What is money, really?

Defining money differently.

According to Wikipedia: "Money is any token or other object that functions as a medium of exchange that is socially and legally accepted in payment for goods and services and in settlement of debts." Furthermore, it is "[a] medium of exchange is an intermediary used in trade to avoid the inconveniences of a pure barter system."

It is also pointed out that money fulfills a useful function as: "A unit of account is a standard monetary unit of measurement of the market value/cost of goods, services, or assets. It is one of three well-known functions of money. It lends meaning to profits, losses, liability, or assets.&qout; Emphasis added. And finally: "The accounting monetary unit of account suffers from the pitfall of not being necessarily a stable unit of account over time." Or as Paul Samuelson has pointed out, measuring value with monetary units is like measuring a distance with a rubber yardstick!

The problem with this definition is that it doesn't actually define money. It just says what money does or how it is used. These notions of money are the accepted ones from economics and have been given without much critical review. But what exactly is a 'medium of exchange'?

I want to offer another, not necessarily contrary, approach to defining money. This definition could provide a way to alleviate the problem Samuelson notes and have the further benefit that the value of things and services in general would incorporate all real costs so that individuals could better judge worth.

This approach starts with the physicist's definition of energy. Energy is the ability to do work. The latter is clearly defined in mechanical, electrochemical, and thermal terms so that one can fix an amount of energy readily. Energy, therefore, can be measured and a standard quantity can be affixed to units of work processes. Furthermore, the physics of energy transfer and transformation (say from mechanical to electrical) is thoroughly understood such that a complete accounting can be made of energy as it flows through work processes.

The reason to start with energy comes from a simple observation. Everything we do, indeed everything that nature does, is a form of work. Moreover, it is a web of work processes through which energy flows as the only real currency. Even thinking, using our brains instead of our muscles, is work — a peculiar but unmistakable form of electrochemical work — and requires considerable energy.

Everything that happens in the economy is due to the flow of high-grade energy. Everything. And given that energy is measurable and consistent in terms of both quantity and quality, it should be recognized as the only real currency. It is the currency that matters.

When two agents trade, when an exchange takes place, what is actually happening is a cross flow of energies. In the case of barter, each agent invested energy in doing work to produce the products they bring to the trade. Each item exchanged, therefore, represents relative amounts of work effort and energy expended. The two agents must judge whether or not the products they receive fairly represent the same amount of energy they invested in the products they give. Long ago, when specialization was less a factor (when trade was still a new idea) these judgments were probably a lot easier to make. One could estimate fairly what the worth of a bag of wheat was relative to a few chickens. In this sense the economy was transparent and the information needed to make such judgments was completely available. It is important to point out that these judgments were not based on explicit calculations of energy content for various kinds of work. It is built into the sub-conscious processing of the brain that balances between ones own efforts are offset against the perceived efforts of others. We cogitate fairness quite naturally.

Humans trade because they are omnivores and need to gain new genes into the tribal pool from time to time. We don't eat the same food day in and day out. Different foods have different nutritional values. It became a matter of necessity to exchange foods of varying nutrition and calorie contents. Hence, barter trade. We also don't mate with kin. So trading mates between villages has been a deeply biological form of trade. I will stick to goods and non-child-bearing services in this post!

But humans also liked to trade trinkets. After aesthetics entered the picture, such as embellishing arrowheads and other implements, early humans apparently enjoyed trading items just for their novelty value. Thus, the pieces were in place for creating a true medium for exchange. The medium was a combination of energy value coupled with aesthetic quality. I strongly suspect that early trade of things like beads and statues were also viewed as kinds of tools — principally for influencing the forces of nature (gods) to favor the possessor. The underlying value of any object or commodity was still its inherent energy content — both the caloric value (of food) and the energy expended to produce it. The energy measure surrogate was effort over time.

Items like bows and arrows, axes, etc. are a special category of objects that could be traded. Their value is not just the effort expended to make them, but is also an estimate of how the object would improve future work efficiencies. In other words, these special objects would allow the holder to save energy in future work. These objects are called tools. A tool is any object or intellectual concept or skill that allows a human to use less effort to accomplish a given amount of work, or in being able to do more work in a shorter period of time to accomplish more and accumulate surpluses. In one sense, tools help us create more wealth for any given input of energy.

Wealth, in this sense, and based on the above framework, is the accumulation of tools, food, and some amount of artifacts for aesthetics. These are, of course, intermingled notions (e.g. culinary arts!). Tools would include things like health care arts and sciences. Anything that makes life more livable by literally creating more energy available to do work is wealth.

Now back to money. Suppose we recognized that money is, in reality, a token form that represents a fixed amount of energy available to do work. Given all the modern attributes of money, e.g. the form of the token, etc. each unit of monetary would equate to a given quantity of energy. In effect this is the same idea as the gold standard — it fixes the value of the monetary unit because there is a measurable quantity to base it on. Except in this case money is tied directly to the real currency in a direct way. We can measure the amount of energy that is available for work. It isn't particularly easy, but it is feasible. National accounts could then be pegged based on their energy storage, use, and production. The amount of money in circulation would be tied to the amount of energy available. There could be no inflation as long as the amount of money is regulated by the amount of energy. The problem here is that if energy available is diminishing, as it seems is the case now, there would be retraction of money and therefore a contraction of the economy. But this is a consequence of knowing the truth about how much work can be accomplished in the economy. Had an energy standard been in effect (say after Nixon took us off the gold standard) I suspect the relationship between wealth creation and energy would have been completely clear. I suspect we would have made very different kinds of decisions about how to spend our energy resources. I also suspect that after the 1970's oil shocks we would have learned a lasting lesson.

So there is a proposal for how to start making the economic activity and valuation relate to something physically real and thus make information about reality more available to decision makers. Pegging money to energy means that we could develop an energy accounting system and make costs and future value highly visible in all transactions. The energy costs of goods and services would provide a physically-valid basis for pricing. Then other factors like aesthetics and estimated future energy value of products would become completely transparent. For example, if you wanted to buy an automobile the basic price would include a valid energy cost of manufacturing. Then you could factor in the style (aesthetics) and future energy returns (as in its ability to get you to work and home again) and future energy costs (maintenance and fuel) to determine a fair price. You would know what the energy return on energy invested (ERoEI) is up front and thus be able to better judge the worth against the price. Note that this is precisely what happens now but based strictly on monetary unit evaluation. Since monetary units are not clearly understood in terms of their inherent energy value, distortions easily creep in and obscure anything like real physical value of products that we have no idea how to compare their worth to our own efforts (expended earning credits toward buying goods and services). Now our only guide to purchasing decisions is our emotional modulation of intelligent decisions (I will blog more on this topic in the future).

One additional benefit of this approach would be that the costs of things will start to reflect their real cost to society as a whole. As I showed in my earlier blog, What's wrong with this picture, it is possible for costs to reflect actual total energy input up the chain of value added processes. This means it is impossible for distortions to hide costs and thus goods and services will have base prices reflecting their true costs. In effect the base price of energy-intensive or wasteful products (the aesthetics aside) will be much higher than is now the case. I suspect far fewer people would buy an SUV if the price actually reflected the true amount of energy it costs.

This proposal does mean we have to rethink a lot of economics as we practice it today. For example the concepts of borrowing and debt will have to be much more clearly understood in light of the energy flow/storage ideas. In point of fact (though I will save the details for a future blog) the entire banking practice known as fractional reserves, and the subsequent creation of ghost monies (all the Mx's above M1) will have to be seriously reworked or even eliminated.

As another example of how we would need to regenerate our understanding of economics we need to understand what growth means and why a consumption-based economy will kill us all. Understood as an energy flow through work processes and the nature of true wealth, we should be able to grasp why growth for growth's sake is a wholly specious idea.

Finally, with an information flow system (the money currencies) based on physical work we will be in a good position to understand the role of regulation of the markets — the places where exchanges of energy take place — in terms of the hierarchical control model I presented in How does Hierarchical Control Systems Theory help us? Hierarchical control - operations at the lowest level, logistical and tactical at the next higher level, and strategic at the highest level - can help humanity solve its problems with equity, stability, and achieving reasonable living standards while allowing individual autonomy to flourish. It won't provide us so-called unalienable rights — life, liberty, and pursuit of happiness. It will allow us to define and construct governance mechanisms that provide support for those rights as long as we exercise responsibilities in light of natural law.

None of what I have suggested here would be easy to implement. I've been thinking about this for years and still haven't got a magic bullet way to do it overnight that doesn't involve some help from an alien race. But I am convinced that it is the only way to make the economy work as intended. Meanwhile Ben Bernanke and all the economics pundits will continue to scratch their heads as the whole enterprise goes down in flames [and while Bush softshoes (instead of playing a fiddle)]. I wonder why very few economists have ever asked the question: what is money - really?

Comments

[Robert]

One important function of money - not addressed in the article - is the ability of certain participants in the economy to commit legal frauds. Most frauds are illegal and are therefore called crimes. However, in the financial world, the creation of innovative financial products very often aims at taking advantage of those "players" who lack access to information or if they do have access to that information, they do not understand that information. Because the product is so complicated, even sophisticated experts have great difficulty to understand what is going on. No wonder that in such situations it is impossible to prove that the products in question constitute fraud. Hence the name "legal fraud".

The purpose of every financial system is to accumulate capital. In other words, to separate the fools from their money (=life energy). That is the ultimate purpose of money.