For background, let’s take from the Spherical Model definition of money, and a few other terms. (I also wrote about basic money terms here and here.)
Wealth is the accumulation of the results of work above what is needed for subsistence. Let’s quickly review the Robinson Crusoe (simple world) example:
|Robinson Crusoe illustration|
from the first edition of
Daniel Dafoe's book
At first, whatever Crusoe has, it’s a matter of what he is able to obtain for himself. He fishes. He gathers. He hunts. He plants, irrigates, and harvests. And barring a catastrophic hurricane or some such disaster, he is free to enjoy the fruits of his labor. This is his wealth—the results of his capacity to recover from the shelterless, foodless situation he finds himself in right after a shipwreck.
But his wealth is limited by his personal time, talents, and energies. It might be that, once he discovers another person on the island, Friday, they commiserate about their limitations. And somewhere along the way they discover differences in abilities. Crusoe is pretty good at farming, but fishing is tedious and frustrating, so he often goes without that protein source. Friday, on the other hand, finds fishing easy, but he’d sure like his garden to yield more veggies and rice to go with it.
Specialization and Exchange
An idea finally dawns on them. How would it be if Crusoe gave up fishing altogether and spent more of his time farming, expanding his garden to provide for the entire population of the two of them? And at the same time, instead of struggling to farm without success, Friday would spend even more hours fishing. Then he would trade his surplus fish for Crusoe’s surplus harvest. They try this, and it works so well, they both have more to eat than they had before, and they both have more spare time for climbing coconut palms or hunting—necessary tasks which neither one is particularly good at.
But this trade thing is working out so well that, when they meet a native who has no trouble at all shinnying up those palm trees, they make exchanges with him. And another native is very handy with a spear and can easily take down a wild boar, which is much too big to use up by himself before it spoils, so he’s glad for the exchange, and the others are very glad not to have to face those wild boars any more.
They specialize. They all work mostly at what they are best at. The result of their total labor is now considerably greater than the total would be without specialization. This leaves them all more actual wealth (results of labor) and even more time to enjoy the wealth.
Money is a more convenient means of exchange than bartering goods; a unit of money represents a particular value, equivalent to a standard unit of work. Money is used for convenience,
When it becomes convenient for the laborers making the exchanges. It’s up to the society. If Crusoe wants more coconuts, but the palm tree climber doesn’t happen to want more veggies right now, but he would like more fish—and it turns out Friday wants more veggies, not coconuts, but he already checked with Crusoe, who didn’t need more fish. They can make a three-way deal. Bring in more if you want. But it gets more complicated to barter without some standard of exchange. Money, to symbolize that standard value, can be useful.
It’s also up to the society to decide what the symbol of exchange (money) will be. On this island, they might use clam shells, as some primitive societies have (bringing us the slang term “clams” for money). Some societies have used salt, which has some intrinsic value to everyone; that’s where the term salary came from. Early Central American societies used cacao beans, which were easy to carry, measure, and trade, and also useful for their own properties. These people also had incremental units based on a measure of grain; their units of gold and silver could always be exchanged for a measure of barley, so they had a standard value. More societies have used gold than any other single commodity as money. It’s usable as a decoration, because of its luster, and it’s easily malleable, making it easy to form into coins. It’s relatively rare, beautiful, and fairly heavy, which makes it natural as a representative of wealth. Silver, with many similar qualities, is next to gold in common use as money, most often used for smaller monetary units….
If Crusoe saved himself enough rice to last through a famine, he could safely exchange the rest of his surplus into clam shells, or gold. And that would even preserve his work, since his produce other than the rice is quickly perishable. In an ideal economy wealth would be represented by something that always exactly equals a standard amount of accumulated work-value.
Price is an agreement from the seller to the buyer regarding how much money (representing effort put into obtaining the good being sold) he is willing to exchange for the item/service being sold.
Do Robinson Crusoe and friends need a government bureaucrat stepping into their little island world and passing edicts about what would be a fair exchange? No. The price is set by the worker willing to exchange his labor. If it isn’t worth it to Crusoe to exchange a basket of veggies for a mended net, he is free not to make the exchange. But if Friday, who needs nets for fishing, prefers to spend his time fishing without having to stop and mend his own nets, he can figure out what a fair exchange is and offer it to the net mender. If his offer of fish is too low, the net mender is free not to make the exchange with him, until a bargain can be reached with a number of fish that will satisfy him. The price is set, then, by the experts on what they value—those willing to make the exchange.
OK, that’s enough background to help you appreciate these quotes on price that I came across this week.
This first is from Poverty of Nations:
Nothing conveys information faster than prices.
Prices convey objective information on the subjective attitudes and feelings of buyers and sellers. As relative prices change, options are altered and decisions are made. Perceived benefits and costs are continuously affected by changing circumstances, including many important variables that are never constant. In other words, not a person in the world knows how to make a market work or how to make even a simple thing like a pencil. But it still happens, because enormous complications are simplified when decentralization and prices take charge. In these ways, prices serve as an amazing, worldwide source of instant economic information [Kindle location 3495-3500].
So, price is what gives us accurate truth as buyers and sellers.
This next is from a Mises introduction of a new book by global investor and blogger Hunter Lewis, called Free Prices Now! I think the words are from the press release about the book:
The most reliable barometer of economic honesty is to be found in prices. Honest prices, neither manipulated nor controlled, provide both investors and consumers with reliable economic signals. They are the foundation for a successful economy.
A corrupt economic system does not want honest prices, honest information, or honest results. The truth may be unprofitable for powerful government leaders, private interests allied with them, or economic “experts” whose careers have been devoted to price manipulations and controls….
Can it really be this simple, that economic prosperity and job growth depend on allowing economic prices to tell the truth, free from the self-dealing and self-interested theories of powerful special interests?
What do prices do? Tell the truth, in the most efficient way, about the value of a commodity to both the seller and the buyer—the experts involved in the exchange. No interference in price (particularly including manipulating the value of the monetary unit) can help convey that truth. Truth surrounding these exchanges helps economies prosper.