Everything You Know About Money Is Probably Wrong — Pt.1

Money comes and goes, but time just goes…

I aim to share what I know about finance in this Medium space and in order to understand where I am coming from in finance, one must first understand where money — the idea of money — comes from. If you ask someone ‘what is money’ you will likely hear any number of definitions. In my experience, these definitions are almost universally rooted in Adam Smith’s conjecture in his book The Wealth of Nations. For those unfamiliar, the story goes something like:

‘Once upon a time, people would trade useful things like shoes or oxcarts. As life and things became more complex, it became too hard to trade these things, for how does one fairly divide an oxcart or a shoe? To fix this problem, these people created money. Then from money came lending, which turned into credit and debt, which gave rise to the financial world we live in today.’

This idea holds a certain logical appeal and seems perfectly sound, aside from the minor inconvenience that Adam Smith simply made it all up. If you run this story by an anthropologist, you will quickly discover there is no evidence of a society on earth ever developing this way. While it is true people have used things like coins for thousands of years to exchange value, the way we think about and use money today is relatively recent.

So Where Did The Idea Of Money Come From?

Rather than a system of barter that organically grew into fungible money, what we have is a system designed to extract taxes from a population. To understand this, we need to adjust our money paradigm a little bit and think about what happens when people exchange value, whether it be time, effort or things. To make this adjustment, we will engage in a little thought experiment.

What we have is a system designed to extract taxes

Imagine a close friend invites you to their house for dinner. You arrive at the agreed upon time, where your friend has prepared a fine meal that you share. Would you expect a bill at the end of the meal? I am sure it has happened at some point, but I think it would be unusual. Now, if two weeks later, your friend fell on hard times and needed some food, would you charge them? I hope not…

Can We Look At Money From First Principles?

As a general first principle then, let us say at a minimum human beings exchange value, whether we call it sharing, selling, trading or something else. There is conceptual research showing cooperation is an essential human trait and has contributed greatly to our success as a species. A key part of that cooperation involves the exchange of actual or perceived value.

With that, we could also say that, at least among close associates, most trade is friction-less. We exchange freely with our friends and loved ones with the expectation of fairness. The unspoken trust is that our sharing and trading will be roughly equal measures of give and take. In fact, there is a growing body of research demonstrating people orient towards three basic patterns: givers, matchers and takers.

We exchange freely with our friends and loved ones

We have all had friends that take more than they give. Even if we keep them as friends, sooner or later if they come to us asking to borrow something of high value, we may well require some sort of collateral to ensure we get whatever it is back. That collateral may be as gentle as social pressure through teasing and could just as easily rise to the level of a signed contract. Likewise, we probably all have friends that give much more than they receive, ranging in ‘quality’ of giving from the doormat to the generous.

Our close personal relationships are often mediated by these ideas. How we treat an exchange varies based on our trust in the person we are dealing with. If I know you are a fair, reliable close friend, I will exchange value with you very differently than I will with a close friend that is always borrowing and never returning. The further away from the ‘trust circle’ we get, the more ‘insurance’ is required to ensure the value given will be matched in like kind.

How Did Early Monetary Systems Work?

This brings us to money. For most of human history, human social groups have tended to max out around 150–300 people in a given ‘sphere of influence’. Generally speaking, value exchange in these small communities was done by informal contract. You need shoes and I make shoes, I give you a pair of shoes. In this is the understanding that you ‘owe’ me an equivalent value for a pair of shoes. If it is a particularly valuable thing or service, we might even write the details down. In this way, many of these informal contracts would also be exchangeable. I could take your promise to repay ‘shoe value’ (or whatever) and trade it with someone else in the community for something I might need, like a shirt, or help with a roof. The shirt maker or the roofer could then trade your ‘shoe value’ promise to someone else.

Value exchange…was done by informal contract

Round and round it goes until at some point, the community gets together and has a reconciliation. During this time, the ‘accounts’ are balanced and any value given and not received is made whole, or at least as close as possible. The balancing of accounts is one of the primary places where specie (coins, usually gold or silver) was historically used to exchange value within a community of high-interpersonal trust relationships. Otherwise, trade in specie was generally limited to transactions involving strangers. A far-flung traveler passing through a community would have no ties there, so the ‘insurance’ against giving value for nothing is to collect in specie from the traveler. So, why does money look like it does now? To answer that, we have to understand the problems money is trying to solve.

What are the problems money is trying to solve?

Now, if you are a landlord and wish to tax your peasant population, the easy way to do this is to simply go around and take a certain amount of whatever they produce. In turn, the landlord then sends a percentage of that to the sovereign to pay their tax and community resources are thus redistributed. The clever thing the inventors of modern money did was to demand tax be paid in specie. If you are the sovereign, there is only so much wheat or meat or shoes or whatever you can store before it rots, loses value, gets too bulky, or whatever. Plus, the taking of resources leaves a pretty substantial amount of value exchange occurring in your population that you cannot take a percentage of. But, if you require your population to pay tax in specie, then they are forced to trade in specie to pay their tax.

The clever thing…was to demand tax be paid in specie

If you make shoes, then you must sell at least some of those shoes for specie, or you cannot pay your tax. Labor must be compensated in specie, or the laborer cannot pay their tax. Landlords must collect specie from their population, or they cannot pay their tax. In turn, the sovereign can now buy needed services and resources using specie they collect from their population by giving it back to them in the form of services, payment or wages. Going larger still, the sovereign can trade with other sovereigns in specie, using their tax collected resources to procure goods and services from outside their borders. Just like that, you have created a relatively low-friction, hierarchical market economy that survives in this general form to this day.

So, Money Is…

To answer the question, ‘what are the problems money is trying to solve?’ I would answer: ‘to facilitate the exchange of value in low or zero trust situations and the bulk extraction of a fractional value of personal or collective industry through taxation’, which is quite different from what Adam Smith (or indeed most economists) would say.

So, why silver and gold? And where did paper money come from? I’ll tackle these in the next post.