Why Money Is Not the Essence of Economics

In the early 20th century, the isolated Pacific Island Yap was home to an unusual monetary system. The economy only contained three goods: fish, coconuts, and sea cucumbers. Yet, Yap had a highly developed system of money. Its coinage—fei—were large stone wheels, some with a diameter of twelve feet. Owners rarely possessed their fei. After completing a bargain, a simple acknowledgement determined new ownership between sellers and buyers. One family even “possessed” a large fei that had lain on the bottom of the sea for generations. No one questioned their wealth.

In Money: The Unauthorized Biography, Felix Martin asks, “What is money, and where does it come from?” Economists typically argue that money emerged as an alternative to barter. Before money, we would trade fish or corn and other goods but it was an inefficient system. Money became a stable commodity—a medium of exchange—that lubricated the markets. For Martin, however, this view is deeply flawed because it draws on a history of money that relies on what survived.

At first glance, that makes sense. If you want to study money, the first thing you examine is the evidence—coins. However, if you only study what physically survived, you’ll never get the full picture. “Coinage may have been only the very tip of the monetary iceberg,” Felix Martin says.

The unfortunate incineration of one of the largest collections of “Exchequer tallies” tells us why. From the twelfth to the late eighteenth century, financial operations in England relied on thin wooden sticks (tallies) typically harvested from willow trees. An Act of Parliament abolished tally sticks, and in 1834 the government burned millions of the defunct sticks in a large stove in the House of Lords (inadvertently starting a fire that burnt down the Houses of Parliament). Thus, an “immense wealth of knowledge that the Westminster archive embodied about the state of England’s money and finances throughout the Middle Ages… [was] irretrievably lost.” By analogy, if a natural disaster destroyed the digital records of our current financial system, we’d hope that future historians studying the Great Recession don’t only examine nickels and euros.

Coinage, in other words, is not essential to a monetary system. “It is the underlying mechanism of credit accounts and clearing that is the essence of money,” Martin writes. Currency is ephemeral and cosmetic; it is not itself money but a representation of credit. Remember the fei at the bottom of the sea.

Update On Timeless Reading/Writing Analog

A good book is a conversation. My favorite writers never preach; they rely on self-discovery, knowing that interpretation and inference are the lifeblood of reading. One moment, we’re confused and anxious. Then the author reveals a detail that forces us to reinterpret the story. I recounted this experience to a friend and she recalled a quote from Italian essayist Umberto Eco. “Books are not made to be believed, but to be subjected to inquiry. When we consider a book, we mustn’t ask ourselves what it says but what it means.”

In How to Read a Book, Mortimer Adler and Charles van Doren compare passive reading (receiving information from an author who is intent on giving it) with active reading (initiating a dialogue with the author). They use the metaphor of a catcher and a pitcher. A book needs a reader just like a pitcher needs a catcher. In a game of catch, the pitcher won’t always throw a strike and the catcher must be willing to adjust. That’s a good thing. The joy of writing and reading align when a reader and a writer are working together.

The same metaphor appears elsewhere, from the Greek Stoic Epictetus (who wrote that “skillful ballplayers,” like skillful listeners, are not “concerned about the ball as being something good or bad, but about throwing and catching it.”) to the Roman historian Plutarch (who said that the “harmonious rhythm” between a speaker and a listener should resemble the harmonious rhythm of a game of catch). In his mediations, Descartes reflected that, “the reading of all good books is like a conversation with the finest minds of past centuries.”


Invisible Money: An Example of Silent Evidence

If you want to understand how an old monetary system worked, the first place to look is the coins. They are durable and typically stored in secured locations, perfect for preservation. Yet, if you only study what survived, you’ll never get the full picture. You must also study the stuff that burned, decomposed and disintegrated. Imagine future historians studying the Great Recession by only looking at nickels and euros. They must examine online banking statements, read economic papers, research mortgage backed securities and junk bonds. “Coinage may have been only the very tip of the monetary iceberg,” Felix Martin concludes in Money: The Unauthorized Biography.

The Nature of the Banking System

Nature understands size much better than humans. Nature penalizes size. An elephant will die from small injuries (a broken ankle) while a mouse with the same injury will survive. The eco-system will not perish when an elephant dies. Many more mice than elephants.

The removal of large species (whales, elephants, hippos) would impact the eco-system much, much less than the removal of small species (mosquitoes, flies, plankton). Banking is the opposite. One failure brings the entire system to a grinding halt. Nature is bottom-up; man-made systems are, generally, top-down. Nature is robust and we are fragile.

We tend to confuse long-term stability within man-made systems with permanent stability, and thus conclude (falsely) that we are smarter than nature. No empire lasts forever, yet at their peaks, its citizens predicted just that. No fortune lasts forever; money runs out. Long-term stability makes us complacent, in fact. So the longer a man-made system has existed (not a physical thing or a rule or a law) we should be more and more worried.



Earthquakes, Terrorist, and Technology

This is an early draft of a 250 essay. I’m posting it here so I don’t forget some of the ideas that were cut from the final draft.

Main concern: Are there two types of gray swans? 1) Conceivable, Unpredictable but forecast-able and 2) Conceivable, Unpredictable in the long-run but predictable in the (very) short term. Earthquakes are in the first category. Terrorist attacks are in the second category. 9.0 Earthquakes and 9/11 are both conceivable (and NOT unknown unknowns) but intelligence analysts had enough info to predict 9/11. Earthquakes are inherently unpredictable. 

Terrorist attacks and earthquakes have a lot in common—at least to Aaron Clauset. In The Signal and the Noise, Nate Silver explains that according to Clauset, earthquakes and terrorist attacks both follow power-law distributions. If you don’t have a mathematics degree, that means that small earthquakes (0-4.9) are common, medium-sized earthquakes are less common (5.0-7.9), and large earthquakes (8.0 or greater) strike a few times a century. Terrorist attacks, in terms of total fatalities, behave similarly.

Of course, we can control terrorist attacks, and that’s one reason why they are different than earthquakes. However, I’d rather be a seismologist than an intelligence analyst. While there are only a few different types of earthquakes, there are thousands of ways a terrorist could strike. The challenge for the intelligence analyst is to scrutinize a large number of hypotheses—hijackings, chemical attacks, bombings, shooting sprees.

National security disasters in the United States are often the result not of a dearth of information but imagination. That is, no one considered the correct hypotheses. For instance, at Pearl Harbor analysts never reviewed the possibility of a full blow aerial attack even though evidence suggested that it was possible—even likely. According to the 9/11 Commission, we had enough information to anticipate September 11th, but the C.I.A and F.B.I never seriously examined the idea that terrorists would hijack four planes and crash them into high-profile buildings. As the Nobel-Prize winning economist Thomas Schelling put it, we tend “to confuse the unfamiliar with the improbable.”

What can earthquakes and terrorist attacks teach us about business? More than you think. Technology also follows power-law distributions. In history, a few revolutionary inventions (the wheel, the printing press, the steam engine) are surrounded by thousands of less groundbreaking inventions (thermometers, zippers, CD-Rom), which are surrounded by millions of small inventions (snuggies and post-it notes). Revolutionary inventions disproportionally affect the economy in the same way that large earthquakes and terrorist attacks inflict a disproportionate amount of damage. The wheel was a 9.0 magnitude invention.

Earthquakes are not predictable. Are inventions like the wheel predictable like 9/11 was? Yes and no. We cannot predict inventions (or terrorist attacks) that will occur in the distinct future. But we might be able to predict an invention that will emerge within the next 2-5 years (if there is one). For instance, all of the components of the iPod existed for a few years before Steve Jobs fit them into your pocket. According to Scott E. Page, all of the components of the steam engine existed for two decades before the steam engine. There was a small window in which someone had enough information to predict the iPod and the Steam Engine.

But remember the lesson from Pearl Harbor and 9/11. They were failures of the imagination and not failures of information. “The signals just weren’t consistent with our familiar hypotheses about how terrorists behaved, and they went in one ear and out the other without our really registering them,” says Silver.