Money: Where it comes from and where it might go

Everyone eventually wonders why people use money when it doesn’t have any ‘intrinsic’ value. It can feel like a house of cards built over an abyss.

Of course the answer is that people want money because they think that other people want money. That means that the value of money is mainly speculative. You value it because you speculate that you’ll be able to offload it to someone else for something you actually want later.

It’s only mostly speculative though. There are two mechanisms by which it acquires a small amount of nonspeculative value which is then magnified by its usefulness.

Firstly, the government demands that individuals give it some of the money it has issued back in taxation. That means that there will always be at least some demand for money. You probably know already that the government is going to demand some of that money from you this year, so you know you need some. That tiny kernel of certainty (death and taxes) is enough to bootstrap it as a medium of exchange, which means that there’s more and more you can do with these tokens, which means that people value them more and more.

If that isn’t enough then the government has another trick up its sleeve – they will not provide the power of the justice system to enforce collection of a debt in anything except the government issued tokens when the debtor has offered to pay in that (that’s the meaning of legal tender). Ebay used to do something similar with paypal; they would insure transactions made with paypal against fraud to a higher value than those made in any other way. By using government issued money, you get to rely on extra government backing. And making sure you have a stock or income of government tokens is a way of protecting yourself against unreasonable demands by creditors.

It can go wrong though. The ability to trade and enforce debts and pay taxes in a currency is valuable in its own right, however if a government is too weak or corrupt or economically pressed to guarantee the payment of debts, or perceived to be increasing the supply of tokens too quickly causing the value of the money you have to fall quicker than it provides value or if it simply becomes too difficult for people to get hold of the government tokens (perhaps they’ve all gone to Germany), then they will start to create their own tokens.

Nevertheless, much of what people think of as money with intrinsic value isn’t in a very different position. Why would a normal person want gold? What can they do with it? The only reason I would want gold is if I believed that other people in the future would want gold which would allow me to swap it for something I really wanted. This is just as speculative as government issued money, assuming the government provides those selfsame two guarantees with gold, otherwise it could be even more speculative. The argument that it’s useful in electronics is valid, but only to the same extent that if the worst comes to the worst I can burn my government issued banknotes for heat. Ultimately, there are few currencies that can’t be converted into the base currency of the universe: joules.

Anything near the bottom of Maslow’s hierarchy is much less speculative. I can eat a hamburger to get rid of my hunger. That’s real, nonspeculative value right there. There’ll be time in anyone’s life where they’ll take a mess of pottage now over a hypothetical fortune in gold later. Indeed, the ancient currency unit ‘shekel’ was originally a measure of barley (180 standard grains). The first metal currencies were actually tokens which represented stored (and could be converted into) actual grain. Hygenie is an essential human need, so perhaps it’s not surprising that tide detergent is being used as currency amoung drug dealers in the US.

But who determines the distribution of the government tokens in society? Well there are a few ways. Obviously we got here from a system of barter, where you would swap one tangible good (a cow) for another tangible good (some gold or silver). When we eventually switched the gold and silver for intangible ‘money’, the government tokens were distributed to people according to how the gold and silver had previously been distributed. The original distribution was not completely fair, but it had a history of at least sometimes rewarding hard work and wealth creation. The government can also modify the distribution by giving people tokens in exchange for work hopefully benefitting the community (employing them), or by paying them interest on a bond or by disbursing some as welfare or grants, not to mention adjusting the amount it takes off different kinds of people in tax.

Some systems try to equate currency with labour. There are time banks where if you labour for an hour you are provided with 1 hours worth of tokens which you can then redeem against someone else prepared to labour for an hour. Since almost everything we want requires labour (either to acquire the raw materials or to work them), labour is in some ways the human equivalent of the joule; an energy based currency.

Early Chinese Tool MoneyIn China, I saw tool based money for the first time. Small trowel heads and knives were used as currency during the Zhou dynasty (although they ultimately became very stylised). Tools are labour multipliers. There’s a lot to recommend tool based money – you can actually use a tool to create wealth directly. Use the trowel to plant, and the knife to hunt or butcher. They can be stored easily and are durable. It seems that there are some people who could survive almost anywhere in the world given a decent machete. It’d be interesting to see what an economy based on survival tools would look like.

Naturally anyone thinking along these lines for the modern age will be considering the ultimate human tool; the computer. There are a number of computer based currencies, some backed by boring old gold (the USA has a history of jailing and shutting down e-gold operations, although pecunix seems to have survived better than many), some just a score in a computer that you can pay to have incremented (and increment others at the cost of decrementing your own). The popularity of these is driven by a distrust in the governments that control their currencies but also by the friction and pain that moving small amounts of money between individuals and sometimes across borders entails at the moment.

Amazingly corporations like Visa can charge an insane percentage on nearly every transaction in our economy. By requiring that merchants offer the same price to those paying with and without credit and debit cards, it means that anyone paying cash is subsidizing the cost to the merchant of everyone else that is paying by card. All this for something (debit) that in the age of the computer should be free.

In a more rational system, banks would be required to provide every current account with an incoming and an outgoing account number (so that there is no danger in sharing your incoming account number), and then an api that would allow me to push money from my account to some arbitrary account number. I imagine that every payment, whether giving a friend 50 cents or paying hundreds of dollars of electricity bill would become something like scanning the QR code of the receiving bank account with a mobile phone. And there’s no reason it should cost anything beyond a normal current account.

Interestingly, removing the 4% rent that the card companies charge would result in a massive stimulus to the economy at a time when it could really do with it. (Reducing VAT in the UK made a big difference and was smaller, and more painful to the government finances than this would be). Beyond the fact of the stimulus though, there are a million interesting business models that the internet is crying out to implement, but can’t because of the needless cost of transactions.

Some startup companies are struggling to address this already. Flattr is a nice idea, but takes a 10% cut, which I can’t countenance. Gittip seems more equitable.

One great hope is bitcoin. It’s decentralised, so there is no need to worry about governments undermining its value (although also of course there is no base value or justice system guaranteed by government either…), semi-anonymous (everyone knows the wallet ids that own the bitcoins, but they don’t know which human owns those ids without further investigation) so you don’t have to worry so much about intrusive marketeers (or governments) snooping into your transactions, and because it’s modern and thoroughly electronic, the transaction cost is vanishingly small.

There are two things I don’t like about bitcoin though. Firstly the initial distribution of coins. While with real currencies, the initial distribution was bootstrapped on top of centuries of barter, bitcoin has a concept of ‘mining’ which is guaranteed to get much harder over time until it ultimately becomes impossible. This means that the people who originally joined the network were easily able to amass millions of dollars worth of bitcoins for very little work, while now to ‘mine’ a single bitcoin requires an amount of computer power outside the reach of casual users. This kind of initial distribution is strikingly unfair and leaves a bad taste.

Secondly bitcoin is not backed by anything. You can’t redeem your bitcoin for anything except its speculative value – even the computer power that went into ‘mining’ it originally wasn’t actually solving a problem that is valued for anything except its effect on bitcoins. You can’t burn it for its joules or get back those computer cycles for something useful.

I would much prefer a system where all grid computing systems offer certificates to certify that you’ve done some useful work (electronic labour, perhaps on protein folding, or on some problem that other people would be prepared to pay the grid providers for). The issuing grid network could guarantee to redeem them for some percentage of the work that you’ve done, and then allow them to be freely exchanged. The decentralisation would come from the fact that anyone could run these grid computing networks, so there would be many authorities. That way the currency is backed by something, has a real value and furthermore is doing something more useful than just bringing closer the heat death of the universe.

A system like this could fix spam fairly neatly by adding a step to email exchange where a server receiving an email for delivery requires a small (e.g. 5 seconds worth) payment in certified grid computing work before passing the email on (potentially smaller or waived fees for mail signed by people you know). That way, to send a spam email to a large number of people would require a correspondingly large investment in solving useful problems, and anyone who can solve protein folding deserves to be able to send a few spam emails in my book.

Regardless of what kind of approach wins, we are being held back by lack of trust and transaction costs more appropriate for yesterdays world. Unless governments can move with the times and give us more value from our currencies, more and more alternatives will be tried and eventually one will stick.

Economically Free

The existence of a free market does not of course eliminate the need for government. On the contrary, government is essential both as a forum for determining the “rules of the game” and as an umpire to interpret and enforce the rules decided on. What the market does is to reduce greatly the range of issues that must be decided through political means, and thereby to minimize the extent to which government need participate directly in the game. The characteristic feature of action through political channels is that it tends to require or enforce substantial conformity. The great advantage of the market, on the other hand, is that it permits wide diversity. It is, in political terms, a system of proportional representation. Each man can vote, as it were, for the color of tie he wants and get it; he does not have to see what color-the majority wants and then, if he is in the minority, submit.

It is this feature of the market that we refer to when we say that the market provides economic freedom. But this characteristic also has implications that go far beyond the narrowly economic. Political freedom means the absence of coercion of a man by his fellow men. The fundamental threat to freedom is power to coerce, be it in the hands of a monarch, a dictator, an oligarchy, or a momentary majority. The preservation of freedom requires the elimination of such concentration of power to the fullest possible extent and the dispersal and distribution of whatever power cannot be eliminated – a system of checks and balances. By removing the organization of economic activity from the control of political authority, the market eliminates this source of coercive power. It enables economic strength to be a check to political power rather than a reinforcement.

— Milton Friedman, Capitalism and Freedom

Physicists and Economists

Robin Hanson from complains that physicists get more respek than economists.

It seems to me that the arguments that sprung up around this are a good example of your original point. Do you think there would have been as much argument if a physicist had said what you said? As far as I understand it your claim was very narrow and specific. There is a consensus that raising the minimum wage has a negative effect on employment rates. People automatically interpret this as you saying that therefore one should not raise the minimum wage, and that is a whole different question, involving many variables beside the employment rate that economists don’t agree on. It reminds me a lot of the controversy around the claim that abortion has decreased the crime rate. You can be aware of this phenomenon and still not be in favour of abortion.

I don’t really think this is a difference between economists and physicists though. I think that no scientist is given much credence when their theories disagree with peoples opinions. Theoretical physicsists have the advantage of rarely coming up with theories that challenge normal peoples opinions, so they just say “that’s cool”. People argue and look for balancing opinions when they perceive a scientific theory as challenging their beliefs (whether in fact it actually does or not). Look at evolution.

The difference is between normal speech and scientific speech. In normal speech, mentioning a benefit of a strategy is usually done by an adherent to the strategy and with the sole purpose of promoting it. Policy decisions are separate from scientific discourse, and although they should be influenced by them, often a group of people will decide that despite all the tangible benefits demonstrated by science, there are intangible costs that outweigh them. They don’t have to be logical in a strict sense of the word.

Perhaps the best way is to put a disclaimer on every example of scientific speech. Something that shows that while what you are saying is considered by you to have been demonstrated empirically, positive findings do not necessarily indicate a personal endorsment of any policy nor do negative results necessarily indicate that a policy should not be persued.

So anyway, back to your original point, I don’t think anyone respects physicists more than economists, it’s just they disagree with them less often.

Liberal Paradox

Every solution that we can think of is bettered by some other solution,
given the Pareto principle and the principle of liberalism, and we seem to
have an inconsistency of choice.
Amartya Sen, The Impossibility of the Paretian Liberal

In 1970, Amartya Sen’s paper demonstrated that given a certain set of circumstances, there could exist no social choice method (more or less a voting system) that would both respect individual rights, and make sure that the option it chose was not pareto dominated by an unchosen option.

Vilfredo Pareto has a couple of ideas named after him, but the one I’m using here is one that is often called ‘efficiency’. Imagine two people are arguing over what breakfast cereal to buy. From Sammys point of view, Frosties is better than Crunchy Nut is better than Cornflakes which is better than All-Bran. From Mothers point of view, Cornflakes is better than Crunchy Nut which is better than All-Bran which is better than Frosties.

Sammy: Frosties > Crunchy Nut > Cornflakes > All-Bran
Mother: Cornflakes > Crunchy Nut > All-Bran > Frosties

What should they choose? Well, there’s an argument to be made for most options, but one thing that they shouldn’t choose is All-Bran. If they took All-Bran home, they’d realise before they got there that both Sammy and Mother would have been much happier with Cornflakes or Crunchy Nut. Nobody wanted All-Bran. I’m going to call ‘Pareto dominated’ any option where there are other possibilites that all parties prefer. It seems obvious that whatever system we want making our choices for us shouldn’t be chosing options that are Pareto dominated.

Anyway, back to the Liberal Paradox. The problem is that there can be no social choice system that respects rights and can be guaranteed not to end up picking a pareto dominated option. Sen proved this with two book readers, Prude and Rude and a single copy of Lady Chatterlys Lover.

Prude is a bit of a censor and prefers that nobody reads it, but if someone must read it, Prude considers that he himself is more likely to withstand it’s influence than Rude. Rude wants to read it a lot, but to be honest thinks it’d do Prude a world of good and so would prefer Prude to read it. So the preferences look like this:

Prude: nobody reads it > Prude reads it > Rude reads it
Rude: Prude reads it > Rude reads it > nobody reads it

We’ve decided to combine these preferences in some way to come up with who should get the book. But really, we want to give Prude the right to not read it if the choice is between nobody reading it and Prude reading it – it’d be a cruel government that forced Prude to read in that case. We also want to give Rude the right to read it if otherwise the choice would be nobody reads it. These are rights we’re giving the individuals, because we’re liberals.

So, we can’t choose Prude reads it because we’d be infringing his rights, we can’t choose nobody reads it, because we’d be infringing Rudes rights, we’re left with only one choice – Rude reads it. That seems like a good solution.

But that’s no good either. Both Prude and Rude would prefer that Prude read it over Rude, so it’s a Pareto dominated alternative.

And that’s a problem that can happen any time you try to come to a community decision on a topic in which individuals have rights that must be respected. There are a few ways around this problem. You can ensure that you only vote on topics that don’t infringe rights (if we’re giving Rude the right to read the book, then why should Prude be allowed to say that he shouldn’t?), you could accept the possibility of choosing an outcome that is suboptimal for everyone, or you could accept that sometimes, you’ll have to infringe someones rights to choose the majority decision.

Navin Kartik, in Liberalism and Pareto Efficiency: Sen’s Paradox argues that the preferences are not independant of other peoples actions, e.g. in a real life version of the above, one person will probably be in the queue at the book shop first, and whomever gets there first gets the book without infringing on the others rights. This is quite true, but it’s not particularly relevant to the paradox, since in that example there is no attempt to use a social choice method. Instead we’re using the “early bird” gets the chance to determine the state of the world method. A dictatorship method based on opportunity. In situations where social choice methods are used (the paradox I think is really trying to be applied to democracy and governance), the decision is made in an instant taking into account the preference profiles fed into it. You can only make an escape via noninterdependence by splitting up the decision into parts that are made at different times.

The paradox isn’t that surprising – I see it as just stating that a community that’s trying to find the best solution for the whole community might choose things that are at odds with the rights of its members. What may be surprising is that following the rights of the individuals can result in choices that are bad for everyone, even those individuals.

What has happened is that giving individuals rights (to be decisive) has meant that in those choices that they are acting like individuals in competition to see their vision of reality come true.

There is a classic example of how following individuals choices can result in a situation worse for everyone.

Al Capone and Dick Turpin are both in the holding cells. They’re about to be taken for questioning. If both of them stick to the story they’ve agreed, there is little evidence to hold them, and they’ll both go to jail for four months for tax evasion. If either of them want to though, he can turn Kings evidence in which case, the other will serve 10 years, and he’ll go free. If they both voluteer to turn against the other, then they’ll both go to prision for 4 years.

It’s the prisioners dilemma. If both of them operate from a free choice to chose their own best interests, then they will choose the Nash equilibrium, and they’ll both go down for 4 years, paying the price for choosing a pareto dominated solution. If they give up their right to choose, and submit their preferences to a social choice method, it’ll look like this:

Al Capone: Al betrays > both hold > both betray > Dick betrays
Dick Turpin: Dick betrays > both hold > both betray > Al betrays

Both betraying – the Nash equilibrium – is pareto dominated by both sticking to the story, and a pareto social choice method would take that into acount. The most likely choice here for any sensible social choice method is that both stick to their story.

Giving people rights, and allowing them to exercise them in a non naive way, will lead to a situation that seeks the nash equilbrium, just like any non cooperative game. Sometimes giving up those rights to find a solution best for the community will also result in a better result for every individual in that community.

If you start from the position that individuals start with all rights, then analysing the situations where your rights are keeping you from pareto optimality can be a hint that it might be better to form a community and give up those specific rights to it. This is the rule that causes humans to band together into communities.

If you start from a position where the community bestows the rights upon individuals, then you need to be aware that the dark side of this is that sometimes the preferences of the majority are to hurt, torture and kill one or two of the communities members.

One way of modelling this would be to consider it as a iterated game. Make the rights something that a social choice function decides, but give the members of the society the knowledge that this is an iterated game, and sometimes they will be in the minority. To do this, we’ll need to attach preference values to each of the choices. These are called utility values. We can model the situation to discover if an individual will, when asked, vote to grant a specific right to all citizens or to withhold that right.

d = Disutility to me of having my right infringed by the others
u = Average utility to me of the social choice function being able to select scenarios where citizens have this right infringed.
p = Probability of being the one who has his rights infringed for any given iteration.
i = Iterations.

d(1 – (1-p)^i) – (u * i) > 0 : I will prefer to bestow this right to the citizen
d(1 – (1-p)^i) – (u * i) < 0 : I will prefer not to bestow this right to the citizen Societies are most likely to bestow rights under this model when the disutility is very high (such as death / torture), or when the members consider that they have a high chance of being in the minority. Perhaps they have fled from persecution in another place, or they are very diverse. There must also be a reasonably large number of iterations (the life expectancy in the society must be reasonably high). Seen this way, although rights may lead to some iterations having pareto dominated results, after all the iterations, we should expect that the final set of decision states is not pareto dominated by any other set, since the society would only choose to bestow the right if enough individuals thought it would be, in the long run better for them.