet we see the price rising to $200,000, $250,000, $300,000 . . . The part above $100,000 is exchange value untethered to use value, and thus represents a bubble.

On the other end of things, precisely because we need excludability and relative scarcity to make the transition from use value to exchange value, there can be use value without exchange value, if either the scarcity condition or excludability condition doesn't hold. If I have a lovely front yard and I don’t want to put up a high fence, I can't exclude you from enjoying the view of my landscaping. It's not practical to charge a use fee for each use of each city street, and even if it were, such exclusion would cut into the overall usefulness of those streets. Where we have use value without a practical or desirable means of exclusion, we're in the realm of public goods. If something is useful and excludable but not scarce (like the lovely autumn leaf in Vermont mentioned earlier), it is in some sense a public good, but the state is unlikely to bother providing it. Where we have use value without excludability, we have the classic public goods that are part of the state's natural economic role: defense, police, basic education, streets, …

Figurer I.7.6 illustrates the possible combinations of use value and exchange value. In the middle, we have the realm where things have exchange value because of some ultimate use value that they will be sold for. In that middle zone, markets do a good job of organizing the production of things that provide use value, and distributing claims on those things (remember, that was the basic coordinating task that we needed to get done).

As we move to the right, we have more and more problems with excludability. Markets won’t build our battleships or pave our city streets, so we have government to pay for those things and to force us all to contribute through the payment of taxes.

Over on the left end of the spectrum, we don’t have problems of excludability, but we do have exchange value unrelated to any use value, and so we get financial bubbles.

That’s money.

Chapter 8 will extend the discussion of money to cover assets more broadly, and then discuss banking.


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