Preamble: Welcome to the Story of Money Podcast week here at RollingAlpha.com. We’re five episodes in – and so it felt like a good time to remind everyone to go and check it out. In particular, we’re desperate for your ratings and reviews. Thanks to everyone who’s given us feedback – it’ll help us improve things going forward. In this series of posts, I’m going to do some selective highlights.
A Money Story
Here’s a story about money that we like to tell in chain emails:
It’s a slow day in some little town.
The sun is hot… the streets are deserted.
Times are tough, everybody is in debt, and everybody lives on credit.
On this particular day a rich tourist from back west is driving through town.
He stops at the motel and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs in order to pick one to spend the night.
As soon as the man walks upstairs, the owner grabs the bill and runs next door to pay his debt to the butcher.
The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.
The pig farmer takes the $100 and heads off to pay his bill at the feed store.
The guy at the Farmer’s Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her services on credit.
She, in a flash, rushes to the motel and pays off her room bill with the motel owner.
The motel proprietor now places the $100 back on the counter so the rich traveler will not suspect anything.
At that moment the traveler comes down the stairs, picks up the $100 bill, states that the rooms are not satisfactory, pockets the money & leaves.
NOW… no one produced anything…and no one earned anything…however the whole town is out of debt and is looking to the future with much optimism.
When this kind of parable makes the rounds, the general conclusion is something along the lines of:
- “Money is so fake”; or
- “How ludicrous this system of ours – it has nothing to do with productivity or earnings.”
An Alternative Interpretation
Here is my reading of it:
- Before the traveller comes into town, you are looking at an economy with real transactions but no money.
- Like any early economy, the system runs on a series of IOUs.
- But IOUs become inefficient when all the economic agents are not close to each other.
- That is: if there were sufficient levels of communication, everyone in the town would have known that they both owed and were owed the same amount of money.
- Then they could have swapped out their debts and receivables, and you would have gotten to the same point. “NOW… no one produced anything…and no one earned anything…however the whole town is out of debt and is looking to the future with much optimism.”
- But the circle had grown a little too large, apparently. And so the flow of transactions had gotten locked into stasis by this hypothetical ‘debt’.
- So what does the money do?
- When it arrives, it acts as a clearing mechanism.
- It allows the swap-out of debts and receivables without any direct communication between all the economic agents.
- And thus, the flow of transactions is greased back into motion.
Isn’t that a comforting way of looking at things?
For more on this: check out episode 1.
Rolling Alpha posts opinions on finance, economics, and sometimes things that are only loosely related. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha. Also, check out the RA podcast on iTunes: The Story of Money.