Everyone out there is pursuing their own interests, and sometimes that will include attempts at separating you from your money. If it is a voluntary trade between both parties, you both win. If you do not understand what is going on, you will lose. Knowledge is power, and ignorance is poverty. You choose.
We all live by trading with others. Everyone is selling something. For a long time we engaged in trade through barter. One person raised chickens, another made furniture. Barter became quite complicated because of what came to be called the double coincidence of wants. In other words, if you raised chickens and I made wooden chairs, we could trade if you wanted chairs and I wanted chickens. But what to do if either of us wanted something the other didn’t have? Modern society and trade on a larger scale was not possible without a universal means of exchange. Sometimes in ancient societies salt was used because everyone needed it to preserve their food. So people would trade goods and services by using salt as a store of value. Your chickens would be traded for X amount of salt, and my chairs would be traded for Y amount of salt, and we both could use the salt received to trade for any other commodities we needed to survive. Salt represented, or was a symbol, of the value each of us brought to the exchange. Salt became a primitive form of money. Anything being traded could be redeemed in salt.
As simple as this sounds, it is extremely important as one of the first building blocks of your knowledge of economics. Money has no objective value in, and of, itself. It is a symbol, and a store of value, and in trade is a medium of exchange. Money’s usefulness to you is only in its acceptance by all others as a reliable store of value.
Money is also referred to as currency. In World War II prison camps, prisoners often wanted to trade with each other, and the one thing everyone wanted was tobacco. So cigarettes became the money, or currency, used to facilitate trade. Everything that was traded was worth so many cigarettes, or parts of cigarettes. So cigarettes came to have two separate values; one as something to be smoked, and the other as a symbol of value to facilitate trade. Anything being traded could be redeemed in cigarettes. Interestingly, there was considerable disparity in the quality of the tobacco, so the prisoners would reserve the best tobacco for smoking, and would use the crap tobacco as their currency. This illustrates another basic economic principle that we will return to later, and that is bad money will drive good money out of circulation.
In time, paper currency was invented. Originally the paper currency was redeemable for tangible items, usually precious metals. In time paper money was detached from any tangible commodity, and became worth only what the trading public accepted it as being worth. This kind of money is called fiat money. There is nothing more behind it than the faith of its users. The faith of the herd. More on that later.
I am keeping things very simple as we move along, and we will build layers of knowledge quickly on prior information. Just as you cannot learn Quantum Physics without prior understanding of calculus, you cannot understand M1, M2, and Quantitative Easing without understanding the concept of Money first. (Caution: I am not presenting the two Q words as equally credible!) The articles I have already written were intended to help you grasp the important relationship between economics and liberty; that political philosophy and economic policy are always integrally related, and if you cannot understand their connection, you could wake up one day a slave without ever understanding what happened to you. All power seeks its own expansion, and no one can take their freedom for granted.
The point of this blog site is not to encourage you to change the world or to become a political activist (unless that is your desire), but rather to improve your personal financial literacy and chances of success. If you seek a quick, easy fix to all of your goals and problems, I suggest you abandon this website and continue watching the six o-clock news and the talking faces. Very, very few of those people understand any more than you do, and are paid to read from their teleprompters and parrot the economic philosophies and indoctrination they received as the ‘wisdom from above’ in their university Humanties classes. And even fewer of those people have any clue as to the origin of the intellectual ideas they absorb and repeat. This tendency to accept ideology as a subsitute for thinking is what I repeatedly refer to in these articles as herd mentality. It is the desire to believe, the desire to be accepted, the desire to not have to think critically.
In another blog linked to this one, www.JohnBechtelBlog.com, I am publishing in serial form a book entitled Passion, Power, and Panties—Confessions of a Businessman, wherein I describe being raised in an intellectually closed society where conformity was a requirement. I describe the growing awareness that my intellectual captivity was made possible only by my own complicity, that my chains were all paper chains. My story would be no different than yours or anyone else’s were it not for what I learned when I left that cult-like society only to discover so much more of the same everywhere else; what I came to describe as the triumph of ideology over rationality, or running with the herd.
The purposes of institutional education are primarily to obtain your obedience, not your enlightenment. Whoever controls the herd achieves either power or wealth, or both. In free trade wealth is created; when personal wealth is expropriated by those who did not create it, it is plunder. In free trade, the herd is often seduced into following charismatic salespeople who speak with great conviction, even certainty, about financial matters. Listen to any economic commentator or stock broker for more than five minutes and ask yourself if their goal is to facilitate your education or to impress you with the complexity and opaqueness of the financial world, and to imply it is all something you cannot possibly grasp without their assistance? The ultimate goal is to get you to accept their judgment as a substitute for your own, and to invalidate and subordinate your own thinking to theirs. Whoever controls your mind controls your money. Witness the millions who blindly follow self-professed market seers whose success rate at predicting markets is roughly equal to three chimpanzees pulling levers in answer to the same questions. The success of these cons has nothing to do with whether you are rich or poor, traditionally well educated or not. Remember that Bernie Madoff made his money off of the wealthy, not the poor; he apparently made his billions off of people we would assume should have known better, but didn’t. The CEOs of hedge funds diverted many millions into their own pockets each year, even as their funds lost billions of dollars for their wealthy clients. I have no doubt that each of these guys could have buried us in jargon and economic obfuscation, because education was not their objective, sales of extremely profitable derivatives was. (The CEOs of the top 26 hedge funds made on average $363 million, each, in 2005). People without money believe all their problems would be solved with money; people who acquire wealth discover a brand new problem—how to keep it. If a person’s wealth is greater than they are, they will lose it. At any level of society, there is no substitute for financial literacy. Trillions of dollars of wealth have evaporated in this country in the last two years because we believed our wealth was being managed by people looking out for our best interests.
The Government, of course, tells us that their regulators are there to protect us from these persuasive snake oil salesmen. To take the Government at face value, one would have to believe that they have finally cornered the market on both brains and integrity, and one would also have to bestow on regulators a benevolence and unselfishness not to be found anywhere else. Does history bear favorable witness to such claims? Furthermore, the belief in Government as our “Protector” carries with it a moral hazard of implying that at last we can relax our guard, get lazy about becoming financially literate, and let Big Brother handle it for us. If we forget that Government also has a monopoly on the use of force in our society, we grant Government increased powers at our peril. The herd will scream Foul Play about the Patriot Act while we abide the nationalization of failed industries. We are expected to believe that the choices of who is saved and who is allowed to fail has nothing to do with politics or returning election year favors.
It is time to define some terms. First let’s define wealth. Wealth and money are not the same. Wealth is accrued value in the form of ownership of assets. All assets are owned by someone. A Balance Sheet tells you who owns what. In your Liabilities section of that financial statement, you will list other parties who share ownership of assets with you. For example, if you bought a home with a 20% down payment, and you financed the remainder, that means that you own 20% of that home and your lender owns 80%. The 20% you own is called Equity. The 80% owned by the lender is their asset, and your liability. Money is not wealth; wealth is composed of assets; money is the store of the value of those assets, the medium of exchange, and everyone’s means of describing or measuring value.
In United States, we measure assets, liabilities, and equity in terms of dollars. If you own a home, and you want to measure its value for use in trading, and your home was purchased for $100,000, you could say for purposes of barter that your home is worth 100 refrigerators @ $1000 each. But that’s a problem because you will most likely never be interested in 1,000 refrigerators. But by means of valuing both houses and refrigerators in the currency of dollars, you now have a means of computing and representing value that both of you accept. The assets are the wealth, your equity in those assets is the measure of your wealth, and your liabilities represent the wealth of other parties. So assets – liabilities = your equity (your wealth).
Assets are created by means of production. Production is harnessing natural resources to add value and utility. Money had to be invented before large scale trade could be possible. With the advent of the industrial revolution, the production process involved increasingly longer chains of endeavor. For example, no one manufactured a car entirely by himself. The car had many moving and non-moving parts, and each of these parts was a product in itself. Car manufacturers do not make the steel, the tires or the batteries, and the manufacture of every single item that goes into a car requires specialized tools that also have to be designed and produced. The land, buildings, tools, and labor used to create assets are called the factors of production. All of the goods and services produced in an economy in a year are referred to as Gross Domestic Product, or GDP.
The value of goods and services produced per worker is called productivity. Productivity has less to do with the energy, focus, and work ethic of the worker, and more to do with the quality of the tools he is given to work with. For example a person equipped with a reel hand mower 50 years ago, working very hard, could be expected to mow a lawn of a certain size in 10 hours. With a small, early model gas-powered lawn mower, he could mow that lawn in five hours, or two such lawns in 10 hours. With a recent model riding zero-turning circle mower with a 72” mowing deck, he could mow that same lawn in one half hour, or 20 such lawns in the time frame of the original 10 hours. His productivity has increased 20 times, and his labor has become much less physically demanding because of the improvement in his tools. Now let’s say that his reel mower, adjusted for inflation cost him $1,000, and his new riding mower cost him $8,000. In each case, these amounts spent on tools are called capital investments. The mowers are the capital, and investment in these mowers is what raised the productivity.
The money to make these purchases of improved tools came from savings. Savings are what is left over when you spend less than what you earned. In business, what is left over when you spend less than what you earned is called profits. Without profits, there is no capital to invest to further raise productivity. Profits therefore are a cost of doing business tomorrow. When profits are accumulated, or retained, there are sums of money available to invest in further productivity-enhancing land, building, and equipment. Everything described in the above paragraph represents a lot of decisions by possibly many different people, each of whom will act in his own self-interest and with the hope of the greatest possible gain for himself. The concept of an entire society of people each free to trade with anyone else in voluntary trade, in order to earn a profit and then to accumulate and invest those earnings, is called capital-ism.
It has never been practiced. What is referred to today as capitalism is a hybrid political philosophy, more commonly referred to as a Mixed Economy. Learn what this means for you in future articles.
Thanks for visiting. Stay tuned for more on money. John Bechtel