Thursday, October 16, 2008

An idiot's Guide to Money - 2. Financial Crisis

As we all know, money can solve any problem. Ask a Doctor how she can save more lives, and she'll say with more resources. Ask a Policemen how he can cut crime, and he'll say with more funding. Ask bankers how to save the economy in the face of financial crisis, and they'll say with more money.

And don't forget those poor Africans. Sir Bob and Bono have both told us that they need more money too. Make poverty history is what they say.

So how do we get all the money we need?

Easy.

1. We increase the value of the money. To do this, we make and do stuff cheaper.

2. We increase the quantity of money. To do this we make promises, and keep them.

So when prices are falling and promises are being kept, money is created. But when prices are rising and promises are being broken, money is destroyed.

Generally, things have been going well for us since WW2. Technology has helped us to do most things cheaper than before. And promises - 'I promise to pay the bearer of this note etc' - have (for the most part) been kept.

So what's the trouble?

Its yer 'flations mix, mate !

1. Deflation increases the value in money, inflation decreases the value in money.

- Falling prices mean that £1 buys more, rising prices means £1 buys less.

2. Inflation increases the quantity of money, deflation decreases the quantity of money.

- Rising prices mean that more £1s are needed to buy the same stuff, falling prices mean that less £1s are needed to buy the same stuff.


The bad news is that we don't really understand inflation and deflation. We can never even be sure which one's the goodie and which one's the baddie, because it entirely depends on your position.

Governments will keep trying to sort it out. Its all they can do. But there are no guarantees that anything will work. No 'one' really knows what the value of money should be, nor the quantity of money needed. That's the point of money, really. I don't decide. You don't decide. Our conflicts of interest are played out through the market, and magically a value/quantity is set.

When money isn't there to help us do that, history shows us that the same conflicts of interest are played out through famine, social unrest, and war.

That's my take on it anyway.

Here's someone else's:

'..there is an unceasing conflict between the interests of debtors, who seek to enlarge the quantity of money and who seek busily to find acceptable substitutes, and the interests of creditors, who seek to maintain or increase the value of money by limiting its supply, by refusing substitutes or accepting them with great reluctance, and generally trying in all sorts of ways to safeguard the quality of money.'
Glyn Davies - A History of Money (1994) p30

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PS. I've left out a ton of important stuff particularly on interest rates, and supply and demand for money (inflation increases the quantity of money is a contentious thing to say - monetarist's think that having too much money in the economy causes inflation). I also was tempted to go into the power dynamics of moneyied relations (which Glyn Davies touches on) [tip - substitute the word debtors with 'the poor' and creditors with 'the rich]. Best to save that for another time though, I think.

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