Money From First Principles

Money From First Principles

In this post, we’ll analyse money from a first principles approach by deconstructing what it actually is, its functions, its properties, its history and evolution, a comparison of different monies and more.

What Is Money?

Money is a technology for transferring value across space and time. As technology changes, what we consider to be money changes.

Money allows us to delay consumption and invest in the future. Thus, it leads to capital accumulation and improvement of living standards. Without it, we would have to consume everything we produced in the present.

The Highest Form Of Energy

Money is stored energetic life force. It’s the highest form of energy human beings can channel because it’s a claim on all other forms of energy (human productivity).

Easy Money Versus Hard Money

A money whose supply is easy to increase is called easy money. A money whose supply is hard to increase is called hard money. We can assess the hardness of money by looking at its Stock (existing supply) to Flow (new supply) ratio (existing supply divided by new supply). The higher the ratio of Stock to Flow, the harder the money.

Historically, bad money has tended to drive out good money (Gresham’s Law). In other words, money moves to the hardest asset. As Saifedean Ammous writes in his book The Bitcoin Standard: “…the majority of money and wealth will be concentrated with those who choose the hardest and most salable forms of money.”

Sound money refers to money that is freely chosen by the market and under control by the owner and safe from manipulation. It is money that gradually increases in value over time and therefore increases in purchasing power.

The Functions Of Money

Money has 3 functions:

  1. Store Of Value (SoV) ― It must maintain its value over time.
  2. Medium Of Exchange (MoE) ― It must be widely accepted as a method of payment for goods and services in the marketplace.
  3. Unit Of Account (UoA) ― It must serve as a standard measure of the value of goods and services in the marketplace.

Again, Saifedean Ammous explains the power of having a globally accepted medium of exchange. He writes: “Having a single medium of exchange allows the size of the economy to grow as large as the number of people willing to use that medium of exchange.”

Indeed, it was during the nineteenth century when the majority of the world converged on a single store of value ― gold ― that saw the greatest explosion of trade in history.

The Properties Of Money

Money has 6 primary properties:

  1. Acceptability ― How widely accepted it is as a form of money.
  2. Divisibility ― The ease with which a single unit can be broken down into smaller units.
  3. Durability ― The ease with which it can withstand wear and tear.
  4. Portability ― The ease with which it can be stored or transported for use.
  5. Recognisability ― The ease with which it can be identified and verified as authentic money.
  6. Scarcity ― The difficulty with which it can be produced.

The Evolution Of Money

Money has historically evolved through the following four stages:

  1. Money begins as a collectible and is accumulated solely due to its peculiar properties.
  2. Once money has been accumulated by enough people, money is recognised as a Store Of Value. As it becomes more widely recognised, its purchasing power increases.
  3. Once money has been fully established as a Store Of Value, its purchasing power stabilises. At this point, the opportunity cost of using money to conduct trade diminishes to a level that it becomes a Medium Of Exchange.
  4. Once money is widely used as a Medium Of Exchange, it is used as a Unit Of Account to price goods and services.

The History Of Money

As technology changes, so too does money. Therefore, the course of human history, there have been 3 major forms of money:

  1. Commodity Money: During the earliest period of human civilization, goods and services were traded directly ― known as “Barter.” Examples include furs, salt, rice, wheat, utensils etc.
  2. Metallic Money: Commodity money relied heavily on coincidence of wants and so was replaced by metallic money. Examples include gold, silver, copper, iron, nickel etc.
  3. Paper Money: Metallic money became inconvenient to carry around and so it was replaced by paper money. Examples include Dollar, Pound, Euro, Yuan, Rupee etc.

The next stage in the evolution of money is, seemingly, Digital Money.

The Evolution Of Money

A Comparison Of Different Monies

Commodity Money is neither effective at moving value across space (it’s difficult to move in large quantities) or time (it deteriorates).

Metallic Money is effective at moving value across time (it’s durable) but not space (it’s difficult to move in large quantities).

Paper Money is effective at moving value across space (it’s easy to move in large quantities) but not time (it loses value due to government manipulation).

Digital Money is effective at moving value across both space (it can be moved instantly) and time (it’s infinitely durable).

Summary

Money is a tool that we use to transfer value across space and time. It has 3 functions which are Store Of Value, Medium Of Exchange and Unit Of Account. It also has 6 primary properties which are Acceptability, Divisibility, Durability, Portability, Recognisability and Scarcity.

Over the course of human history, money has evolved from Commodity Money to Metallic Money to Paper Money and seemingly looks to be at the beginning of its latest stage as Digital Money.

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