Praxeology - Episode 15

Translations of this material:

into Russian: Праксиология Эпизод 15 — Деньги. Translated in draft, editing and proof-reading required.
Submitted for translation by IrinaChernykh 20.06.2015

Text

Why money?

Hi guys, Praxgirl here.

In our last lesson, we learned why exchanges occur and how they are beneficial to those who voluntarily engage in them. We found that the division of labor is the key process that humans engage in in order to increase their productivity. And finally, we saw that even in situations where one individual is better at all modes of production, it is still more advantageous for him to engage in exchange with an inferior trading partner rather than to continue in isolation.

In this lesson I’d like to explain the concept of indirect exchange in society. Why and what exactly happens when men stop trading directly and start using a medium for exchange.

THE PROBLEMS: INDIVISIBILITY & COINCIDENCE OF WANTS

In any exchange, we are all both buyers and sellers. We act as the seller of the good already in our possession, and the buyer of the good we are trying to obtain. The fundamental problem with direct exchange is the limitations it causes in satisfying the ends of acting men.

Take for instance this example: a baker wants one sword and he is willing to pay with 4 pies. His challenge then, is to find a blacksmith who is willing to accept pies in exchange for his sword. Obviously, this desire is very specific and difficult to meet. For this exchange to take place, it will require a double coincidence of wants. Both individuals as buyers and sellers will need extraordinary circumstances to occur.

The other looming problem of direct exchange is also implied in this example. While we can state the price of one of the baker’s pies as 1/4th of a sword, it’s clear that a sword becomes practically useless when divided into smaller pieces. The problem of indivisibility for objects like swords, plows, or other tools are inherent in a society of direct exchange. What this would mean is that there would be little marketability for these products to be exchanged and hence very little of these tools would be created.

It is clear therefore, that a barter economy is doomed to stay in a primitive state.

THE EMERGENCE OF INDIRECT EXCHANGE

Indivisibility and the lack of “coincidence of wants” is a problem that cannot be solved by any method other than from the emergence of indirect exchange. Indirect exchange means that a man buys a good--not for the purposes of consumption--but in order to facilitate his trade with another. At first, it may seem that indirect exchange is actually a less efficient method of achieving the exchange of goods and services. But as we will see, it is the most direct and efficient method of achieving an exchange in a complex modern economy.

Let’s return to our example of the baker and the blacksmith. We saw that it was not worth it for either party to exchange a fraction of a sword for one pie. But it may be worthwhile for the blacksmith to find some other good to exchange with the baker in order to acquire a pie. The blacksmith may go to a farmer and exchange a sword for butter in order to exchange that butter with the baker. This is the emergence of indirect exchange. In order to satisfy his desire for a pie, the blacksmith acquired a medium to facilitate his exchange.

MONEY

As you can probably begin to see, in a market, some goods will have more value than others to people for indirect exchange. Suppose that in the society where the baker and the blacksmith live, butter is an important good. It may be that butter is demanded more often than any other good for the purposes of exchange. If enough people start using butter as a medium of exchange, then butter’s marketability increases precisely for its value as a medium too. A snowball effect occurs where the society sees more and more value in butter to facilitate exchange, and people begin to store butter in order to trade it for some goods and services in the future, rather than just as a facilitator of exchange in the present.

A good that comes into general use as a medium of ex­change is defined as being a money. Praxeology is not concerned with which good becomes a money, but only with studying the implications of money on a market. Historically many goods have been money: tobacco in colonial Virginia, sugar in the West Indies, cattle in ancient Greece, nails in Scotland, and copper in ancient Egypt. In the course of human history, two metals have emerged as the predominant media of exchange in the world: silver and gold. Their natural qualities have contributed to their long term use as money. They are valued as ornaments, highly durable, highly divisible, scarce in relation to other types of goods, etc. But all these functions are simply corollaries of the one great function: as a medium of exchange.

CONCLUSION

True barter economies are an imaginary construction. There is no evidence that they have ever existed. If the baker has pies to trade and the blacksmith has swords to trade, what would happen if the baker wanted eggs? How would a man building a high rise in New York City happen to have every good his construction workers would be willing to accept as wages in exchange for their labor? For that matter, how would a lonely teacher of Praxeology determine how many pies and swords were fair in exchange for lessons? If she accepted more than she can consume for the purposes of trading later than we already have indirect exchange! Clearly, any sort of civilized economy is impossible under direct exchange!

Indirect exchange and it’s immediate byproduct, money, are the answers to these problems. The important implications of money as a facilitator of exchange and it’s ability to transmit information over time and space will become clear in part 2 of this lesson on money.

I’ll see you guys in the next lesson.