I once read a book by the inestimable John Kenneth Galbraith on what money is (Money: Whence It Came, Where It Went). For him it was a wisp of a book, just over 300 pages. I condensed the major point in one phrase I have always remembered:
Money is a consensual hallucination.
To explicate: Money is stuff that’s money because we all agree that it is money.
This is not just Ken being clever, but thanks for thinking so. This is really, at core, what money is. As long as enough people will take it in exchange for something, it’s money.
When the U.S. detached it’s currency from gold, the economy went on its merry way, just better. (This happened in 1971, and is called the “Nixon Shock”, which amuses me.) It meant that we could decide how to handle money without worrying about how much gold had been mined last year, or how many shiny bars of the stuff we had stacked somewhere, and could instead concentrate on things like, say, people. How it works for people.
Once you accept that money truly is an idea rather than a thing, it becomes clearer that there is no single “right” way to run a monetary system. It is merely trying to figure out, through trial and error (and mankind has had plenty of error over our history), what system works best.
Some societies, including this one until 1933, have strictly tied the value of their money to gold or other precious metals. […] the government may not be able to create new gold from thin air, but miners can definitely get it out of the ground. And it is a strange state of affairs when the price level of an entire society is allowed to fluctuate based on advances in mining technology or the discovery or non-discovery of new reserves.
The main point to take away is that systems of money and currency are not laws of nature, or long-proven gifts from our ancestors. They are tools of commerce, built by people, and subject to human improvements.
During the wars of Yugoslavian dissolution in the 90’s, the dinar hyperinflated. Several attempts at de-evaluation to stabilize the currency failed. Finally, in 1994, they introduced the Novi (“new”) dinar. New notes and coins, with a new name that had the word “new” in it. And that worked, inflation over problem solved. (The novi dinar was worth about 13,000,000 of the most recent old dinar, and was 2.4 ×1030 pre-hyperinflation dinars (yes I had to look this up, I do not store historical dinar conversion rates in my brain).)
Of course it wasn’t just the word “new”. The novi dinar was pegged to the Deutsche Mark. But really, why would that work?
It worked because people believed in the German Central Bank. They had lost faith in the Yugoslav dinar. So they no longer consented to the hallucination that dinars were worth, well, anything. But they still believed in the staid, doughty Germans having a stable currency.
And when it comes to inflation, the Germans are in fact totally believable. The Germans, it turns out, will send entire countries into austerity-induced convulsions and pain, risk the Euro monetary union, and worship the confidence fairy rather than tempt the slightest hint of inflation.
So that was that — the money hallucination of the Germans was gratefully embraced by the remains of Yugoslavia and now you could buy bread reliably.
Money is hallucination, it is faith, it is will. Believe it, but don’t forget it.
P.S. Jonh Kenneth Galbraith’s Ambassador’s Journal on being JFK’s ambassador to India is also worth a read. He was a witty, observant, and humane writer and mensch.