Economy and the Role of Money

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By Nidal Sakr

(MAF- 4/14/2009) - The answer to the question of the role of money is not merely a philosophical one. Rather the very answer to this question is the key to understanding the realm of the world’s economic problem today and is indeed the starting point to finding a solution.

As human societies evolved so did both human needs and the goods and services human produces. As needs grew and became more diverse, humans became less self sufficient and more co-dependent on one another. Instead of surviving on few items of food shelter and clothing, humans used a basket of numerous goods and services. Combination that makes such baskets varied from one person to another and items that make up such a combination started to come from different sources producing same or similar items. Exchange that allows producer of a commodity to trade it in for one that is produced by another needed a medium to make such an exchange easy or even possible. It is that need to facilitate exchange of goods and services between various producers and consumers is what gave rise to the need for money. Thus money was invented as a means to facilitate exchange.

The function of money as medium for exchange required that money acts as a measure of value, otherwise how else would we know how much one item is measured in terms of other items? So human need to facilitate exchange is what gave rise to the role of money as both measure of value and medium of exchange. So far there would be little or no argument as to what money is or its role. As measure, money in and by itself has no value except in terms of the goods and services you can get in exchange for giving up an amount of that money. As a measure, money also is a neutral medium where it only shows how much each commodity is worth in relation to another commodity. A tape measure is the same tape measure whether you are measuring carpet, a pipeline, or how tall or short you are. The value is not in the tape except for the function of standard measuring it provides. It is in what the tape is measuring, and such a value is weighed in relative terms. The distance a taxi travels is measured in terms of money which the driver gets in return for the services of traveling such a distance, which is the same amount of money the passenger pays the driver in return for the service.

Neutrality of money is a guarantee that money does not distort the terms of exchange as the relative value of things would be measured of how much one is willing to sacrifice in terms of one commodity in return for another. Once neutrality of money is violated then its very role in facilitating exchange and promoting economic growth of producing more and consuming more in and by itself is compromised. Placing value on money itself then becomes a distorting factor where things are no longer only weighed in terms of relative values to buyers and sellers. A new player comes into play where terms of exchange are now affected by how much value a “money supplier” places on that money where money abandons the role it was created for to become a commodity in itself.

The fact that someone placed value on what is essentially neutral means of measurement and medium of exchange is at the heart of our economic meltdown today. When you buy a house today, you take a loan called mortgage to pay for that house. The amount of money you take out as a loan and agree to pay back has much more to do with the value the lender places on that money NOT on the house itself. A house could be worth a thousand dollars today, but when its purchase is financed by a loan which you agree to pay back over thirty years installments, its price immediately jumps to at least three times as much. In some cases you will have to pay that amount even if you decide to pay off your loan sooner than those thirty years. The mechanism by which your loan tripled is called interest, measured by interest rate, and is argued to be the value of money or the cost of borrowing.

That is precisely where the problem is. When you take out a loan, such a loan is no longer valued by the lender in terms of the money you took out rather by the amount you owe. To have money to lend to other people, the bank sells the amount you owe to another bank much earlier than the end of those thirty years for a discount, and new markets emerge where money is valued and exchanged in terms of contracts. But contracts are not money, and money is no longer a neutral means of measurement and exchange, thus just like everything else we lost our standard of value.

We started to hear terms such as “toxic assets.” I can understand using the word toxic to describe food or waste that harms or kills you, but how can neutral meaning harmless means such as money be toxic? When money is assigned value in terms of interest it becomes less and less payable as you end up having to pay back more that the money you took. As you become less able or certain to pay back your loan, chances of defaulting on your loan increase. When banks bundle uncollected or uncollectable loans along with other loans in new financial products to conceal such a risk, then we end up having a from of money circulated called “toxic asset” because it kills the economy of goods and services we exchange thus providing the exact opposite role for which money was created to start with.

When neutrality of money is compromised so is its role and function of facilitating production and trade. Instead of acting as stimulus for growth and prosperity, money becomes a barrier to trade and production and a catalyst for poverty and misery. When banks knowingly and intentionally defraud investors by selling them those toxic assets we are all taken for a ride, and this time not in a taxi.

Interest is the mother of all economic ills. It assigns a role to money other than what money was created for, and that is a store of value. When money is a store of value people no longer put money to good use by investing in producing more goods and services and whole fanatical markets such as money and financial markets emerge where greed instead of utility is traded.

Next time you take a taxi, remember that you are not buying the distance you are travelling. You are merely paying for the service of travelling that distance. This way someone else can travel that same distance. You get your mission accomplished, the cab driver is happy to collect the fare, and someone is happy to travel that same distance or even further.