The Invention of Money

My mother alerted me to this show on "This American Life" devoted to exploring the idea of money.  It is a little silly given that it is the "Planet Money" team that is reporting this and that only after a few years on the job did they stop to consider what any principle of macroeconomics student is immediately faced with: how to explain money (or if you take Money and Banking you have to study the definitions of money).  You also have to endure the tired and (to my mind at least) incredibly annoying mannered style of Planet Money as well as This American Life, the show upon which it is modeled.  Nevertheless, it is an interesting show and I recommend it to those without an economics background and suggest it to those with or for those who haven't really thought about it.

I will stay they start off on the wrong foot in talking about all the 'money' that was lost in the housing bubble recession.  It wasn't money as much as 'value.'  But in a sense this is the point - people don't get the distinction.

Economist's Notebook: Money and Sports Drafts

On the morning after last year's number one pick in baseball, Stephen Strasburg, had a stunning debut for the Naionals...

AP sports writer Jimmy Golen has a nice article that wonders why Major League Baseball does not allow the trading of draft picks as do the NFL and the NBA.  MLBs prohibition doesn't make sense to economists who know that prohibiting voluntary transactions almost always leads to sub-optimal outcomes.  Why not let teams trade draft picks if they think it can make their club stronger?

Steve Levitt mentions this article on the Freakonomics Blog and Economist Richard Thaler is quoted in the article making the same point.

But I wonder why these economists have not mentioned the obvious question: why not monetize the draft?  In fact this is not my idea, it was the idea of a friend of mine from grad school who, before he went to grad school worked as an economic consultant and even got an audience with the NFL to suggest the idea.  Apparently he was not persuasive enough.

The idea is pretty simple: barter economies are much more inefficient than money economies.  If you have a kumquat and would like to consume an orange in a barter economy, you have to find someone who both wants a kumquat and has a orange to offer.  In a money economy you need only to find a buyer for a kumquat and then you can take your money and give it to the holder of an orange.

Trading in sports drafts is the same thing.  If you have the number one draft pick, but prefer, say, three role-players you have to find a team that both wants the number one and has three role-players that you want.

What if instead of getting to pick first, the worst NFL team from last season were given 10,000 "draft bucks," the number two team 8,000, the number three 7,000 and so on.  The absolute amounts are not important, only the relative amounts.  Then on draft day, you hold a big auction - e-bay style - on all players eligible that year.  Teams that value a certain player highly will bid a lot ( and will therefore have less to spend on other players if they win the auction), and teams that don't won't bid at all.

So instead of having the number one pick, you have the most money to spend, but you can spend it exactly as you see fit. It wouldn't have the drama of the draft and nowadays these things are big media events, but it should increase efficiency and improve the level of play in the league.

In fact, according to economic theory, what you should get is Pareto-efficient outcomes, outcomes that capture all of the total surplus available in the market.

What's not to like?

The Money Illusion

The Onion, once again, has the exclusive:

U.S. Economy Grinds To Halt As Nation Realizes Money Just A Symbolic, Mutually Shared Illusion

WASHINGTON—The U.S. economy ceased to function this week after unexpected existential remarks by Federal Reserve chairman Ben Bernanke shocked Americans into realizing that money is, in fact, just a meaningless and intangible social construct.

Calling it "basically no more than five rectangular strips of paper," Fed chairman Ben Bernanke illustrates how much "$200" is actually worth.

What began as a routine report before the Senate Finance Committee Tuesday ended with Bernanke passionately disavowing the entire concept of currency, and negating in an instant the very foundation of the world's largest economy.

"Though raising interest rates is unlikely at the moment, the Fed will of course act appropriately if we…if we…" said Bernanke, who then paused for a moment, looked down at his prepared statement, and shook his head in utter disbelief. "You know what? It doesn't matter. None of this—this so-called 'money'—really matters at all."

"It's just an illusion," a wide-eyed Bernanke added as he removed bills from his wallet and slowly spread them out before him. "Just look at it: Meaningless pieces of paper with numbers printed on them. Worthless." ............... 

Read the rest at The Onion and start buying your gold here.

Econ 101: Confidence and Money

All of this talk about a lack of confidence in the credit markets causing all of this turmoil makes me think of one of the most basic economic mechanisms that exists - fiat money. Fiat money is essentially money that is backed by the full faith an confidence of the government (and, by fiat, must be accepted as a means of exchange) but not backed by any real commodity, like gold. We take the solidity of the Dollar for granted in the United States. In fact, I am reasonably confident that I can take a wad of dollars almost any place on earth and it will be accepted for exchange (and usually much more happily accepted than the local currency) - far out of the reach of the US government. How on earth can a simple piece of printed paper be so valuable? Well, because we believe it is.

What I believe, and what most people in the world believe, is that I will always be able to exchange Dollars for stuff: goods, services, interest, etc. And the reason I believe it is because everyone else believes it too - the fact that others believe it is what makes them willing to exchange stuff for my dollars. This is what gives the Dollars its value. It is a confidence game.

The Dollar is still the international currency of choice, thanks in large part to the dominance and stability of the US economy and government. What would happen if this crisis shakes world confidence in the US so much that the Dollar and US Treasuries are no longer seen as safe harbors (in other words, what happens if people start to believe that the US could possibly default)? The Dollar could suddenly become essentially worthless for international transactions. I am not predicting this, in fact I predict that the Dollar will remain the currency of choice and perhaps even more so now that the world is watching Europe struggle to come up with a coordinated response to the crisis lowering slightly their confidence in the Euro.

What if I started worrying about the US government and the monetary system, I might prefer to take payment in kind for my services. If a lot of people felt this way pretty soon that piece of paper with George Washington's face on it, is just a nice memento. Again, I am not suggesting this is where we are headed, rather I wanted to use this amazing demonstration of a crisis in confidence to point out how something as fundamental as currency relies on confidence.

It is pretty amazing when you think of it. A bunch of carefully printed pieces of paper in my wallet allow me access to an amazing array of goods and services - simply because we all believe in them. So it is not "In God We Trust" it is really in each other that we trust.