WEBVTT NOTE What is Money? 1 00:00:00.000 --> 00:00:08.000 What is money? It seems to be a simple question. It's even a very simplistic question. Obviously, we all know what money is. 2 00:00:08.000 --> 00:00:15.000 It's the stuff we carry around in our wallets every day. It's the stuff that you get paid in when you cash in your paycheck, right? 3 00:00:15.000 --> 00:00:23.000 But it's a little more complicated than that when you look at it from the point of view of economics. 4 00:00:23.000 --> 00:00:29.680 So as economists, what we want to answer is how come these paper bills, these green paper 5 00:00:29.680 --> 00:00:36.240 bills that we carry around in our wallets, how come they are worth so much, right? Because 6 00:00:36.240 --> 00:00:40.720 the paper in itself is not worth anything, right? It's probably worth a few cents, but 7 00:00:40.720 --> 00:00:46.160 how come on the market, if you go out, how come you can take this paper and exchange 8 00:00:46.160 --> 00:00:50.400 it for something really valuable? You can buy a car, you can buy things which are worth 9 00:00:50.400 --> 00:00:54.160 So much more than what is in that paper, right? 10 00:00:54.160 --> 00:00:56.680 This is the question that we want to try and answer. 11 00:00:56.680 --> 00:01:01.360 And to do that, what we do first is we distinguish 12 00:01:01.360 --> 00:01:05.400 between what we call direct exchange and indirect exchange. 13 00:01:05.400 --> 00:01:10.400 So direct exchange is basically a stage of border, right? 14 00:01:11.440 --> 00:01:13.400 A place where there is no money, 15 00:01:13.400 --> 00:01:16.160 where a stage of civilization, 16 00:01:16.160 --> 00:01:19.280 where goods exchange for other goods. 17 00:01:19.280 --> 00:01:23.280 So people exchange with each other and they exchange goods for goods. 18 00:01:23.280 --> 00:01:31.680 So that's my, so this is the case of barter and I'll read it out, it's not that clear. 19 00:01:31.680 --> 00:01:34.640 There's no money in the society, it's a very primitive society. 20 00:01:34.640 --> 00:01:37.520 There's a Mr. Smith and there's a Mr. Jones, okay. 21 00:01:37.520 --> 00:01:41.600 And Mr. Smith has, is a farmer, he has a lot of corn. 22 00:01:41.600 --> 00:01:47.360 And Mr. Jones owns an apple orchard, so he has a lot of apples, okay. 23 00:01:47.360 --> 00:01:54.960 and Mr. Smith has corn but he would like to acquire some apples and Mr. Jones has apples 24 00:01:54.960 --> 00:02:01.200 and would like to acquire some corn. So now here, I mean, you can see that conditions are kind of 25 00:02:01.200 --> 00:02:09.520 perfect for these two people to profitably exchange with one another, to trade, okay. They could, 26 00:02:09.520 --> 00:02:16.160 Mr. Smith and Mr. Jones could come up with some kind of ratio which is agreeable to both of them 27 00:02:16.160 --> 00:02:22.160 Where they would exchange corn and apples with each other and they would both be better off at the end of that exchange. 28 00:02:22.160 --> 00:02:31.160 And this would be called direct exchange where they're exchanging goods for goods and there is no money in this society. 29 00:02:31.160 --> 00:02:35.160 But this is a very simple society. 30 00:02:35.160 --> 00:02:40.160 It's very quickly that you will see that problems start to kind of come up. 31 00:02:40.160 --> 00:02:49.160 So it's very easy to see that problems quickly arise in a very simple society in which there is no money. 32 00:02:49.160 --> 00:02:54.160 So here we have a case where we have a Mr. Smith and Mr. Jones again. 33 00:02:54.160 --> 00:03:02.160 But Mr. Smith, who has the corn, now wants to acquire some salt in exchange for that corn. 34 00:03:02.160 --> 00:03:07.160 And Mr. Jones still has the apples and still wants corn. 35 00:03:07.160 --> 00:03:15.560 Mr. Jones would love to exchange with Mr. Smith, but Mr. Smith right now does not want 36 00:03:15.560 --> 00:03:21.760 what Mr. Jones is selling, he wants something that Mr. Jones does not have. 37 00:03:21.760 --> 00:03:30.160 So this would be called that it is a lack of a double coincidence of wants. 38 00:03:30.160 --> 00:03:36.480 In order for direct exchange to take place, both parties of the exchange must actually 39 00:03:36.480 --> 00:03:40.200 want exactly what the other person has at the same time. 40 00:03:40.200 --> 00:03:45.640 This is the only way trade can take place when there is no money. 41 00:03:45.640 --> 00:03:50.120 But in a case like this, in scenario number two, between Mr. Smith and Mr. Jones, we have 42 00:03:50.120 --> 00:03:51.120 a problem. 43 00:03:51.120 --> 00:03:53.160 We have a lack of a double coincidence of wants. 44 00:03:53.160 --> 00:03:55.960 Each of them wants different things. 45 00:03:55.960 --> 00:04:00.840 They have something, but Mr. Smith does not want what Mr. Jones is selling, so this is 46 00:04:00.840 --> 00:04:01.840 a problem. 47 00:04:01.840 --> 00:04:05.800 Society would not get very far in a scenario like this. 48 00:04:05.800 --> 00:04:12.800 Now, what can happen is that if Mr. Jones, so Mr. Jones is a smart guy, okay, so he's 49 00:04:12.800 --> 00:04:17.640 going to kind of go around and he's going to find somebody. 50 00:04:17.640 --> 00:04:19.680 We have Mr. White there. 51 00:04:19.680 --> 00:04:22.420 If he's a smart guy, he's going to go and find Mr. White. 52 00:04:22.420 --> 00:04:28.840 And Mr. White has salt, he owns a bunch of salt and would love to buy some apples in 53 00:04:28.840 --> 00:04:30.520 exchange for them. 54 00:04:30.520 --> 00:04:38.740 What Mr. Jones can do is buy salt from Mr. White in exchange for his apples. He's going 55 00:04:38.740 --> 00:04:45.640 to buy the salt and now he has the salt, he wants Mr. Smith's corn, he can go back to 56 00:04:45.640 --> 00:04:53.520 Mr. Smith, hey I have your salt, now let's trade. So what did Mr. Jones just do here? 57 00:04:53.520 --> 00:04:59.040 He went and bought something, in this case it was salt, he went and exchanged something 58 00:04:59.040 --> 00:05:03.760 which he did not want directly. He had no demand for this good directly. He did not 59 00:05:03.760 --> 00:05:09.080 want to consume the salt for himself. The only reason he went and bought the salt was 60 00:05:09.080 --> 00:05:15.960 because he wanted to further exchange it with Mr. Smith and then get what he actually wanted. 61 00:05:15.960 --> 00:05:23.880 This would be an example of indirect exchange where somebody, so Mr. Jones in this case, 62 00:05:23.880 --> 00:05:29.080 And bought something which was not of direct utility to him. 63 00:05:29.080 --> 00:05:30.560 There was no way that he wanted it. 64 00:05:30.560 --> 00:05:31.900 He did not want to consume it. 65 00:05:31.900 --> 00:05:36.800 The only reason he went and bought it was because he wanted to further exchange it because 66 00:05:36.800 --> 00:05:41.880 he knew by doing so he could then further exchange and then get what he wants. 67 00:05:41.880 --> 00:05:47.480 Okay, so this is what we call indirect exchange and obviously this is a great way to get over 68 00:05:47.480 --> 00:05:49.560 the problems of barter. 69 00:05:49.560 --> 00:05:55.480 In a barter economy, you have people who have a lack of double coincidence of wants, but 70 00:05:55.480 --> 00:06:00.280 people like Mr. Jones who are smart can go and start to buy things, which they can then 71 00:06:00.280 --> 00:06:02.460 further exchange, right? 72 00:06:02.460 --> 00:06:07.720 So in this economy, we can see that something like salt, right, salt, which is actually 73 00:06:07.720 --> 00:06:11.680 a marketable good, a more marketable good than maybe apples, everybody would like to 74 00:06:11.680 --> 00:06:18.440 have some salt, a commodity like salt will start to emerge, everybody will start to kind 75 00:06:18.440 --> 00:06:25.700 and want to hold salt in order to exchange it further, in order to engage in indirect 76 00:06:25.700 --> 00:06:35.560 exchange with it. So this is basically how money starts to emerge. A commodity like salt, 77 00:06:35.560 --> 00:06:41.040 which is valued for itself, but then also because it is so marketable, people start 78 00:06:41.040 --> 00:06:46.740 to acquire it to engage in indirect exchange with it. This is what is called a medium of 79 00:06:46.740 --> 00:06:55.100 of Exchange, and as more and more people start to catch on, since a lot of people will now 80 00:06:55.100 --> 00:07:00.460 accept salt in exchange for their goods, there's going to be all these other people who are 81 00:07:00.460 --> 00:07:04.860 going to start to demand salt, not because they wanted to consume it in any way, but 82 00:07:04.860 --> 00:07:10.700 because it's starting to emerge as this medium of exchange. 83 00:07:10.700 --> 00:07:15.380 So it's kind of like a self-perpetuating process once it gets started. 84 00:07:15.380 --> 00:07:20.740 All you need is a few smart people to kind of figure this out, that if we actually did 85 00:07:20.740 --> 00:07:23.460 this we could get over this problem of barter. 86 00:07:23.460 --> 00:07:28.580 But then once a few people have figured it out, it's the self-perpetuating process where 87 00:07:28.580 --> 00:07:34.380 the demand for a commodity like salt kind of really jumps because everybody knows that 88 00:07:34.380 --> 00:07:40.520 other people are going to accept it and this is how a medium of exchange comes into being. 89 00:07:40.520 --> 00:07:46.760 So this is really kind of at the heart of when we talk about what money is, how we define 90 00:07:46.760 --> 00:07:53.620 money, it isn't what it is, it's not defined by the thing that it is, but it's defined 91 00:07:53.620 --> 00:07:56.440 by what it does, by its function. 92 00:07:56.440 --> 00:08:01.540 And the main function of money is that it is a medium of exchange. 93 00:08:01.540 --> 00:08:07.760 It enables people to buy things that they would not otherwise be able to buy. 94 00:08:07.760 --> 00:08:13.400 And the main characteristic of this medium of exchange is that people acquire it, people 95 00:08:13.400 --> 00:08:18.720 want to hold on to it only for the reason of further selling it, not because they want 96 00:08:18.720 --> 00:08:19.720 to consume it. 97 00:08:19.720 --> 00:08:24.220 So if you think about money, the money in our pockets, we don't get direct utility 98 00:08:24.220 --> 00:08:25.220 from it. 99 00:08:25.220 --> 00:08:29.200 There's no way we can consume it like you can when you go out to lunch and you eat a 100 00:08:29.200 --> 00:08:30.200 burger. 101 00:08:30.200 --> 00:08:31.200 You can't consume the money. 102 00:08:31.200 --> 00:08:34.840 The only reason you're holding onto the money is because you can then further exchange it. 103 00:08:34.840 --> 00:08:39.880 So at the heart of it, what money is, is that it is a medium of exchange and it enables indirect 104 00:08:39.880 --> 00:08:41.300 exchange to take place. 105 00:08:41.300 --> 00:08:45.800 So obviously, as you can see, in a case like this, this is a very simple case obviously, 106 00:08:45.800 --> 00:08:51.180 but as money starts to emerge in a society, it enables trade and exchange. 107 00:08:51.180 --> 00:08:57.160 Where you have no money, where there's only barter, you can have a very low level of trade, 108 00:08:57.160 --> 00:09:03.380 a very low level of specialization, because there is going to be all these problems. 109 00:09:03.380 --> 00:09:08.540 But with money, you start to get over these problems and trade, exchange and the market 110 00:09:08.540 --> 00:09:14.540 start to develop because of the existence of money in the market. 111 00:09:14.540 --> 00:09:17.420 I'd like to give you an example of the problems of barter. 112 00:09:17.420 --> 00:09:23.260 So this is a real world example and it was written by a 19th century economist, William 113 00:09:23.260 --> 00:09:28.940 Stanley Jevons in his book and he, the book is called Money and the Mechanism of Exchange 114 00:09:28.940 --> 00:09:37.260 And it's a true story, and he tells the story of a French singer who went to a Tahitian island. 115 00:09:38.860 --> 00:09:45.500 She would tour the world, and she was on this island, and she agreed to give a concert to sing 116 00:09:45.500 --> 00:09:52.060 for the island people. And the person, the manager who kind of organized this concert, 117 00:09:52.060 --> 00:09:58.380 agreed to give her one-third of the ticket sales in return for her doing the concert. 118 00:09:58.380 --> 00:10:04.380 and when she got paid, what she found was, when she counted her share, her share was 119 00:10:04.380 --> 00:10:12.020 found to consist of three pigs, 23 turkeys, 44 chickens, 5,000 coconuts, besides considerable 120 00:10:12.020 --> 00:10:17.100 quantities of bananas, lemons and oranges. 121 00:10:17.100 --> 00:10:20.260 And this was because there was no money on this island. 122 00:10:20.260 --> 00:10:23.020 So people wanted to come and watch this concert, right? 123 00:10:23.020 --> 00:10:26.060 They want to hear this famous singer sing, but there's no money on this island. 124 00:10:26.060 --> 00:10:29.700 The only way they pay for the ticket was with commodities. 125 00:10:29.700 --> 00:10:32.140 This was bought or they were giving commodities. 126 00:10:32.140 --> 00:10:35.420 And the only way she got paid was in those commodities. 127 00:10:35.420 --> 00:10:40.900 And he said that in Paris at the time, if you took all those commodities, they would 128 00:10:40.900 --> 00:10:43.380 have actually sold for 4,000 francs. 129 00:10:43.380 --> 00:10:44.380 It was a lot of goods. 130 00:10:44.380 --> 00:10:50.180 It would have sold for 4,000 francs, which is a great price, which is a great price for 131 00:10:50.180 --> 00:10:51.180 a concert. 132 00:10:51.180 --> 00:10:52.180 It's great money to make. 133 00:10:52.180 --> 00:10:59.020 There was no way that she could now transport all these things back to Paris. 134 00:10:59.020 --> 00:11:00.660 So basically she had to leave it behind. 135 00:11:00.660 --> 00:11:02.860 She had to lose her money. 136 00:11:02.860 --> 00:11:05.060 She had to lose the payment that she had got. 137 00:11:05.060 --> 00:11:08.260 She'd done this concept, but there was no way she could actually use things that she'd 138 00:11:08.260 --> 00:11:09.620 got paid with. 139 00:11:09.620 --> 00:11:15.500 So this would be an example of how barter discourages trade and exchange. 140 00:11:15.500 --> 00:11:19.900 So the next time she's not going to go and give a concert where people don't have money. 141 00:11:19.900 --> 00:11:24.540 If there was a money, if there was something that was acceptable as a medium of exchange, it would be great. 142 00:11:24.540 --> 00:11:28.700 It would encourage other people to come in and do things like give concerts. 143 00:11:28.700 --> 00:11:35.580 So this is the basic point, that in the presence of money, trade is facilitated. 144 00:11:35.580 --> 00:11:42.460 So trade would exist without money, but with it, it expands, it grows. 145 00:11:42.460 --> 00:11:48.180 Another important function that money plays in society is that it is a unit of account. 146 00:11:48.180 --> 00:11:53.580 And by unit of account, it means that all prices are quoted in terms of money. 147 00:11:53.580 --> 00:11:57.020 So when we go out and you buy something, prices are in terms of money. 148 00:11:57.020 --> 00:12:00.780 They're not in terms of amounts of other goods. 149 00:12:00.780 --> 00:12:02.420 And we kind of take this for granted. 150 00:12:02.420 --> 00:12:05.740 But if you kind of think about it, it would be extremely difficult 151 00:12:05.740 --> 00:12:07.460 to get over a problem like this. 152 00:12:07.460 --> 00:12:09.580 So we can think of an example. 153 00:12:09.580 --> 00:12:13.580 So let's say you want to buy a washing machine. 154 00:12:13.580 --> 00:12:15.820 And you go to one store, and the washing machine, 155 00:12:15.820 --> 00:12:20.700 The price of the washing machine is 500 loaves of bread. 156 00:12:20.700 --> 00:12:25.540 So you have to give them 500 loaves of bread to buy the washing machine. 157 00:12:25.540 --> 00:12:27.460 You don't know if that's a good deal or not. 158 00:12:27.460 --> 00:12:30.180 So you're going to go to another store and see what their price is. 159 00:12:30.180 --> 00:12:37.940 So you go to the other store and their price is 30 pairs of shoes. 160 00:12:37.940 --> 00:12:39.180 And how do you compare? 161 00:12:39.180 --> 00:12:44.780 How do you compare whether it's a better deal to give up 500 loaves of bread or 30 pairs 162 00:13:14.780 --> 00:13:22.780 How do you, you're literally comparing oranges and apples. There's no way to really tell if you're actually getting a good deal or not. 163 00:13:22.780 --> 00:13:28.780 You would have to find a store which quoted prices of both those goods in everything else. 164 00:13:28.780 --> 00:13:37.780 So you would have to find a common denominator. You would have to find another store which maybe quoted those shoe prices in oranges as well. 165 00:13:37.780 --> 00:13:41.580 So maybe the shoe price is 2,500 oranges. 166 00:13:41.580 --> 00:13:46.140 This way now you have a common denominator, you can actually compare which one is the better deal 167 00:13:46.140 --> 00:13:50.460 and therefore you impute backwards and you say which washing machine is the better deal. 168 00:13:50.460 --> 00:13:52.460 In this case, it would be the first one. 169 00:13:52.460 --> 00:13:54.460 But this is extremely cumbersome. 170 00:13:54.460 --> 00:13:57.220 So money actually gets rid of all of these problems. 171 00:13:57.220 --> 00:14:03.420 If we did not have money serving as this unit of account, we would have these problems 172 00:14:03.420 --> 00:14:06.460 and these are extremely, these are very, very cumbersome problems. 173 00:14:06.460 --> 00:14:09.060 It takes a lot of time, it's very hard. 174 00:14:09.060 --> 00:14:12.580 A lot of trade that exists today would not take place 175 00:14:12.580 --> 00:14:15.180 because there's just such high costs to going around 176 00:14:15.180 --> 00:14:17.020 and figuring out which is the best deal. 177 00:14:17.020 --> 00:14:17.840 You'll be like, you know what, 178 00:14:17.840 --> 00:14:19.340 I'll just wash my clothes at home, 179 00:14:19.340 --> 00:14:20.940 I'll just do it by hand, right? 180 00:14:20.940 --> 00:14:21.900 And this is how we did it, 181 00:14:21.900 --> 00:14:23.780 this is how we did it in earlier times, 182 00:14:23.780 --> 00:14:27.020 you would wash your own clothes by hand. 183 00:14:27.020 --> 00:14:31.660 So this is basically the two most important functions 184 00:14:31.660 --> 00:14:35.940 of money and in the end I would like to talk about 185 00:14:35.940 --> 00:14:39.500 some of the implications of talking about money like this. 186 00:14:39.500 --> 00:14:47.980 Of course, we spoke about how money encourages trade, but it also encourages specialization. 187 00:14:47.980 --> 00:14:53.020 Specialization meaning that everybody has the incentive in a monetary economy to do 188 00:14:53.020 --> 00:14:58.340 what they do best, to specialize in what they are best at, because they know that if they 189 00:14:58.340 --> 00:15:04.580 produce a good which they are best at producing, that there is, because it's a monetary economy, 190 00:15:04.580 --> 00:15:08.780 that they are going to have a market for that good, that there is going to be other people 191 00:15:08.780 --> 00:15:13.460 who are going to want to buy that good, that it's very easy to sell your good if other 192 00:15:13.460 --> 00:15:16.500 people use money, right? 193 00:15:16.500 --> 00:15:23.700 If other people don't use money, you have to kind of be very tuned into what other people 194 00:15:23.700 --> 00:15:29.800 will really, really accept because there is no this one common medium of exchange. 195 00:15:29.800 --> 00:15:34.800 So in a monetary economy, it encourages not just trade, but specialization. 196 00:15:34.800 --> 00:15:39.760 And by engaging in a monetary economy, not only do we specialize, but we can also reap 197 00:15:39.760 --> 00:15:44.160 the benefits of other people specializing in what they are good at, in what they are 198 00:15:44.160 --> 00:15:45.160 best at. 199 00:15:45.160 --> 00:15:48.800 So this is, it's a great advantage of having a monetary economy. 200 00:15:48.800 --> 00:15:52.880 In fact, the amount of specialization that we see today or through the ages would not 201 00:15:52.880 --> 00:15:57.040 exist if we did not have money. 202 00:15:57.040 --> 00:16:00.720 And money has obviously taken many forms through the ages. 203 00:16:00.720 --> 00:16:10.040 So I mean, in older times, I mean, anything from cows, salt, shells, beads, more prominently 204 00:16:10.040 --> 00:16:17.120 the precious metals have been money, gold, silver, copper, copper for the smaller exchanges. 205 00:16:17.120 --> 00:16:22.640 It's only recently that we see paper money being so widely used. 206 00:16:22.640 --> 00:16:28.960 And till very recently, which would be 1971, even that paper money did have some backing 207 00:16:28.960 --> 00:16:31.220 in gold, in something valuable. 208 00:16:31.220 --> 00:16:36.360 It's only very recently that our money that we have in our pockets is a pure fiat money, 209 00:16:36.360 --> 00:16:40.100 meaning that there is no backing of a commodity behind it. 210 00:16:40.100 --> 00:16:45.080 It's only the government which says that, you know, we say that this is money and this 211 00:16:45.080 --> 00:16:46.080 is what it's worth. 212 00:16:46.080 --> 00:16:55.080 The money that we have today is fiat money, but it has evolved as a commodity through our history. 213 00:16:55.080 --> 00:17:05.080 And this sort of explanation that we went through today was first given by Carl Menger, who was Mises' teacher, 214 00:17:05.080 --> 00:17:10.080 and he's the founder of the Austrian School of Economics. 215 00:17:10.080 --> 00:17:15.080 And basically what he showed was that money actually evolves spontaneously in a market, 216 00:17:15.080 --> 00:17:45.080 in a Market. That you do not need to have a state or a government legislate and say this will be money. This is not how money evolves. Money can actually evolve spontaneously just through the actions of people. So just in this way with Mr. Jones kind of figuring out that if I go and engage in indirect exchange, that this is going to facilitate trade. That this is how money evolves. And this is actually historically this is what we see. And I didn't get to talk about this at all. But if anybody's interested about the evolution 217 00:17:45.080 --> 00:18:00.080 The foundation of our money through history, a great book is Murray Rothbard's What Has Government Done to Our Money, which will give you a great feel for how our money, especially in the United States, has evolved and come to be what it is today. Thank you.