Frederic Bastiat wrote the classical work “What is Seen and What is Hidden”. Oddly enough, for once my work has nothing to do with that prolific journalist and economic thinker, but his title is so apt, I thought I would mention it. Instead, this essay owes a lot more to Lord Say, and his famous dictum that goods trade against goods, the production creates its own demand, and money serves only to obscure that. Now, Say was hardly the simplistic straw man against which Keynesians and monetarists argue, his only argument was simply that recession cannot occur because of a “lack of demand” or an “excess of supply”.
Actually, if I can be allowed an aside, I would like to make an important distinction. Inflation is often misused. People tend to use it for any rise in prices and that is simply wrong. There is no “supply side” inflation. Inflation is always an increase of money supply driving prices. I suppose we could call the other “price inflation”, but there really is no need for such a term. Price increases, while annoying for consumers, are always a transitory phenomenon, or almost always. In a completely open market, the high price will draw investment, increasing supply, and dropping prices. If the government interferes, closing competition or otherwise obstructing entry, substitute goods will draw investment and have a lesser, but similar, effect. The only way it can be a lasting phenomenon is if the government is so intrusive no substitution is possible, such as the energy market would have been had we ratified Kyoto. Otherwise the market will correct for any non-monetary rise in prices. Only monetary inflation causes the bad effects we attribute to inflation.
But that is an aside. What I wanted to discuss here was something else. The supposed “complexity” of the money market. Now, granted, with all the various ways money can be created, the many ways the government can manipulate credit, and the many ways investors, banks and others found to work around government regulations, the market is very involved, and it would take time to examine all of that.
But at its heart the market is simple. At least if we start from basics. Just as Lord Say said, the simple fact is, goods exchange against goods, even when that is obscured by money. Of course, when it is a commodity currency, such as gold or silver, or even tobacco or salt, the truth is more obvious. But even when we introduce meaningless government scraps of paper we pretend are money, the truth is I trade my good for your good, the money just allows us to simplify a number of intervening steps.
For example, if I make shoes and you make pies, I may try to trade my shoes for your pies. If you want shoes, very good. If not, I may have to trade my shoes for the pan you want, then trade the pan for pies. And if the pan maker doesn’t want shoes, I may have to trade my shoes for some tin which I trade for an pan which I trade for pies. And there may be another several steps. money simplifies, as I sell my shoes to someone who wants them, and then use the money to buy your pies. However, the money just simplifies the transaction, I am still obtaining the money by trading my shoes and trading that money for pies. Goods are still trading against goods.
In our next installment we shall imagine a very simple barter economy and examine the effects of the transition to the use of money.
NOTE: This is a reprint of an old essay first published in the, now defunct, Random Notes blog, and later reprinted in the still extant Ghost Squirrels blog. Typos have been corrected, some minor changes made to content and some reformatting has been done.