the thing called "money"

[this blog is a continuation of the last two blogs "Does money grow on trees?" and "Why doesn't government print more money?"]

Let us suppose there is an island with a population of 100 people. Unfortunately, all the food currently produced on the island is just enough to feed 80 people (say we have 80 pizzas)

How do you suppose we address the food shortage?

Will printing and distributing more money to people solve the problem? Or will producing more food help? 

Did you say "producing more food will help ?"

Well... Yes! I believe the last example sets the mind of the right track.

An economy or a country is more likely to grow/prosper with increase in resources, output and productivity rather than with printing more units of currency.

Hold on! I know some of you might be thinking that with more money, the island people can buy/import food from other islands :)

Nice idea, but if this worked… before long, all countries would just be printing money and buying stuff from the other countries :)

Unfortunately, there is one huge island in the west that specializes in the art of printing money/paper and importing resources from all the other island's :)

For a change, let us go over the history of money...

Who created Money? (No, money was not created by the almighty!)

Why was Money created? And how does it really work?

You must have heard about the "barter" system. In fact, most of you would have practiced it too (knowingly or unknowingly)

How the barter system naturally evolved as a medium of exchange of resources between people. Cattle exchanged for wheat, meat exchanged for swords and so on…

Having thought as much, also think of the challenges and constraints of the barter system (particularly with mutual coincidence of needs (lack of open markets) and lack of standardization; making storage or transformation difficult)

Before long, everyone converged and felt the need for a standard unit or measure that could be the medium of exchange and even storage for that matter.

Well, it started as sea shells or rather beads made of shells for north American Indians, whale’s teeth for Fijians, tobacco for early American colonists, cakes of salt in Ethiopia and Tibet; gold, bronze, nickel and silver slabs for most other civilizations… eventually took the form of coins and notes, scaled out to bank accounts /cheque books and then to smart cards.

It occurs quite naturally that the real things in this world are the resources though. We don’t really eat and drink money, rather exchange it for resources (“goods and services”, to be technically correct)

As you begin to look at money as a measure or an exchange for goods and services, may it be milk, oil, sugar, rice or gold; or the dress you admired in the store the other day, or a hair cut or a body massage; you also start thinking of money as a resource itself that you could store to exchange for some other resource in the future.

Further, the purchasing power (or "value") of money itself also adjusts over time, just as other resources adjust in their relative demand and supply, and consequently in the their relative value.

that is to say...just like everything else, even money does not escape the laws of demand and supply...

• With the increase in supply of money, as if it were freely flowing everywhere, the value of money (like other things) goes down. (Ever heard the term “liquidity” on news/money channels)
• So as a result of more money in the society/system (or excess “liquidity”), the prices of other resources increase (self adjust) and consequently you have to shell out more money to buy the same thing. (Ever heard the term “inflation” on news/money channels)

Though not the best way to look at, but for now think of the equation as:

“Sum of all money = Sum of prices of all goods and services available for consumption”

[the equation always balances itself, but with higher prices every time]

This explains why having money trees or printing more currency wouldn’t work.

In fact, in most circumstances, these solutions would lead to more imbalances caused by the uneven distribution. The balance gets disturbed, every time fresh money gets pumped into a selective section of the society. (For Instance: IT professionals getting relatively higher average salaries compared to several other fields; thanks to outsourcing and currency difference between rupee and dollar)

Ever heard about 11000000% (yes, that’s 11 million percent) Hyperinflation in Zimbabwe in 2008?

(A loaf of bread costing 200,000 in Feb 2008 had surged to 1.6 trillion Zimbabwe dollars by August 2008. And most notes are worth a lot more in scrap than what they can collectively buy as currency. Imagine taking a briefcase full of money to the grocery store, so you could buy a loaf of bread or hiring several trucks to carry notes to pay for your new car. To address this, the government introduced new notes of higher denominations every year adding more and more zeroes; more zeroes than you can count using all your fingers (hands and feet combined)

From Wikipedia:

Hyperinflation in Zimbabwe began in the early 2000s, shortly after Zimbabwe's confiscation of white-owned farmland and its repudiation of debts to the International Monetary Fund, and persisted through to 2009. Figures from November 2008 estimated Zimbabwe's annual inflation rate at 89.7 sextillion (10²¹) percent.^[1] By December 2008, annual inflation was estimated at 6.5 quindecillion novemdecillion percent (6.5 x 10¹⁰⁸%, the equivalent of 6 quinquatrigintillion 500 quattuortrigintillion percent, or 65 followed by 107 zeros – one googol 65 million percent).^[2] In April 2009, Zimbabwe abandoned printing of the Zimbabwean dollar, and the South African rand and US dollar became the standard currencies for exchange. The government does not intend to reintroduce the currency until 2010.

Such can be the results of extreme situations such as a world war, a revolution, a political disturbance or natural disasters; For Zimbabwe it was the land reform that started in 2000, which completely devastated the economy.

In situations like these, people tend to shift back to other resources (such as gold) or more stable currencies. (Having lost faith in their currency, which is paper after all)

Nevertheless, coming back to less adverse situations:

In times of excess money (liquidity) in the society: sucking some money back into the banking system sounds like a reasonable idea to me. (Just like we drain out excess water from our homes in time of floods or heavy rains)

For instance, with every hike in interest rates:

• More people tend to save money  
• Businesses have to shell out more interest on their loans, hence making it less favorable for businesses to take loans for expansion etc

Now you know both “why” and “how” the Fed in the USA, RBI in India and similar bodies in all countries endlessly keep trying to maintain a balance between the interest rates, inflation, liquidity (flow of money), unemployment rates, GDP and so on…

Upon some more thought I realized that the problems we face though aren’t with lack on money, but about lack of resources/production and more so in the uneven distribution of those.

Coming back to the example of the island with 100 people and food availability for 80 people, there are 3 possible ways of distribution: 

• First, all 100 people share the 80 pizzas equally amongst themselves (or based on their needs) 
• Second, 80 people consume 80 pizzas and the remaining 20 people scramble, fight or crave for food. 
• Third, 40 people consume 70 pizzas (some consume two or three, some overeat and some even waste) and the remaining 60 people scramble amongst themselves for what’s left.

While first is too idealistic and second is unlikely (too theoretical); third is a reflection of how we usually establish the balance…

As for the money plant, as I grew up to be 8, I did plant a French beans creeper instead; nurtured it well, enjoyed watching it grow and distributed the first lot equally amongst all my neighbors.