Money, Stability, and small is the new big

Money is probably the most common abstraction we deal with in the everyday, and as such is special because we easily forget its pretend nature, of just a concept, transformed into coins, paper or bytes. Watching young kids grasping the elemental nature of it, challenges you to try to understand it from their perspective, without any previous knowledge or bias, perhaps before introducing the subject to them we need to undertand its sociological roots ourselves.

Many people have speculated about the social processes that brought about the use of money, as there is evidence of money use from 100,000 years ago. Aristoteles was probably the first one (like in so many things) to formally theorize about its origins, attributing it to the need of facilitating what was only barter based commerce and the problems of having things to trade —that although valuable— were not required by the other party you wanted to trade with. This notion of the origin of money (efficiency basis) was held true for most of history. Only recently modern anthropology have challenged that notion, reasoning that barter transactions were only common with strangers, or members outside the community, city, or regular social circle of trade. These interactions were rarer in occurrence in ancient times —most of trade was intra-community— then the efficiency basis was probably debunked from its place as natural origin of money in a social sphere. A current view of the matter, is that transactions within the community were done on the basis of gifts and debt, where an item will be provided to another member disregarding whether they have anything immediate to exchange back, on the tacit, or formal promise, of returning the favour when required in the future, for other items or services, the receiver could eventually produce. As small communities evolved into bigger social organisations, like chiefdoms, cities, and eventually states, the mental accounting of debts and gifts surely proved difficult to keep by (with an increasing number of individuals), generating the need for a more sophisticated technology to keep check for an increasing amount of obligations.

Therein lies a key step in the evolution of money. It can really unlock transactions outside a community, or for people that don’t have any incentive to repay back. It’s origin might not be barter substitution, it’s probably closer to a need for an accounting method (in the social sphere), that can be traded among individuals.

A one likely example of this trade, and the transition from mental accounting to formal abstraction of debt, was to allow a lender (someone being owed), to formalize its right to claim that debt from a borrower (the person with the debt), in the form of a paper promise, that can then be exchanged by the lender, to any other person wanting to settle the obligation for the borrower, and claim the debt in the future himself. This simple transaction gave the “paper promise to pay” the characteristic of a right to collect something in the future (money) and unlock trades between strangers. As there was always going to be an individual willing to bear risk of people not being able to settle the debt. Present here we can see the hint of the birth of banking, and how money and financing are inherently born together. In the system of strangers —or pretend to be ones— money becomes the only way to unlock commerce transactions, with a systemic need for someone to profit on taking risks few are willing to take. These individuals became the nodes of commerce, kind of clearing houses where debts and trades were settled. Another way to see them as an early ancestor of banking is like translation agents. People needed not to understand the other party motive or trading need, and still be able to communicate (monetarily) through them, and their debt clearing system, getting most of their exchanges realised in an almost anonymous way.

Another example of a social interaction transformed into trade was the fragmentation of produce, like when a farmer knowing more or less the amount of grain to be harvested decided to fraction the rights of consumption in smaller pieces. At first they took the form of sea shells, rare pebbles, wood or anything that could be marked appropriately, but nothing proved better than metal (longer lasting, difficult to replicate) and probably coins are its most recognised example. Coins itself evolve to be later minted out of precious metals, and lose their equivalency to a commodity right (like one bushel of wheat grain), to have intrinsic value for the material they were minted of, again, more than for the promise the carried with.

In its true essence, money use to represent just a right to claim something valuable from a known individual or society of them. Its abstraction level was achieved already, but with a real claim, and known parties. The transfer of risk from the individual to the debt clearer was only up to a certain point, the maximun risk they could tolerate was driven by their wealth, and related interests for allowing commerce to grow.

A social interaction is transformed into an item of trade (an abstraction in itself), and from there we have created the most complicated economic machinery history has ever seen. Commerce was and is, a representation of our interactions as as society, but why all this that sound very simple and human evolved to widespread malaise like inflation and financial crises?

Let’s start with the dumb tax, Inflation, and its cousin the creation of money (supply). They usually go hand by hand.

Money used to be created by the party requiring to accelerate commerce transactions with a counterpart in real debts or a claim to a commodity (wheat, rice, gold, silver). It was the individuals that created money, and also individuals who wore the risks around clearing it for other parties. With the rise of another needed abstraction “government” —by cities and states— came the need to finance its activities by creation of money. This option was originally copied from the treatment of wealth in a Kingdom (real owner of silver, gold and any other goods in the land). Kings usually were the wealthiest of individuals and with the natural right to be the issuers of money (which cannot be held true, for many reasons, in bureaucratic government of the modern state). There is an almost unnatural incentive, to print money (abstraction), by a risk-free government bureaucrat (another abstraction), that soon degenerates in too much money creation. Money stops having anything to do with the real things produced in the land, and Inflation is born. You can see how a little agency problem, or transfer of risk from one party to another one, quickly becomes a big problem for everybody.

If inflation is a dumb tax, a financial crisis is the equivalent to a collective commerce depression in society.

They appear to be in its essence, just a trust issue magnified in a rapid an exponential basis, and augmented by too big to fail trade institutions. In the past, they were enough individuals and small clearing houses of debt, to distribute risk among a great amount of people, money was also only created as a direct link to increases in wealth (better harvest, more crafts to sell, etc). Therein was an incentive to keep money supply limited to the risk parties were willing to take, and for nodes of finance never to be bigger than the needs for commerce in the community. A lot of micro banks to spread the risk of lack of payment, and if one eventually went bust, not big enough to affect the community as a whole. With the modern state came the central bank, and its dual monopoly of creation of money, and saviour of insolvent banks (when they were exposed to large risks and suddenly went bankrupt), all of this with the intention to protect the individual. Relationship of money to real things and individuals was broken (fiat money creation), and no more complete wearing of risks of financing (cyclical government bailouts guaranteed), with banks liberated to become as big as they could dream to be, taking more risks that they weren’t ultimately really bearing. One big transfer of risks for the protection of the individual by a few bankers with no real downside, and a government too large to see its consequences.

Our current macro risk transferring machine, was the one proved completely useless (at its core) during the GFC, and still (for government and banks) the way out the mess is not clear. But, worse they don’t realise the core design of the system is broken to address the same problem in the future. So, seems they are just waiting for the economy to pick up again, and let risk build up for the next big crisis to happen. They don’t know any other way.

Is there a better way?

Maybe, we are already at a point in time when handing back control of money supply from government to individuals is the right thing to do, paired with a redefinition of banking rules, and promoting risk taking at the personal level again. Yes, personally liable again.

In a society more interconnected than ever, where your community probably includes people from more than one continent —helped by communication technologies— why do we have to keep trading like strangers?

Abstractions takes away the real human interactions, and money has always been very good at that. Perhaps, we just need to come back to our essence of community functioning (welcome any technology help), no more big paraphernalia in government financials, or money/banking regulation. When individuals are given the keys to drive commerce again, the central bank will be exposed at what it really is, just an aberration.

In money and finance, small is the new big.

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