Wednesday, July 25, 2007

Moving wealth into the future through money

Saving is good, but what does it mean? If in the future we will need some grain, then it is wise to save some. If in the future we will need something perishable then maybe we can save something non-perishable that we can swap for the perishable item at that time. We treat money as such a non-perishable item. This works in a small way, for individuals, but not for a whole society.

Suppose I save some money in a suitcase under the bed. That reduces the amount of money in circulation (by a small amount), thus making all the money that is in circulation more valuable (deflation). When I later put the money back into circulation it acquires its value from all the other money in circulation by making that other money fractionally less valuable (inflation). In this way an individual or a group can move wealth into the future through money. Society as a whole can't move wealth into the future through money. This is slightly confused by the fact that an individual country might be able to do it in the context of all other countries. However since there is no global economic control, or global currency, a country can only do it by putting itself at the mercy of some other country, as countries holding US dollars do today.

There is also a problem when too many individuals try to move wealth into the future. In so far as they try to hold money they cause deflation. However governments can't allow that, so more money is put in circulation. The trouble is that this leaves the potential to cause inflation in the hands of consumers, and the government has more trouble taking money out of circulation when inflation starts. The other way people try to move wealth into the future is by buying assets. This leads to bubbles when there is too much money chasing too few assets of genuine long term value.

Money has three roles: as a mechanism for efficient exchange of goods, as a unit of value, and, as discussed above, as a way of moving moving wealth into the future. The first two are related and inseparable. The third doesn't work and gets in the way of the other two, because stored money is always threatening to flood onto markets causing inflation and bubbles.

More on this another day.