Part 14: Money and Uncertainty
Three decades ago, I was visiting a friend. He was a graduate of the Harvard Business School. He was beginning a successful career as an entrepreneur. We were outside, watching his son play. His son was about five years old. "Robbie," he said, "why does daddy have to go to work every day?" "To buy money," Robbie replied. "No, Robbie. I go to work to earn money."
I responded: "Robbie's right. You go to work to buy money."
Robbie now owns a highly successful microbrewery, Allagash. He goes to work every day to buy money.
Out of tradition, we speak of buyers and sellers. But they are both buyers, and they are both sellers. We refer to "buyers" when we mean "sellers of money." We refer to "sellers" when we mean "buyers of money." Why?
I think the reason goes back to Ludwig von Mises' definition of money as the most marketable commodity. The seller of money is the universal buyer, because that which he offers for sale is the most widely used commodity for making bids. Why universal? Because money is the medium of exchange.
The person who has money to spend has the upper hand in most transactions. There are lots of people who want his money. There are fewer people who want whatever the producer or middleman offers for sale. Over millennia, the public has understood the seller of money as a buyer of goods and services. He specializes in allocating the most marketable commodity. He stands before a crowd and says: "I've got what you all want. Make me an offer." He is a specialist in getting producers of all sorts of goods to make offers in the common unit of account.
The sellers are specialists in bidding for money. They focus on the most marketable commodity as buyers. They must specialize in producing for a narrow segment of the community. Not everyone wants what they have.
By tradition, we designate as a buyer the person who owns a universal good. We designate as a seller the person who owns the less universally demanded good.
THE STRONG HAND
The buyer is in a position to negotiate. He can take his money elsewhere. There are lots of offers for his money.
The person who does not understand economic theory generally thinks of the owner of money as the weaker party. Why? Because the buyer is a victim of advertising techniques. He is a victim of organized cartels. He is a victim of insufficient knowledge of products. In contrast, a seller is rich. He can set the terms of exchange. The most famous modern economist to promote this idea was John Kenneth Galbraith. He offered a theory of countervailing power. He thought the U.S. government should regulate the terms of exchange in order to defend the helpless consumer, i.e., the seller of money. He began his career as a senior official in World War II's Office of Price Administration, which set prices below market and then handed out ration coupons to offset the widespread shortages created by the controls.
The black market was the countervailing power to the OPA. He resented this intrusion into the government's power. This hostile attitude toward the market never left him.
What about advertising? The seller uses advertising to compete against other sellers. The consumer can pick and choose among advertisers.
By the way, the critics of advertising rarely apply this criticism to national elections, where political candidates hire the same advertising firms that businesses do. The inventor of the modern political sound bite was Rosser Reeves. He used brief film clips to help sell Eisenhower to the voters in 1952. He was also the man who came up with the phrase, "melts in your mouth, not in your hand."
What about organized cartels? They are the creation of governments. The most powerful one is the bankers' cartel, which operates the monetary system in today's regulated world. The enforcer is the central bank. The critics of the free market never mention this. This includes the economists who write the textbooks.
The buyer is supposedly the victim of insufficient knowledge. This was not true when Galbraith wrote. In the era of the Web, this argument is no longer even remotely plausible.
The seller of money has the strong hand because everyone wants what he owns. The sellers of goods have what relatively few people want. They hold the weak hand.
BUYING MORE CERTAINTY
Because money is the most marketable commodity, people can hedge against unexpected bad events by accumulating money. We cannot know all of the bad things that may come. We cannot plan for every contingency. The word "contingency" points to the problem: uncertainty.
Because we cannot afford to take steps to defend ourselves against all the things we want to avoid, we accumulate money. Money is the most marketable commodity. It therefore offers us ways to buy our way out of any number of bad circumstances.
When we accumulate money, we are saying, "I don't know what's coming. I don't want to be caught flat-footed. Money lets me escape a broad range of potential disasters. I don't have to become a specialist in disasters."
In contrast, a seller of solutions to disasters has to specialize in those types of disasters for which he can produce solutions at a profit. He cannot sell solutions to everyone who may someday want to buy his way out of a disaster. The amount of knowledge required for such an endeavor is too great. The capital required for such an inventory is too great.
To escape a major calamity, people rely on money, prayer, and the state, not always in this order. When they run out of money, they look to God or the state. Some look to the state as the only available god.
The seller of a solution to a specific calamity is in a strong position when that calamity hits. He can sell his inventory of solutions at high prices. There are lots of buyers and few competing sellers.
Then he gets arrested for price gouging.
Sellers then get the message. They do not bother to stockpile solutions. Why bother? The government will not let successful sellers sell to buyers who stockpiled money. Government officials resent both forms of stockpiling.
The seller of solutions is willing to bear a lot of uncertainty. The disaster may not hit. A rival supplier may offer a better solution at a cheaper price. Or he may be arrested for price gouging.
Notice what is happening here. One person is uncertainty-averse. He accumulates money. The other is less uncertainty-averse. He accumulates solutions: an inventory of goods or skills.
The two work out a deal. One person stores up what he wants: money. The other stores up what he wants: solutions.
Because anyone can hoard money, the rate of return on near-money assets will be low. There are few entrepreneurial opportunities here. The smartest entrepreneurs on earth are looking for profit opportunities in currency exchange. The obvious opportunities get bid up in price. So, the rate of profit falls. You cannot buy low and sell high when sharp forecasters have bid up the asset.
In contrast, the seller of highly specialized future solutions has lots of profit opportunities. They are matched by loss opportunities. But he is less uncertainty-averse, so he rushes in where angels and competitors fear to tread.
PROFIT AND LOSS
There is less profit from depositing money in a government-insured bank account than there is in successfully forecasting a disaster. There are lots of people who want to buy greater certainty. They pay for their preference by purchasing a low rate of return. Market pricing bids down the rate of return. "Buy high, sell slightly higher."
In contrast, the entrepreneur wants a high rate of return. He buys this by purchasing wads of uncertainty.
When an entrepreneur thinks he has had enough — enough money, enough uncertainty — he switches from supplying services to supplying money. He no longer expects to get richer. He expects at best to hold on to what he has.
Entrepreneurs make money by buying uncertainty with whatever money they own or borrow. Security-seekers gain their goal by forfeiting opportunities to get rich.
In a free market, each participant is allowed to bid for the outcome he prefers.
INFLATION AND UNCERTAINTY
The great threat to a buyer of security is inflation. When the banking system expands the money supply, it introduces uncertainty. Prices will rise. Which prices? That is uncertain.
The boom bust cycle will begin. How soon will the boom turn into a bust? That is uncertain. The person who wants security is threatened by inflation. But he does not know what is causing price inflation. He does not know that a rise in the money supply sets off the boom-bust cycle.
The person who revels in uncertainty has an advantage in times of monetary inflation. The supply of uncertainty increases. But he may guess wrong. He may find that the uncertainty he planned for does not arrive on schedule. In such cases, he may lose.
However, hanging onto money is highly risky in a time of monetary inflation. The security-seeker does not understand this. Keynesian economists do not understand this. Politicians do not understand this. The result of inflationary central bank policies is the production of uncertainty in excess of what the public wants to accept. But the public does not understand Mises' theory of the business cycle. Voters do not demand a halt to the increase in money.
It would not matter if they did. Central bankers do not answer to voters. They also do not answer to politicians. "Monetary policy is too important to be left to politicians," the paid propagandists called economists assure us. The politicians believe this. Until the crisis of 2008, so did voters.
The economists also add: "Monetary policy is too important to be left to the free market." This leaves only central bankers.
THE GOLD COIN STANDARD AND UNCERTAINTY
Under the gold coin standard of the nineteenth century, central banks found it difficult to expand the monetary base, in order to fund the national government. Other central banks began demanding payment in gold. So did depositors in commercial banks. The outflow of gold would call into question the wisdom of expanding the monetary base.
Prices remained relatively stable, 1815—1914. For the period 1870—1900, prices in the United States fell. The money supply was stable. Output increased. Sellers of goods and services were forced by market competition to reduce their selling prices.
Because market participants could more easily forecast the direction of prices, there was reduced uncertainty. They did not worry much about rising prices. They did not worry about rising prices in a foreign currency. The gold standard was international. Currency exchange rates were stable, not because of a government exchange rate system but because the various nations' IOUs to gold kept currency exchange rates in a tight band.
This way, those participants who wanted greater security at the old price level could buy it. There were few price increases. Those participants who wanted greater uncertainty could specialize. They did not have to factor in general price increases.
Europe lost that system at the outbreak of World War I, when governments allowed banks to defraud depositors by refusing to pay in gold coins, as promised. The United States lost it in 1933, when Roosevelt confiscated as much gold as the government could get its hands on. The result was predictable: increased uncertainty.
The free market lets us buy and sell uncertainty. Buyers of uncertainty spend money, buy capital goods, and restructure production. Then they sell their output for money. Then they repeat the process.
Sellers of uncertainty (buyers of security) accumulate money (cash) and exchange this for digital promises (bank accounts). They are promised instant currency withdrawal on demand or instant spending with plastic cards. But the international value of the digital money they accumulate has much wider zones of fluctuation.
The central banks of the world have been offering less uncertainty for large banks in the capital markets. They do this by creating new money and spending it to buy assets, i.e., promises to pay. The public can therefore expect what it got in 2008: much greater uncertainty.
As the uncertainty of money accelerates, the uncertainty of future financial events increases.
November 11, 2009
Copyright © 2009 Gary North