What is money?

What is money?

Scenario #1:

Imagine 100,000 people magically appear on a large island. Of course, each person is unique, with different strengths and weaknesses. In order to survive, individuals find something they’re good at, whether growing food, making clothing, fishing or hunting, providing medical care, building shelter, or even entertaining others.

Initially, the informal understanding is, that just ask, and you shall receive. And most people, being good people at heart, and not selfish, make sure and “return favors”. One day, Ethel gives James some fruit. James says “Thank you”, but being a good person, realizes his words alone are empty. So the next day, when he catches some fish, he makes sure to find Ethel and gives her the best of the catch. This, thinks James, is a much more genuine and sincere way to say “Thank you” than just saying the words, since the fish represented some very hard work on his part, fighting the waves while using his advanced fishing skills.

INSIGHT: Reciprocity is the fundamental cornerstone of being a good person.

Before long, it becomes apparent that the level of devotion people have to helping others in their community varies dramatically. Some people work tirelessly, 7 days a week, to help others and improve their skills, while others put in just a few hours every few days helping others and spend the rest of the time pursuing their own interests. While some people are fairly self-sufficient and need little help, some people, even smart, able-bodied people, ask for a lot of help, while offering little or nothing in return.

INSIGHT: Given the choice, some people would rather pursue their own interests rather than help others.

Over time, people, especially the hard workers, realize this non-reciprocal understanding where people just help each other whenever asked has turned out to be intrinsically unfair.

So they move to a reciprocal barter system where, rather than giving things away upon demand, they trade goods and services voluntarily. To ensure each transaction is fair, they decree that a trade cannot take place unless both parties agree on the terms of the trade.

INSIGHT: A free market is an intrinsically fair and democratic system in which one helps others, and gets help one needs in return.

This arrangement, of course, works much better, rewarding the hard workers for their work. But there are still problems. One day, Ethel, who grows fruit, decides she wants a new house. She offers the housebuilder 10,000 apples and oranges. The housebuilder says “If you deliver all that fruit at once, it will spoil. Can you just give me a box of fruit for now, and 9,990 fruit IOUs that I can redeem over the years whenever I would like more fruit?

They are still trading a house for fruit, but the fruit IOUs makes the trade more practical.

Now, the housebuilder needs shoes. But the shoemaker does not need a house. So the housebuilder gets an idea, and says, “You know Ethel, the orchard owner? In return for a pair of shoes, I will give you 75 fruit IOUs that you can give her for fruit.”

Now, because there is a trusted monetary standard, people feel confident in making trades with Ethel’s fruit money, always backed up and redeemable by apples and oranges.

INSIGHT: In a free market, money is just a convenience or “marker” that people use to keep track of who is working the hardest or provides the most valuable help to others.

Everyone gets used to paying 75 fruit IOUs for a pair of shoes. Then, another handy person learns the art of sandalmaking and charges only 25 fruit IOUs for a pair of sandals. Who decides whether the shoemaker or sandalmaker gets money? The People do. Each individual decides whether they want shoes, sandals, or want to just go barefoot.

INSIGHT: Free market capitalism is purely democratic. All people have the power to decide who to reward and how much to reward them based on how they value their contribution.

What is a “transaction”?

Picture a hungry boy walking into a sandwich shop with $5 in his pocket, staring at a $5 sandwich on the menu. The boy has the power to choose whether to trade the $5 bill for the sandwich, or walk out the door without buying anything. The seller has made an offer: sandwiches for $5, but she cannot force the boy to purchase the sandwich. All the power lies with the boy.

After some thought, the boy decides he would like to trade the $5 for the sandwich. He is really hungry, and the sandwich looks good! So he chooses to trade— the $5 goes into the cash register, the sandwich goes into the boy’s stomach.

What just happened?

The superficial thinker only sees two assets changing places. Two things changing ownership. Nothing lost or gained. This is the most destructive misunderstanding in economics.

The truth: Once you examine the situation, and interview the boy afterwards, you find the boy, having been hungry before, after eating the sandwich, has improved the quality of his life. Unlike so many in rural China, India and Africa, this boy is now no longer hungry! He is better off now, after the trade took place. The sandwich shop owner, in their work to provide good food, has succeeded. The boy is happier now that he has eaten.

And the restaurant is also happy with the trade, because the sandwich only cost them $3 in costs, so after the trade they have actually created $2.

This bears repeating: $2 of real money was just created. There is now $2 more money in the world then there was before the boy bought the sandwich.

This is genuine wealth creation. Definitely not the same as a counterfeiter just printing up a couple of dollar bills. Counterfeiting does not create real wealth, it just devalues all the other dollar bills in existence.

This $2, along with all the other profit the shop makes, enables the shop owners to expand, to hire and train more people, and save and perhaps even open a second or third shop, at no one’s expense. All this is paid for from profits that the business created.

Are both parties always better off after a trade?

Not always. People buy things, and later regret the purchase, or feel they paid too much. Sometimes sellers sell things and later realize they sold them too cheaply. But, if, for any reason, a party was not happier after a trade, they’ve learned their lesson, and you can bet in the future they won’t make a similar trade again. Obviously, each party’s motivation is to make trades in which they are better off afterwards. By learning, each person makes more and more intelligent choices about what to sell and what to buy and how much to spend, that resonate with each person’s personal system of priorities.

Over time, this learning process, with companies always fine-tuning and improving their goods in a competitive free market, and shoppers always looking for better quality and lower prices, leads to impressive gains in the standard of living in a society. This learning process leads to constant improvement in the matching of goods and services to each individual.

In this way, companies that serve people well prosper while companies that do a bad job perish, as they should.

The owner of the shop might open a chain of other shops over time and make a lot of money. You might be envious of the half million dollar per year salary they might eventually pay themselves. But that money doesn’t come out of your pocket, or anyone else’s.

If you bought sandwiches from the shop, you chose to do so freely, and that’s not your money any more. You traded it, and got something of greater value in return (otherwise, why would you have made the trade?). When you traded, your money became theirs. Only by thoroughly thinking things through does one truly understand that the CEO’s $500K salary does not come at the expense of anyone else. They created it.

Someone who believes in the fallacy that economics is a zero-sum game, that wealth cannot be created, that there is a fixed pie, simply does not get it. They cannot understand how, after the trade, the boy can be better off, and the sandwich shop can be better off. How can both sides win?

On one side, customers get what they need and want– food, clothing, and shelter, iPhones, PlayStations and trips to Paris. On the other side, companies generate profits, which go back into the economy, in JFK’s words, the “tide that lifts all boats”.

Some people don’t understand why the standard of living is much higher in free, capitalist countries than centrally controlled economies like China, North Korea and the former Soviet Union. But all they need to do is sit in a sandwich shop and keep their eyes open, talk to the customers who keep coming back, and the shop owner, keep their mind open, and eventually they will understand.

Since both parties are better off after most voluntary transactions, there has been a “net gain” overall. The entire community is better off.

INSIGHT: Both sides of any free, voluntary trade will generally be better off afterwards. There is a “net gain to society”.

What is an involuntary transaction?

Scenario #3:

Before the boy gets to the restaurant, a bigger boy wrestles him to the ground and takes his $5. The smaller boy does not want this transaction to occur.

Result: The bigger boy gains $5. The smaller boy loses $5. Financially, the gain cancels the loss, so there is no net gain to the parties involved, as there was in the voluntary transaction. No money was created. You might say the smaller boy has gained knowledge, but this knowledge, if it were offered freely, well, I doubt the boy would have offered $5 for it. He would have probably preferred a sandwich.

Not only this, but the bigger boy will probably spend the $5 more capriciously knowing he can always get more money by force, thereby negating the important benefit that bargain shoppers bring to the market.

INSIGHT: In a forced, involuntary transaction, one side is almost always worse off, and the “net gain to society” is zero or negative.

How does an entire society “lift themselves up by their bootstraps?”

Scenario #4:

Imagine a family living with no plumbing, electricity, phone, TV, air conditioning, or car. Imagine that they are in danger of starving sometimes if there is a particularly bitter winter or late frost. I am not describing a poverty-stricken family in sub-Saharan Africa today, but a well-off family in 1700 in North America.

Hundreds of years ago in North America, even the richest people lived in conditions worse in some ways than the most poverty-stricken do today. If you took any family from their home today and put them in a situation closely resembling a rich family in 1700, they would be far below the poverty line.

So how has this country gone from everyone living in poverty, to such a high standard of living?

The answer is simple:

A series of voluntary trades results in a net gain to a society. Both sides are better off, thanks to the learning process detailed above. In a free market, companies compete to offer goods and services that make customers happier and improve their lives. While they don’t succeed all the time, the constant striving brings results. People live better and better. The law protects people from fraud, theft and violence and punishes wrongdoers.

Over hundreds of years, free trade in the U.S. has resulted in tens of trillions of net gains in wealth. When millions of people work very hard to help each other, and get valuable feedback concerning how much they are helping in the form of the prices employers and customer are willing to pay, they refine and develop their methods of helping to a high degree so they are ever more helpful. At the same time, societies that aren’t based on free trade are mired in poverty.

INSIGHT: A series of voluntary trades will result in increasing the net worth of everyone in a free market-based society.

Who serves who?

We have established that a group of good people will choose the free market as a fair way to help each other. But what about evil, greedy, power-hungry people?

In the olden days (you kids don’t remember, but back in my day), without any laws protecting individual rights or freedoms, one gained power through use of force. If you could gather a group of big, strong men with swords on horseback, you could take land from people, force them off it and live there (until a bigger army came along). You could take possessions, own people, and do whatever you wanted with violence. The most powerful, wealthiest people in lawless times and places got there through looting, stealing, killing and plundering, and their minions serve them.

INSIGHT #5: When you are backed up with big men with weapons, you can force others to do things they would not voluntarily do.

In a free market, with a system of enforced individual rights, you can’t gain wealth by force. You gain wealth by serving people. The rich are our servants. Rich people work very hard to provide you with things you really need or want, hoping that, in return, you will acknowledge their efforts with the most genuine thank-you—one of Ethel’s fruit coupons.

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