The Symbology of Money

First off, the word symbology really does exist. I looked it up. Whether or not I'm using it correctly is another matter... I haven't talked much about the roles of money and pricing in an economy, mostly because it is a very long discussion that won't interest most people, and I was more inclined to dive right into the present economic situation as fast as possible. I wanted to go on to a post on the business cycle and then finish this thing off with a post about The Crash of 2008 and my expectations with regards to inflation or deflation, but I'm finding it difficult to discuss without some basic background on money and pricing. So far, I've been taking it all for granted, but I'm beginning to think I need to take a breather on the FED and talk about basic money and pricing for a bit. Most of us have a reasonable understanding of what money is and how it functions, despite the fact that the community of economists can't seem to get it straight. That is correct: economists cannot agree on what money actually is (are you detecting a pattern here?). I'll just use a simplified definition and leave out annoying details. In a nutshell, money is the medium of exchange. Yes, there's more to it than that, and lots of great discussions can be had on what properties make for a good monetary unit, but I'll leave that for another time, and possibly for other authors. For the present, I want to talk about the business cycle and how it is related to the money system we have today, not hypothetical systems. So, I'll stick with this basic definition and take it for granted that the money we have today is the one we just have to deal with. If you are looking for some real expertise on the subject, Leo provided some excellent links yesterday to a series of posts at LRC that discuss the topic as well as its relationship to the banking system. Again, Mises on Money is another great place to get the lowdown, if you find yourself so inclined. I'll try to confine myself to a brief discussion, just so we can be settled on a few concepts that will be useful going forward. But I have a habit of being long-winded. Money and Barter Under a barter economy, there is no medium of exchange. Goods are traded for other goods in one-off transactions. This works reasonably well in a primitive economy, and it is better than trying to produce everything yourself. The problem arises when it comes to pricing. Sure, you can bargain the terms of each transaction, but in the larger scheme of things it is nearly impossible to keep track of all the zillions of exchange rates between every possible pair of goods. It is also quite impractical to make plans or projections should you have a mind to set up some adventurous profit-seeking enterprise. Accounting is difficult without any form of monetary unit. But if you are just trying to get by, barter beats the alternative. By pricing every other economic good in terms of money, an economy with a money system opens up all sorts of new possibilities. Yes, simplified pricing in money greatly facilitates economic exchange, but it also does far more than that. The symbology inherent in a money-pricing system allows us to form abstractions in our minds of myriads of possible economic transactions and to understand in vastly greater detail the workings of our economy. It allows us to conceptualize things like profitability, discounting, and interest in ways that were only dimly recognizable before goods became priced in universal money-units. All of this was muddled when we were trying to keep track of all those different kinds of goods and the complexities of their production. Money simplifies things. We only keep track of the things we are interested in, and money-system symbology takes care of the rest without our having to think about it. In a few words, money vastly expands our capacity for rational economic calculation. Not necessarily perfect calculation; perhaps estimation is a better word. But these estimations are orders of magnitude better that what is possible under a moneyless economic system. Like an architect looking at a blueprint or a schematic for a building, the information tabulated in balance sheets, income statements and cash flow allows a trained accountant to understand how a business is performing, how things might be improved and where things might be going wrong. Symbology and Economic Planning But symbology is just symbology; it is not the real-world. Taking our architectural analogy further, just as money is neither actual wealth nor the real economy, a blueprint or a schematic is not a building. It is only a series of symbols on a piece of paper. Yet the symbology contained on the paper allows the architect to understand the the layout and function of the building without ever seeing the building itself, and before it is even built. Schematics allow plans to be drawn up and errors spotted before costly mistakes are made. Suppose that an architect is drawing up designs for his next project. What happens when some jerk comes along and fiddles with his measuring tools while he is gone? Suppose he swipes the architect's ruler and replaces it with one that has slightly smaller units? If the architect does not spot the switch in time and continues with his design, his plans will be full of errors. Depending on the degree of the change, his plan could merely not come out quite right and produce a crumby building, or it could turn out to be a total disaster. If the plans are bad enough and they are implemented anyway, the building could collapse! (Hopefully, by now you see where I'm going with this...) Likewise, the symbology of money allows balance sheets, projections of future profits and the like to provide accurate expressions of the health and productivity of a business in the real world. If the data is incorrect because the money system has been tampered with and its effective symbology compromised, estimations become incorrect and successful-looking business plans are more likely to go bust. Why Not Just Make Adjustments? Everybody knows that money is inflating. Everybody knows that the FED manipulates interest rates. Why don't those shrewd old businessmen and economists just make adjustments? Here is where our analogy breaks down. An architect is not overly concerned with his measuring units. He is concerned with producing a sound, functional, and attractive building. Supposing that he did find out about the nefarious act of measuring-stick espionage, the architect would probably do his best to search out all the errors and make the necessary changes to see to it that the building turns out right. Barring that, he would probably be more inclined to start over than allow a menace to public safety be built with his name stamped on it. Businessmen, on the other hand, are only concerned with making money. Money, the unit of measure in economic design, is also the measure of economic success, and a sound, functional, and attractive business is one that makes a lot of money, however irrational its physical, real-world activities may actually be. If real-world, wealth-destructive activities render monetary profits, by golly, they're good business! Furthermore, as far as individuals are concerned, evaluations are usually concerned with the short term. Competition is fierce and quarterly reports come out every few months; who has the luxury of thinking ten years out? Who knows what will happen anyway? Better to make money today than worry too much about tomorrow. It would be irrational for businessmen to somehow altruistically make adjustments ahead of time even if it were possible, as in many cases it could very well constitute an act of career suicide. And if a businessman may know full well that he faces future losses in monetary terms and make bad decisions anyway, he certainly isn't likely to care about real-world material waste no matter how stupid his actions may look on the face of it, whether now or in the future after all the dust settles. What matters is that bottom line, and it matters today! I'll wager most of us can think about our place of employment and come up with a few shining examples in this regard... All of this presupposes that businessmen are capable of such adjustments, of which I have my doubts. When economic signals have all become unmoored from physical reality, who is to rightly say which way is up and who is responsible for acting on it? Whatever the case may be, business cannot be relied on to make adjustments for errors instigated by monetary authorities and financial systems. They are beholden to the bottom line, and rightly so. Not to behave so would be to betray shareholders and their obligations as stewards of sacred property. If false signals are sent in error, we can be sure that businessmen will act on them regardless, whether through ignorance, greed, nobility, or whatever other motive we might ascribe. In chasing down this tangent, I hope I've managed to illustrate just why it is so critical that the monetary system and its symbology be well-grounded in material reality. There are many ways that wealth-destructive and subversive activities can be made to appear profitable. All red-blooded conservatives and libertarians are familiar with ways that government meddles with pricing and money transactions in order to achieve political objectives: taxation, subsidy, regulation, welfarism, and the like. They are also likely familiar with many of the results of this meddling: waste, corruption, impoverishment, etc. Those who seek to manipulate economic outcomes through such tampering are playing a dangerous game. But even activities such as taxation and subsidy are relatively narrow in scope and magnitude. Malicious as they are, they are still quite limited. If these acts are so destructive, how much more dangerous is tampering with the entire money system itself? The FED: Money-Tamperer Extraordinaire Thought I'd gotten away from the FED, didn't you? Well, so did I, but we are talking about money. We have already seen how the FED increases the money supply, keeping inflationary fractional reserve banking afloat and suppressing the interest rate. A quick check of the historical Adjusted Monetary Base (AMB) will confirm that the FED has, almost without exception, pursued a policy of monetary expansion throughout its history. In doing so, the FED inevitably sends false economic signals that create incentives for a variety of behaviors, including:

• subsidizing debt, and therefore encouraging taking on higher levels of debt
• punishing savings, and therefore encouraging profligacy
• expanding welfarism, through finance of the welfare state (purchase of US Treasuries and suppression of interest paid on debt)
• encouraging market speculation over more productive activities by eroding the value of savings
• eroding qualities historically associated with fiscal responsibility and sound economics: thrift, prudence, discipline, the pursuit of excellence in a specialized trade

This we can all understand without delving much deeper into the topic. Simple recognition of the consequences of persistent erosion of the monetary unit will suffice to explain these more obvious effects. But wait, there's more! We have already covered how new money enters the economy specifically through credit markets. By entering at a specified point, and not somehow "across the board," the entry of new money has very focused effects on pricing in certain markets and not simply a general effect on all prices as a whole. Suppression of interest rates and monetary expansion via the credit market sends rippling effects throughout the economy by warping the pricing system, causing changes in economic behavior and the allocation of resources and wreaking economic havoc as it goes! The Fallacy of Neutral Money This simple observation should put the lie to a popular economic fallacy that Austrians like to call "The Fallacy of Neutral Money." Simply put, expansion of the money supply does not affect all prices equally, as believers of the fallacy would have it. Monetary expansion is not neutral in its effects. It raises prices where it enters the market first, then these price increases slowly spread outwards through the economy as later actors receive the money and perform new transactions. Economic actors, especially entrepreneurs, investors, and businessmen, respond to the new price differentials by changing their behavior in the pursuit of profits. This results in changes in investment patterns and the allocation of resources, which can be summarized by noting that markets with rising prices tend to attract more capital. Since these changes do not reflect actual changes in the real world, but are only responses to fleeting, illegitimate financial incentives, these new capital allocations are in all likelihood bad decisions. By investing capital and resources in response to these deceptive signals, investors and the economy suffer a wave of malinvestment. When the monetary expansion ends and the price changes have run their course, the malinvestments are revealed. The boom ends and the bust begins. The process of asset liquidation commences, including high unemployment of both capital and labor which we call a recession. And usually, right alongside, so does the process of interest rate suppression and reinflation by the central bank as it tries to "ease the pain" and "stimulate the economy." That, in a nutshell, is how and why monetary expansion and suppression of the interest rate cause the business cycle. But I'll go into more detail in another post. For now, I only want to point out that monetary expansion distorts market signals, including not just interest rates and the debt market, but warps the pricing regime of the entire economy. It undermines the symbology of money in a way that is far more pernicious than virtually any other action government could take. The effects are far reaching and difficult to detect, with highly destructive results. Conclusion By making rational economic calculation possible, the money stands as one of the most important human advances of all time. The modern world would not be possible without it. Tampering with the money supply and manipulating interest rates interferes with the pricing system and undermines rational economic calculation. This results in a disconnect between financial incentives and economic reality. Money is not neutral. By systematically creating price distortions, monetary expansion creates the destructive phenomenon we know as the business cycle. The disconnect between the financial world and economic reality results in the misallocation of resources known as malinvestments. The buildup of malinvestment eventually requires a period of liquidation known as a recession in order to more closely realign the capital structure with economic reality. Now we are ready for a closer look at the business cycle...