Friday, March 4, 2016

the value of money

Let's continue on the idea of eggs as a medium of exchange.  In particular, while they make a decent store of value for a short period of time, they're terrible at storing value for very long; even if you boil them, they won't be a way to stockpile wealth on the scale of a generation or something.  They hold their value well enough, though, that one could reasonably use them to facilitate a couple of trades before they end up with their final consumer; eventually, though, their value is that of a straight consumable.

Now consider an agricultural economy with limited currency of other sorts such that eggs pick up at least some of the slack.  The consumer of the eggs presumably sees some gain from trade in the final transaction; that person values the eggs at least as highly as what is being exchanged for them.  The penultimate owner presumably values what is being received from the final owner more highly.  Now consider the trade between the antepenultimate owner and the penultimate owner of the eggs.  We suppose
  • the transaction couldn't have happened had the eggs not been available as a medium of exchange
  • there was a substantial gain from trade in the eyes of both parties
  • if it is common knowledge that the eggs are deteriorating, the terms of trade should reflect this.
Young eggs, in particular, with three or four transactions left in them, might be worth more than eggs with only one or two transactions left in them — "eggs" may not be a unit of account (by which I really mean "standard of value"), exactly, even though they're a medium of exchange. At all both points, though, the eggs can acquire a liquidity premium in excess of the value that any consumer puts on them, essentially incorporating some of the gains from the trades they will facilitate into their initial value.

Now let's go back to money that is expected to last, in some practical sense, forever.  The social value of a dollar is the value of the transactions it can facilitate; a dollar that is return-dominated is, in some neutral unit of account, depreciating, but as long as the present discounted value of the gains from trade of the trades it will mediate is at least (say) a few dollars, the dollar can kind of steal that.  The more slowly the dollar deteriorates, the more marginal trades it can intermediate; a dollar that depreciates quickly will only be accepted as payment if the gains from trade are large.

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