On the utility of money

Hans in Luck

Read your children ‘Hans in Luck’ by the Brothers Grimm, probably the most underrated tale in the collection. Returning home after his apprenticeship, Hans trades his hard-earned lump of gold again and again: for a horse, a cow, a pig, a goose, and finally a whetstone. Each time he feels better off. At last he loses even the heavy whetstone and feels unburdened, arriving home believing himself the luckiest of all.

Some read it as a lesson that happiness does not come from wealth, that sometimes it comes from letting go. You’ll own nothing and be happy. That degrowth framing misses the point. ‘Hans in Luck’ is a lesson on the inefficiency of barter. Imagine Hans had been paid not in a lump of gold but in gold coins.

The value of money

To understand money, two questions have to be answered: why does money have economic value at all, and why does it command a ‘monetary premium’?

• SCARCITY Anything scarce (in demand but limited in supply) has economic value, which is what warrants the cost of producing it at a profit.
• MONETARY PREMIUM The premium stems from a duality: the value of a good in its non-monetary uses versus its higher value once monetised into base money. Bitcoin, still a proto-money before full monetisation, prices the perceived probability of that monetisation.

The monetary premium of a base money asset comes from the utility it affords those who use it as a medium of exchange. That is the primary utility of money; every other function (store of value, unit of account) derives from it. Without exchange mediated by money there is no specialisation and no division of labour, and a modern, highly efficient economy becomes impossible. With bad money, progress slows. Without money, mankind sinks back into poverty.

Two dimensions, both necessary

Money mediates exchange in two dimensions. Base money (gold, silver, bitcoin) transmits value in place, in the present. Credit money (gold-redeemable banknotes, bitcoin-redeemable e‑cash) transmits real value in time, into the future, mirroring stores of real goods that are ready, or not yet ready, for sale. The two are inseparable: an exchange for money (a sale) must always precede an exchange with money (a purchase).

Lost time

Imagine a world without money: impoverished Austria after the Second World War. Goods had to be exchanged directly for other goods, and those who did not produce had to trade a store of value, an art object, for bread, milk, or a breakfast egg.

Under barter you must not only find someone who has what you want; that person must also want what you have. This is rarely the case, so barter turns into a roundabout, time-consuming chain of exchanges, repeated for every item you need. For producers, the time lost to barter costs production. For workers, it eats into leisure.

Lost value

Every one of Hans’s trades was rational in its own moment: he was tired, thirsty, hungry, in danger, and each exchange fixed the problem at hand. Yet a short series of exchanges wiped out seven years of savings.

Negotiating terms afresh at every step leaves value on the table, and the loss repeats along the whole chain, across unrelated goods at different stages of production. The roundabout way of exchange puts whoever has the more urgent need at the mercy of the counterparty. In the simple world of Grimm’s tales that is bad enough; in a modern economy with millions of intermediate products, running on barter is impossible.

What that utility is worth

≈½

OF WORLD GDP

The money recently needed to transact world production and transmit value along supply chains.

≈¼

OF GDP, HISTORICALLY

Roughly three months’ worth of output, the historic norm.

Money affords enormous savings of time and value compared with barter. But today’s fiat system carries much higher money holdings than the historic norm. Part of that may be longer production and supply chains; much of it is likely idle precautionary liquidity.