We concluded Part 1 by saying that, in this advanced age, money works as a medium of exchange because we all pretend agree that it works – we agree that it has value. How money has value at all and how much value it has is what we will discuss next.
Going back again to barter, the type and foundation of commerce, we see that economic value – trade value – depends entirely upon what people are willing to exchange for something. I may value my horse or X-34 Landspeeder as the apple of my eye, but if I want to trade it, it’s worth exactly how much someone will give me for it.
And that’s the trick: in a free market, speaking strictly economically, *everything* is worth exactly whatever the buyer is willing to give up for it. Doesn’t matter how much we love it or hate it, doesn’t matter what we think is ‘fair’ (a prohibitively elastic term) – if I can’t find someone to pay me what I think my precious X-34 is worth, then it’s not worth that much. Nothing personal, it’s just business.
Back to value. As the medium of exchange, money gets its value based on the comparative values of the things traded with something of standard value. The mechanism is so refined at this point that it is invisible to the naked eye, but it is there even when we pick up a pack of gum at the QuickStop. In free markets, a naturally occurring ‘gold standard’ soon arose (or a silver or copper or cigarettes or sea shell standard – it just has to be something people trading value). Then, as a matter of convenience and tradition, things for sale have their prices denominated in the agreed-upon standard. Next, following the process described in Part 1, that value represented by the standard gets transferred to paper money and electronic ledger accounts.
Bottom line, as we finance types like to say, paper money is valuable based ultimately as a pricing mechanism dependent on the value of goods established in a free market, through the intermediary steps of currency creation outlined previously.
And now, it has to be noted that there is one other way currency can have value – by governmental fiat. The government can simply set prices based on some perceived need, often some notion of ‘fair’. This governmental price-setting by fiat can take place in two ways. The first is straight-forward in effect, if often byzantine in implementation: passing laws or making regulations that set prices on some items that are more or less than what the market price would otherwise be. Sugar, for example, has been consistently about twice as expensive in America than anywhere else in the world, due to a 250 year and running series of bills and regulations made to win the political support of sugar producers and refiners.*
But the main price setting by fiat that the government enacts is the price of government itself. Projects are bought and taxes levied and debt incurred with little if any market involvement, meaning that the buyer and seller are not simply looking for economic value and are not really free to turn deals down. Governments can do a better or worse job of managing this process, but it is unlikely in this vale of tears that they will do as good a job as a free market. Just as the temptation to fraud afflicts those in the open market, the temptation to use government money to buy or pay off political favors besets those spending government money. Well talk a little about why this is so later.
To sum up: money has value due to its implicit historic relationship to standards of value (e.g., the gold standard), and our more or less conscious decisions to act as if those standards still existed. Standards allow for a consistent valuation across many different types of goods and services, and have sprung up everywhere a material number of people want to buy and sell stuff.
Next up: where money comes from. Hint: probably not from where you think.
*Consumers pay for this twice, both in higher sugar prices and in the taxes and debt that fund the government subsidies and the bureaucracies that manage them.