An illustration on the concept of money

[H2Bro]

Here is a funny story for your review:

http://economistsview.typepad.com/economistsview/2005/09/yapping_about_m.html

The gist of it is, on a small island the locals use as their currency massive (several tons) stone wheels. The stone wheels are so massive and difficult to move, they don't move them. When someone would like to pay for something, say, some chickens or a house, they simply change ownership of the stone wheel to the other person.

Everyone knows who the wheels belong to, so there's no need to actually move the money around. Additionally, the stone wheels come from a distant island and are hard to get, which curbs inflation.

Once, they tried to transport some stone wheel around the island by boat. The boat sank, and it was a great tragedy, when they thought - wait, it doesn't matter if the stones are underwater. We knew what they were, who owned them, etc. So now people change ownership of some stones several meters underwater, without ever seeing them.


The funny thing is, this money works just perfectly fine. Money doesn't need to exist at all for people to use money. All that needs exist is the idea of it.

 

[Evo]

Here is a funny story for your review:

http://economistsview.typepad.com/economistsview/2005/09/yapping_about_m.html

The gist of it is, on a small island the locals use as their currency massive (several tons) stone wheels. The stone wheels are so massive and difficult to move, they don't move them. When someone would like to pay for something, say, some chickens or a house, they simply change ownership of the stone wheel to the other person.

Everyone knows who the wheels belong to, so there's no need to actually move the money around. Additionally, the stone wheels come from a distant island and are hard to get, which curbs inflation.

Once, they tried to transport some stone wheel around the island by boat. The boat sank, and it was a great tragedy, when they thought - wait, it doesn't matter if the stones are underwater. We knew what they were, who owned them, etc. So now people change ownership of some stones several meters underwater, without ever seeing them.


The funny thing is, this money works just perfectly fine. Money doesn't need to exist at all for people to use money. All that needs exist is the idea of it.

In a small closed group that all know and trust each other, that would seem to be the point. Won't work otherwise.

 

[Ryan_m_b]

Have you heard of debt the first 5000 years? Turns out that for many ancient societies money that "doesn't exist" was very common. In some societies money would be silver but it would never change hands, it would be stored in a temple or similar structure and who owned what silver would be written on tablets and paper.

 

[H2Bro]

In a small closed group that all know and trust each other, that would seem to be the point. Won't work otherwise.

This can also be a group of countries. The gold inside Ft. Knox is an exact parallel of the stones underwater. No one ever see's them, no one can really take them out, but that's not the point.

Also electronic money. There is not enough currency in circulation to cover the value of all deposits, loans, or bonds. Even in theory a great deal of that money is "underwater." In practice, almost all of it is.

 

[Evo]

This can also be a group of countries. The gold inside Ft. Knox is an exact parallel of the stones underwater. No one ever see's them, no one can really take them out, but that's not the point.

Also electronic money. There is not enough currency in circulation to cover the value of all deposits, loans, or bonds. Even in theory a great deal of that money is "underwater." In practice, almost all of it is.

Again, as I said, you have to know and trust the source.

If you wanted to sell your car and I told you I had a couple of bars of gold buried in a cave somewhere and I told you I'd give you a slip of paper transferring their ownership to you, you'd hand me the keys to your car, right?

 

[H2Bro]

Again, as I said, you have to know and trust the source.

If you wanted to sell your car and I told you I had a couple of bars of gold buried in a cave somewhere and I told you I'd give you a slip of paper transferring their ownership to you, you'd hand me the keys to your car, right?

You said a small and closed group. The point is this dynamic holds even in massive, open groups, with mutually non-interacting / non-observing parts.

And yes, I would hand you my keys, if the slip was a bank note. A bank could say the gold was in orbit for all we care. In this case, institutions act as proxies for trust.

So no, you don't have to know, or trust the source. You just need to trust the guarantor.

 

[Ryan_m_b]

Whether or not the commodity exists, does not exist, is in your pocket or on the moon is largely irrelevant (that's not to say these systems are equivalent though). What matters is that people are willing to trade for it and have confidence that others will.

 

[Evo]

You said a small and closed group. The point is this dynamic holds even in massive, open groups, with mutually non-interacting / non-observing parts.

And yes, I would hand you my keys, if the slip was a bank note. A bank could say the gold was in orbit for all we care. In this case, institutions act as proxies for trust.

So no, you don't have to know, or trust the source. You just need to trust the guarantor.

In the US, if the government defaults, the "institutions" won't be able to pay you when you take that note in. They are the middle men, the government, in this case, is the source. Banks do go bankrupt. They are not the source of the money.

That's why there is a big scare about buying gold, people are afraid the government is going to default and they feel people will trade for gold. Other's believe they need to stock up on items to barter.

 

[Ryan_m_b]

In the US, if the government defaults, the "institutions" won't be able to pay you when you take that note in. They are the middle men, the government, in this case, is the source. Banks do go bankrupt. They are not the source of the money.

That's partly right. Due to fractal reserve baking banks can make up money on the basis of some money that they have. They can make up money that is then backed up by government fiat currency.

 

[H2Bro]

In the US, if the government defaults, the "institutions" won't be able to pay you when you take that note in. They are the middle men, the government, in this case, is the source. Banks do go bankrupt. They are not the source of the money.

I hate to get nitpicky but...

In the US, currency is issued by a bank (Fed).

However, most money is in effect generated by private banks. They have a few stones, but lend more stones than they have. People sell these stones, they wind up in a bank somewhere, which are loaned out several times more.

The real problem is this. Let's say you pay me with several large stones. I am content and happy. I go to inspect my stones and find they are not there. I become angry and demand payment of the stones. You, unfortunately, have used the stones to pay someone else. Then someone steps in and breaks up the fight. They say, "now listen, I have a large supply of stones back at my cave which you are not allowed to look at. I will lend/give you these stones if you agree to stop fighting and go back to work."

Thats the role of the Fed.

 

[H2Bro]

That's partly right. Due to fractal reserve baking ...

Do you realize how cool fractal reserve banking would be?

"So Tom, how much in the vault?"
"Well sir, the more accurately I try to measure that, the more it seems to be."

 

[Evo]

That's partly right. Due to fractal reserve baking banks can make up money on the basis of some money that they have. They can make up money that is then backed up by government fiat currency.

Which goes back to what I said, accepting a form of payment relies on knowing and trusting the source. I know and trust the US government so I accept US currency from anyone, regardless if I know them or trust them.

 

[Vanadium 50]

I think that's fractional reserve banking. Fractal reserve banking would be a system that only Benoit Mandelbrot could love.

 

[Ryan_m_b]

Which goes back to what I said, accepting a form of payment relies on knowing and trusting the source. I know and trust the US government so I accept US currency from anyone, regardless if I know them or trust them.

Yup. That's what it all comes down to, trust and confidence.

 

[H2Bro]

So, trust it is.

But the thing is, you don't need trust for it to work, at all. All you need is one entity that's cornered the market for coercion.

Fiat sounds like faith, which is similar to trust, but it actually means an arbitrary decree.

It's not that you personally trust the US government. I think few people do. It's that the Govt will shut down anyone trying to set up a competing currency inside their borders. Then your stuck with bartering, which makes life harder.

 

[H2Bro]

I think its more like this:

I have trust, and confidence, in the ability of that guy who claimed to have stones in his cave, to prevent other people from checking whether there are stones there.

 

[Evo]

I hate to get nitpicky but...

In the US, currency is issued by a bank (Fed).

However, most money is in effect generated by private banks. They have a few stones, but lend more stones than they have. People sell these stones, they wind up in a bank somewhere, which are loaned out several times more.

The real problem is this. Let's say you pay me with several large stones. I am content and happy. I go to inspect my stones and find they are not there. I become angry and demand payment of the stones. You, unfortunately, have used the stones to pay someone else. Then someone steps in and breaks up the fight. They say, "now listen, I have a large supply of stones back at my cave which you are not allowed to look at. I will lend/give you these stones if you agree to stop fighting and go back to work."

Thats the role of the Fed.

My ex-boyfreind owns a bank. I know how banks work in the US. From your stone analogy, I don't think you're completely clear on how a bank works.

Let's change stones to checks from my bank account. I write you a check, you take the check to my bank and they inform you that I have no money in my account. Exactly who is stepping into cover my insufficient funds?

 

[Ryan_m_b]

So, trust it is.

But the thing is, you don't need trust for it to work, at all. All you need is one entity that's cornered the market for coercion.

Fiat sounds like faith, which is similar to trust, but it actually means an arbitrary decree.

It's not that you personally trust the US government. I think few people do. It's that the Govt will shut down anyone trying to set up a competing currency inside their borders. Then your stuck with bartering, which makes life harder.

I don't think that's the case at all. In many countries with fiat backed currency other currencies have thrived in times of poor economic conditions. Fiat currency does not mean that you must trust it by law, it means that the currency will be backed by government and thus is more likely to be trusted on the basis of the trust of that government.

I think its more like this:

I have trust, and confidence, in the ability of that guy who claimed to have stones in his cave, to prevent other people from checking whether there are stones there.

The stones don't really have to be there at all. That's the point of credit based monetary systems over commodity based: money is simply a system of transferable debt.

 

[H2Bro]

Let's change stones to checks from my bank account. I write you a check, you take the check to my bank and they inform you that I have no money in my account. Exactly who is stepping into cover my insufficient funds?

My example illustrates what happens when a bank(s) goes bankrupt, or rather when it has a bank run, not when a person defaults on their debt. Its a difference of magnitude. In the former, yes, the government will cover the debts, what happens if they don't? 1930. What happened in 2007/8? Govt footed the bill.

My ex-boyfreind owns a bank. I know how banks work in the US. From your stone analogy, I don't think you're completely clear on how a bank works.

I don't think dating someone that ones X means you understand X, so I don't see how that's relevant. I also don't see how you think you understand banks when you claim banks are not the source of money.

@Ryan. Thats exactly my point, that the stones aren't there in the first place. To take it one step further, money is transferable obligation, which is a social relation and not a thing.

Edit: I must resume this conversation tomorrow.

 

[Ryan_m_b]

@Ryan. Thats exactly my point, that the stones aren't there in the first place. To take it one step further, money is transferable obligation, which is a social relation and not a thing.

What do you mean by "not a thing"? Seriously if you haven't read the book I linked in post 2 you probably want to if this stuff interests you.

 

[Evo]

My example illustrates what happens when a bank(s) goes bankrupt, or rather when it has a bank run, not when a person defaults on their debt. Its a difference of magnitude. In the former, yes, the government will cover the debts, what happens if they don't? 1930. What happened in 2007/8? Govt footed the bill.

You seem to be jumping all over the place. Why would you suddenly switch scenarios from a personal transaction between you and me?

I don't think dating someone that ones X means you understand X, so I don't see how that's relevant.

Don't ever underestimate how much knowledge you can gain from the inside.

I also don't see how you think you understand banks when you claim banks are not the source of money.

The banks that you and I use are not the source of the money. Their business is to make money handling and investing money. They have a limited amount of money on premise to hopefully handle any normal cash transactions.

You're just not making any sense to me. Let's clarify terms, we'll call the source "The Fed", banks will be "financial institutions".

 

[lisab]

I've heard economists talk about the stone story. Their point is, it's money's *value* that is based on trust. It's a strange concept to me - I only have a BS in physics, so I did a lot of work learning about closed systems, or systems where conservation laws are key. So the concept of trust-based value is sort of mind-blowing to me.

 

[leroyjenkens]

If I went there and sold something for one of those giant stones and left it there to come back here to America, I doubt I would have possession of that stone for long. I'm sure if I went back 5 years later, I'd find out that huge stone that should have been mine is owned by someone else now.

 

[Evo]

If I went there and sold something for one of those giant stones and left it there to come back here to America, I doubt I would have possession of that stone for long. I'm sure if I went back 5 years later, I'd find out that huge stone that should have been mine is owned by someone else now.

Lol.

 

[H2Bro]

You seem to be jumping all over the place. Why would you suddenly switch scenarios from a personal transaction between you and me?

Right, I can see my example was ambiguous. The You and Me wasn't intended to represent literally you and me on the street corner. It was just to typify some generic transaction in a three person society. In a three person society, if two people stop working, it would be like many banks going bust all at the same time in a much larger society.

Don't ever underestimate how much knowledge you can gain from the inside.

I'm just not fond of second-degree appeals to authority.

You're just not making any sense to me. Let's clarify terms, we'll call the source "The Fed", banks will be "financial institutions".

We can call the issuer of currency the Fed. And everyday banks financial institutions, or what have you. But, the great majority in growth in the money supply comes from the everyday banks through their fractional reserve lending. So, it's misleading to say banks deal with a fixed supply of money from the fed. They are money multipliers.

 

[H2Bro]

What do you mean by "not a thing"? Seriously if you haven't read the book I linked in post 2 you probably want to if this stuff interests you.

I mean that the function of money is not a physical, distinct, locatable object you can point to and say "look, there it is," like you might do if you see someone using an axe or driving a car. The function is to embody a social relation, so to point at what money "does," you need to point at a social situation involving more than two people. But a dry description of the situation isn't enough, you need to include subjective understanding of the meaning of various items and actions in the situation to appreciate what money "does".

I think I will check out that book, it looks to be very interesting.

 

[Ryan_m_b]

It was hardly an appeal to authority as Evo wasnt saying she was right because her ex-boyfriend said so.

 

[H2Bro]

It was hardly an appeal to authority as Evo wasnt saying she was right because her ex-boyfriend said so.

Yes, you are right. It would be stubborn to argue for arguments sake about it. Thanks for the book reference Ryan, I will try to get hands on a copy from my library.

 

[Lsos]

This stone story makes it very difficult to expand your economy. What if I invent something which...I don't know, makes it 10x easier to gather water and food? This would have a huge benefit on the economy, but unless someone prints more stones then it's not going to do anything.

 

[Ryan_m_b]

This stone story makes it very difficult to expand your economy. What if I invent something which...I don't know, makes it 10x easier to gather water and food? This would have a huge benefit on the economy, but unless someone prints more stones then it's not going to do anything.

Actually it doesn't make it difficult, it simply means it now costs less deeds to rocks to produce food nd water than before. If the cost is now less than one rock then simply start trading in lower denominations of rock like 1/10th, 1/20th etc. It's deflation basically and even though I don't really understand how bitcoin works I gather that this is inevitable for that popular service.