III. Ordinary Things Essay 16
Money Is a Shared Story That Works
Paper, unit, trust, and the thing underneath
Here is a banknote. It is a piece of paper, about the size of your hand, printed with a portrait of a dead statesman, and made of a material that is mostly cotton. You cannot eat it. You cannot burn it for warmth. You cannot use it to make anything. It is, physically, one of the least useful objects in the room.
And yet you will carry it carefully, in a separate pocket, and you will not hand it to a stranger, and you will be mildly annoyed if a shopkeeper gives you change in coins when you gave a note. It is worth more to you than a nice pen. The difference between the pen and the note is that everybody agrees about the note and nobody agrees about the pen.
Money is a story that a lot of people tell each other, and the story happens to be true because everybody tells it. That is not a criticism. It is the most impressive piece of collective machinery humans have ever built, and it works so smoothly that the machinery has become invisible, and the paper has become the thing.
Three layers, and the bottom one is a promise
It helps to separate money into three layers, because each one is doing a different job, and most confusion about money comes from mixing them up.
The bottom layer is the paper. This is the physical object, the note or the coin. It has a size, a material, a design, and a serial number. It is a carrier, and it is a good one, because it is light, durable, divisible, countable, and hard to counterfeit relative to its value.
The middle layer is the unit. This is the number, the abstract thing that the paper stands for. A ten pound note stands for ten of something, and the something is not a thing you can point at. It is a unit, and a unit is an abstraction in exactly the sense used earlier in this site: a compression that keeps what matters and drops the rest. What it drops is enormous. Ten pounds is not a particular amount of anything. Ten pounds is whatever the price of the thing is today, and it is a different thing for a bus ticket, a loaf, and a night in a hotel.
The top layer is the acceptance. This is the belief, held by people you will never meet, that the unit is worth what it says and the paper is a claim on it. The banknote does not contain any value. The banknote contains a printed promise that somebody will give you ten pounds of something for it, and the promise is kept because keeping it is in the interest of the person who keeps it.
And the top layer rests on the middle one, which is why the story is not just about trust. Trust would not be enough on its own, because trust is vague and money needs precision. The note works because the unit is precise enough to be counted, and the counting is what lets a vague belief be enforced by people who are not thinking about it at all.
Why it circulates
Here is the loop, and it is worth looking at properly because it looks like it should not work and it works anyway.
You hold a note. You want something. The person whose something it is wants the note. They take it. They hold it. They want something else. And so on. Every exchange in this chain is a transaction between two people, and each of them is doing it because they expect the next link to happen. The note does not move because of its value. The note moves because the person receiving it can use it with somebody else.
That is the whole thing, and it is remarkable, because it means that the value of a note is a property of the network it sits in and not of the note. A note in a pocket in a country where nobody accepts it is paper. A note in a pocket in a country where everybody does is money. Nothing about the paper changed. The network did.
And the network has a property that makes it robust: it is a loop, and a loop that works for everybody tends to keep working, because each participant's willingness to accept the note is increased by the fact that they know the next person will accept it. The more people who are in the loop, the more certain each one is that the loop works, and the more the loop works, the more people can be in it. This is the same reinforcing shape as the path across the grass, and it is why the adoption of a currency has always looked, from the inside, like a wave.
Take a market where a particular kind of note is unfamiliar. Somebody selling fruit does not want it. Somebody buying fruit does not want to be given it. A trader in the middle is holding notes nobody will take, and the notes are not worth their face to him at all.
Now change one condition: the trader offers the note at a discount for fruit, so that the person with the note gets more fruit for it than the market price. The person buying fruit now has a reason to accept a note they did not want, because they have immediately turned it into something they do want. The note now circulates, not because anybody believes in it, but because somebody is paying a premium to move it along.
Now change a different condition. What if the discount is not enough to cover the risk that the fruit seller will not accept the note in return? Then the loop stops. The note stays with the trader, who is now worse off than when he started, and the market has learned that this note is a bad thing to hold, which makes it a worse thing to accept, which makes it a worse thing to hold. The loop runs backwards, and the note is a bad asset, and the same piece of paper that was money three transactions ago is now a liability.
Notice that nothing in this story requires anybody to be fooled. Nobody has to think the note is valuable. The notes are valuable to the people who can pass them on, and worthless to the people who cannot, and the whole thing runs on people being accurate about who is who.
What the abstraction costs
Every abstraction has a cost, and the cost of money is specific and worth naming. It is that money cannot be looked at.
You cannot see whether a thing was a good price. You can see that you paid eleven pounds and that you would have paid nine, and the difference of two pounds is a number on a screen, and it does not tell you whether the thing was worth nine. The shopkeeper knows exactly what the trade was worth and it is nowhere in the transaction. A person who is skilled, whose work took twenty years to become good, is paid the same number as a person whose work took an afternoon, and the number cannot say otherwise, because the number does not know.
This is what economists call the problem of missing information, and it is not a flaw in the design. It is what the design is for. A unit that could carry quality with it would be useless as a unit, because it would have to be a different number for every different thing, and then it could not be compared and it could not be carried and it could not be counted. The loss of quality is the price of the gain, and the gain is enormous.
What if a shop ran on a system where the price carried the information about quality? Not a higher price for better work, which is a different thing, but a price that actually recorded how good the thing was, so that a customer could see the quality in the number. Now the number has to be different for every good thing, and comparing two shops becomes impossible, and paying by note becomes impossible, because the note does not know which kind of good you are buying today.
Now change the condition. What if the quality information travelled separately, as a description, and the number stayed simple? This is more or less what happens in markets where reputation, warranty, and a description do the work. The number stays countable and the quality travels alongside it. It is a workable arrangement and it is also the arrangement that produces a shop where the description and the price can disagree, which is where a lot of the ordinary trouble in money comes from.
"Money has value because of the work that goes into making it." No. The work that goes into a banknote is a small fraction of the work that goes into the goods it buys, and if you set the note's value by the labour in it, the price of everything would change every time wages changed. The value of the note comes from the agreement, and the agreement comes from the fact that the note is a convenient way for two people who want different things to be sure of getting them.
The other misconception: "trust is what makes money work." Trust is part of it, but the word covers too much and hides the interesting part. What makes money work is not a feeling. It is a set of specific, checkable arrangements: a unit everybody uses, a way of settling disputes, a mechanism for punishing counterfeiters, and a network dense enough that most of the people you will deal with are people you have met. Money works in the places where the arrangements are strong, and in the places where they are weak, what substitutes for money is usually something else entirely, and everybody in that place knows it.
What money is not for
It is worth saying what money is not for, because the commonest trouble with money comes from asking it to do a job it cannot do. It is not a measure of worth. It is not a measure of effort. It is not a record of how much somebody contributed. It is a unit of exchange, and a store of value, and a unit of account, and those are three useful jobs and no more.
When a currency is used as a measure of worth, the result is a strange thing: a number that was designed to make things comparable gets used to rank the people attached to them, and the ranking is then treated as a fact about the people. A market pays for what somebody will pay for. A market does not have a view about what anybody is worth. When the market's number is read as worth, the number is being asked a question it was never built to answer.
Limits
This essay is careful about claims it cannot make, and there is one claim it deliberately does not make: that money is nothing but a collective fiction, and that therefore it is unreal, and that a world without money would be better. None of that follows, and all of it is a mistake of emphasis. Money is a real arrangement of real people, with real effects, and the effects are not reducible to the story. People who are paid badly are not paid badly because of a story. They are paid badly because of who has power in the arrangement.
Second limit: the explanation works best for a currency and badly for a payment system. A bank transfer, a wage paid through an employer, a credit card balance, all of these are arrangements with rules, contracts, and enforcement, and the story of shared belief is only a part of how they work. The older, simpler case of the note in a pocket is the clearest one, and it is the one used here.
Third limit: the account says nothing about history. It does not say where money came from, or what replaced what, or why the arrangements that exist are the ones that exist. It is a description of how a working system works, which is a different and a smaller claim than an explanation of why this one and not another.
Stuck
You are stuck with money when you can explain the mechanism and still feel stuck about it. The mechanism is clear, the abstraction is clear, the network is clear, and the person across the counter still cannot pay the amount you need. Knowing that the note is a promise does not make anybody solvent.
The way out is to change the question from what is money to what is missing. A promise that cannot be honoured is not a money problem, it is a capacity problem, and a capacity problem has a different set of answers, none of which involve thinking harder about currency. The question that is actually useful is: what would have to be true for the next person to be able to accept this?
Sources
- Money as a social convention, and the problem of missing information in markets, are both well established topics in economics. No specific study, author, or date is cited here.
- The example of a note at a discount in a market where it is unfamiliar is a standard illustration of currency acceptance and is used here in a simplified form.
- No specific currency, amount, or historical claim is made in this essay.