User:Woozle/rethinking economics

Introduction

It seems to me that when people talk about economics, they get very much tangled up in a particular set of ideas and customs that have arisen, and this prevents them from grabbing hold of the basic purposes of economics. They end up applying patches and kluges for the weaknesses of the current design rather than re-engineering it from a lower level which might really fix some of the design's inherent problems.

I am not an economist, and I have no special knowledge of economics or finance, but I do have experience untangling other people's convoluted and undocumented critical systems, documenting them, and redesigning them in a more robust way. Finance strikes me as being very much this sort of accumulated amalgam of shallow solutions.

The financial meltdown of 2008 poses a conundrum: nothing has been suddenly destroyed; our farms, factories and homes are still intact, our roads and bridges are still passable (despite some neglect), our power grid is in no worse shape than before, our communications infrastructure continues to grow -- and yet people are "out of work", being kicked out of their homes, sometimes even going hungry. At the same time, many of those factories stand idle, their workers sent home without pay, many houses (both newly-built ones and those repossessed by banks) cannot be sold.

In other words, as a nation we (still) have more than enough capacity to provide the things which many people are now being forced to do without. How is this possible?

A further question is posed by the recurring fears of impending hyperinflation, in which the money we currently use to buy the things we need on a regular basis would be rendered nearly worthless: if we still have the capacity, as a national community, to produce the things we each need in order to survive at a reasonable level, why couldn't we just keep on trading with each other, regardless of what the money is worth? What system could we put into place that would survive if the US dollar became worthless or undependable?

Clearly, the system by which trade is conducted is in need of a major design review.

Basics

Economics is not about money; it is about resources. The way we allocate resources (and have done so for many centuries) is through money, so most discussion of economics ends up being about money.

when the equivalence works

When looked at locally, it's true that money and resources are more or less interchangeable. If you have $10, you can easily buy a decent meal. If you have $100,000, you can buy several years' worth of meals -- or a small house (possibly a large house, depending on where you look), or a handful of cars, or some combination of these. Money is easily transformable into whatever resources you happen to need at the moment, as long as you have enough of it.

On the other hand, just because you have a house (or a warehouse full of several years' worth of frozen meals, or a small collection of cars) doesn't mean that you could quickly trade them for $100,000, or (more relevantly) for any of the other things you might need which $100,000 could buy for you. This is one of the reasons people tend to think in terms of "money" rather than "resources".

Another reason is that it reduces the accounting of resources to a single, simple number: instead of saying "I could buy a house, or several years' worth of frozen meals, or about 5 new mid-sized cars, or some combination of the above", you can just say "I have $100,000".

Yet a third reason is that we don't pay our bills in resources. Even though the power company may need things which you could provide -- say you have a dozen reams of paper and you're an excellent typist -- the power company will not accept those things (your paper plus a certain number of hours of your typing labor) as payment for this month's power bill. Nor will the grocery store accept your reams of paper, or a few hours of typing, as payment for a bag of groceries. They might hire you as a typist and give you money, or they might buy the paper from you as a supplier, but the deal will always involve money on one side of the trade.

The reasons why this is so seem pretty obvious:

• money has an essentially fixed value -- my $5 can be traded for the same resources as your $5, while you might be a much better typist than me, or have nicer paper
• negotiating for resources is complicated -- maybe the grocery store doesn't need any more typists or paper at the moment, and a policy of being willing to consider accepting these things in trade for groceries would open them up to having to negotiate with you for other ways to pay for your groceries, which would cost them more in employee-time
• money is arbitrarily dividable -- if we decide that a pound of bananas is worth a ream of (your) paper, what do we do when you only need half a pound?

a very brief history of money

The idea of money seems to inevitably evolve out of this sort of situation. Let's say that the store agrees to owe you half a pound of bananas or half a ream of paper. What happens next time, when you need a bunch of grapes? The obvious solution is to assign the grapes some cost expressed in pounds-of-bananas or reams-of-paper -- but then what happens when there's a banana shortage?

There needs to be some thing upon whose value which everyone agrees, so that you don't feel like the grocery store is impugning the quality of your paper (or typing) when all they're doing is trying to deal with the increased difficulty of obtaining bananas. Assigning a value (in units whose value isn't subject to argument) to each item in the trade avoids this confusion.

In the early days of money, it was typically assumed that the thing we use as a value-standard -- the "currency" -- had to have some intrinsic value itself, hence precious metal coinage (gold, silver) in measured weight denominations. The English "pound sterling" was originally an amount of sterling silver -- a particular grade of silver which was highly useful for producing functional objects -- presumably weighing one pound.

Later on, someone came up with the idea that instead of the currency itself being valuable (commodity money), it could be issued as a promise that the issuer would, on request, accept it in trade for an item of fixed value (representative money). From the point of view of the issuer, this had a number of beneficial effects which should probably be part of our evaluation.

Finally, it was realized that once a currency had been widely adopted (or imposed), there wasn't really any need for an official "backing" of fixed value; such currencies are called "fiat money", and they are used by every modern country. Fiat money can be thought of as being backed by the production capacity of the country in question: if you have 10 United States dollars, you can be pretty sure that you can get a decent meal out of it, at least for now.

when the equivalence doesn't work

One of the problems with fiat currency is that it can be abused by the issuer. If a government needs more money than it has, it can print more. This ultimately reduces the value of existing money, a phenomenon known as "(cost) inflation". The result is that prices (and wages) creep upwards -- and saved money loses its value over time.