How Money Works: Part 1 – The Evolution of Flow Value

Our civilization is built on concrete exchange of a flow-value. Values may decrease or increase depending on the subject’s perspective. In current state of civilization, we can say the flow-value is represented by money, to be precise, currency. Currencies give a definition of potential flow-value. To know how money really works now, we need to take a look deeper in to the forms of money and its evolution.

Form of Money

Barter

Beginning from barter, it’s an exchange of things worth the same value, a way to bridge between supply and demand.
What is supply..? Something that is not needed.
What is demand..? Something that is needed.

‘Need’ is the quality referenced from a subject’s point of view, a value perceived as.
Having defined the ‘need’, we exchange it with the same valuable form of tangible/intangible stuff (productivity, skills, leverage numbers, and it could also be moral gap-filling in the form of social service) to settle a balance between the need of an individual to the society.

Barter is an exchange of things worth of same value, a way to bridge between supply and demand. Click To Tweet

Though it seemed easy and practical, barter has seen its disadvantages:

  1. Match of value at the same time. “I need some hay for my farm and I can give you my new Axe” — “But I don’t need Axe.”
  2. Partition of the value. “I want only half of your cow” doesn’t sounds good.
  3. Agreement between two valuables. “I think 1 egg is worth the same as 10 potato” — “I don’t think so, 1 egg should be 12 potato”
  4. Store “value” to use for another time (lack liquidity). Imagine storing potato/egg for 3 months!

So then as an intelligent being, we discovered another model..
Enter the ‘Shells’. The adoption of shells to give value to goods opens an entirely new era of flow-value.

Cowrie Shells

Native Shell Money

Shells eliminates all the disadvantages of barter, except the density of value in it. The desire to expand and trade of values demands greater values of flow at the same time. Imagine trading two crate of shells (1000 pieces each) to a tool like bronze knife sold by a smith.. In the end of the day, the smith can’t even sleep on his home due to too many Cowrie shells crate in the house. Thus, the need to pump up the density of “currency” is there, and we found the solution.. so far..

Metal, Electrum, Coin, Leather, Paper Currency

In order to raise the density of value, we need to have a new convention that is more widely agreed. Locally traded goods of value agreed on accepted flow-value which eventually brings the Metal age (Bronze , Iron, Copper). Flow-value is depicted as an exchange between metal tools or metal appliances. Eventually this form of metal trading also isn’t worthwhile because the form is not standard and sometimes it is hard to transfer.

Bridging the need between more density of value, form, and also ease of transfer, modern human founded the Electrum.

Electrum
Electrum as a form of flow-value

Electrum is naturally occured gold-silver alloy. The problem with Electrum as a form of flow-value exchange is the gold-silver composition. It’s not always the same composition. So when we look deeper, Electrum found in different geographical area will have different composition of gold-silver. The disadvantages of Electrum is the standard-density of value in each weight of piece. This is why human started to standardize the electrum. Purification and remake of the alloy with certain composition of gold-silver, making it possible to have pure gold and pure silver, and also segments of class of the standard-density in each. The coin that is minted from different composition of gold-silver is born. Coin became so easy to use because it has standard composition of gold-silver.

The few next big evolution of currency is basically to improve the standard-density of value and to practically endorse the expansion of economy into wider geographical trade.
For example, leather can be written as a piece of understanding between two parties, that it is worth sum amount of coin. This can be considered the first moneynote which in time evolves into paper money due to its versatility. Moneynote with all its advantages also introduces other derivative of liabilities. One liability is that eventually paper money will worn-out. The other liability is forgery, this also means that there should be security features in the paper money which differentiate between original-official ones with the fraud ones.

Getting there, human population keeps growing and the same goes for the technology and economy. Along with the expansion of network, human then need to apply a system of convention, we need to standardize the universality of exchange in each network of economy.
Solution?

The Gold Standard (British 1704, 1717, 1821, America/German 1873)

The gold standard basically states that gold covers:
1. The division value needed (specie; coin types with certain amount of gold composition on each effectively divide the class of intrinsic value for the coin)
2. The standardized density
3. The universality of network

The weakness of the gold standard though, it can not keep the stability of flow-value rate with the population growth rate. This happens because more people means more economic activity.. economic activity involves 2 party. So, the rise of 2 times population growth need gold to be mined at 4 times the worth minimal. This is impractical in the long run due to balance sheet miss between gold reserves and moneynote circulated.
The other key disadvantage of gold standard is the exchange currency. In a currency backed by gold, it is possible to convert all moneynote to a physical gold worth of equal value. This make a problem where the currency flow in one country is actually more than the gold held by a country due to excessive trading (moneynote flow is faster than gold flow).

Many countries left the gold standard on World War I because of the need of rapid financing and outsourcing trough available local resources. This ultimately mess the numbers between gold and moneynote.
Germany issued a non-convertible mark (not worth of gold) that can be used for trading both locally and also inter local (Europe). This was meant to be a temporary band-aid but it gone out of control, which make the condition called hyperinflation (intrinsic value on liquidity is much more compared to asset).
On the other hand, United States issued a “bond” meant to mitigate the balance sheet between gold and moneynote, worth of gold. This makes the bond the first credit ever happened in history of mankind and also US as the net creditor. This means that whomever own the bond as a flow-value actually is in debt towards the United States worth-of-sum amount of gold.

The next evolution is needed to combat the slow growth of gold production compared to the growth in economy and  population.
In 1933, President Franklin D Roosevelt effectively ended the Gold Standard, further trailed by President Richard Nixon in 1971 declared a flat system dollar. That is, the dollar isn’t tied to gold or other resources anyhow.
Now, gold (and other precious metals) still traded as a commodity.

Electronic Money and Credit System

The reason why money is still accepted in our civilization:
1. It is liquid (ease of exchange)
2. It is used because of the ability of division, storing
3. It is and has a standardized agreement

With more population, the need for buying power is more. With the arrival of electronic banking and credit system, the majority of the population can have greater buying power provided they want to promise that they will conform into the payment in the future.

The weakness of current physical money is “What You Have equals What You Can Get”.

The keyword here is buying power. Buying power is a perfect solution when you are out of liquidity (short on cash). Credit system makes it able for someone to purchase items or service way before the time you have your liquid cash. It is important to note that credit is different than a loan. Loan effectively charged interest at the first agreement, while credit give allowance up to 1 month until it is charged into interest.

Credit is a potential payment worth a sum of flow-value trusted by an institution that has surplus of money. The act of crediting and debiting defeats the original purpose of flow-value exchange.

How Credit Works – credit.com

What’s Wrong with Money as It is

Society embraces the practice of credit system while also still using the barter and local cash currencies. Since the fall of Gold Standard, civilization isn’t one world economy any more. There are these pocket of economy announced by the so-called reserve currency. Reserve currencies act as the buffer for each region of economic activity (Euro-Zone, Asia-Pacific, etc), a buffer against growth as well as a buffer against depression.
It is also useful to know that depression comes in cycle because of the peak economy margins to the interest rate hikes.

Population as whole need more buying power in order to gain a stature in the society.
People are psychologically feed the image of a complete stature of ‘successful’ view in society. This new trigger prompt the rush of demand that is completed by surplus of virtual money (credits). There is no system to hold the already flat money system to keep going. So far, FED and other Central Banks tried to mitigate the inflation by playing with the interest rates and sometime flood the market with newly printed money. 

It seems that the imbalance balance sheet is the new normal.

Money as a means of exchange between things worth of same value has progressed into merely numbers that depicts the potential buying power (not the actual buying power). The more number you have in your account practically decides the amount of your credit potentially available. This also prompt some pockets of society to work more in order to increase their buying power locally. This act is called saving. Saving in the long run reduces the available effective flow-value in the market. When the effective sum is less, the market will need more liquidity, this in turn trigger more credit to be exercised and more flooding of the market with new printed money.

We are On a Highway to Inflation.

It is then simple to say:
What we need more is buying power, but why do we need it..?
What if we can get it from the other people who don’t use it..?
It is a simple supply and demand problem to fulfil the ‘need’, it’s just that now ‘need’ has an entirely different meaning in our lifestyle.

Lifestyle is not only about need but also about luxury. We need buying power to provide ourselves luxury..at least that’s the original assumption.

The fact is, we as a modern society can easily fulfil luxury than ‘need’…. this is not only impractical, it is unsustainable.
I will elaborate some of the solution conceptually because every one of us has different background and experience to synthesize solutions. After all, flow-value is more than having enough money.