THE MYSTERIES OF THE MARKET: Keywords: Shopping and Freedom, American communism, Mamdani, market ethics, empathy, inflation, currency debasement, seigniorage, justice, good intentions and the economy, Say's Law, barter and money, greed and profits.

From barter to buying and selling with money: commerce
Ecommerce settled with Crypto currency

VI

THE MYSTERIES OF THE MARKET

A meditation about forgotten lessons of American Exceptionalism

By Xuan Quen Santos 

THE SIXTH MISTERY 

THE MANY MYSTERIES OF MONEY

 

                  GOING TO MARKET 

             Forget for a moment your own experiences with money and what you know of its history. Think about bartering many centuries ago. Imagine again you have collected from the forest a basketful of seasonal fresh mushrooms you want to trade. On the way to the market you meet a father and a son that are also going there. The son has a small bag with sharp flint arrowheads he has knapped, and the father is carrying a sack with one ephah (bushel) of dry oats from his harvest. As you get there, you meet again the fisherman who intends to trade a handful of fresh fish. Each one of you has a “wish-list” of what you want or need. When you get to the market you separate to go about your business, and after some time, you meet again before going home.

Any voluntary exchange benefits both parties

                THE INEFFICIENCIES OF BARTER

               You are empty handed and the others asked why. You wanted enough cloth to make a garment, but the weaver was not interested in the mushrooms. He said they were growing everywhere and would not last long before they spoiled. After trying with other vendors, the cook  at the inn was willing to take them in exchange for a hot meal, and you accepted. The fisher had only been able to trade four fish and was taking home the rest with two loafs of bread the baker had exchanged for them. He was going home to cook the rest of the fish before they spoiled. The father explained that on the way to the granary he had received offers of fruit, pots, leather strapping, olive oil and others. Many seemed interested in his sack of dry oats, but he was only interested in exchanging it for seed of wheat to plant the next harvest, which he did. Finally, the boy  showed a sack with fruit, a jar of olive oil, a pair of sandals, and several bone awls. He explained that as he went around offering his flint arrowheads many people were interested to use them in the hunt. Others thought they were very pretty, and some accepted them as payment because they would keep their value over time and could trade them in the future with anyone needing arrowheads.

                Consider now that you have decided to sell a pig that has matured. You have a whole list of things you intend to obtain from trading it. You take your pig to the market and after a few attempts to trade you realize you have a problem. You have found people offering what you want, but you realize the  pig is worth more to you that any of the separate things you want. You would need to butcher the pig and offer its parts. How to do it? How to carry around all the meat cuts? What if you find that only a few want to exchange what they have for fresh meat? If you don’t trade all the parts, what will you do with them?

Ronald H. Coase developed the concept of transaction costs

                THE MEDIUM OF EXCHANGE EMERGES

               Obviously, bartering is a process that requires time, finding out, trial and error, a lot of walking around and bargaining, going back to reconsider, and finally closing deals or going home without having made any but confident that what we have to trade is more valuable than the choices the market offered. What describes the process is the concept of “transaction costs”, first coined in 1931 by John R. Commons in a discussion about the inefficiencies or burdens that affect the exchanging of goods and services. It was further developed by Nobel Prize-winning economist Ronald Coase in his seminal work “Theory of the Firm” in 1937. He added the functions that firms -entrepreneurs- have in reducing transactions costs by concentrating under one management the control of different resources, such as labor. Instead of temporary labor transactions, the idea of “employee” appears. Coase also discussed the costs imposed on the firms by legal considerations and the enforcement of contracts. In 1984, Professor Douglas C. North, famous for applying real economic theory to the analysis of history and also a Nobel Prize winner, published “Transaction Costs, Institutions, and Economic History.” In it, he introduces the idea that transaction costs must also include “all the costs of political and economic organization” that affect the functioning of the market. These would include the burdens of “transaction taxes”, regulations, litigation and insurance, “political protection” contributions, extortions, losses from ineffective police, losses from theft, cameras and security…

Douglas C. North - economic thinking in history

                MONEY REDUCES TRANSACTION COSTS

          The spontaneous order of the market solved the problem of the transaction costs of bartering. It is called money. Solving the Second Mystery allows us to solve the many mysteries of money.

                All the participants in the bartering process have similar problems that have high transactions costs. Sooner or later, a few goods being traded have some characteristics that are recognized by many as desirable to accept in exchange, even if they don’t have an immediate use for them, like the arrowheads. The pig is more easily traded in parts, but that represents problems as time passes, just like the short life of the mushrooms. The sack of oats is very desirable since everybody eats them and could be divided in small amounts. Resulting from all these difficulties that represent some form of cost, from the actions and common general objectives of all traders, some goods emerge as facilitators of trade in all the markets because of certain qualities they have.

Money has many forms - it is a medium of transactions

                 The first one is a general acceptability as a medium of exchange in as many trades as possible; many people should recognize it and relate to it. Divisibility into smaller units makes trading easier; a sack of oats is better that a live pig. Durability allows the values involved in the trade to last over time. If you do not need to consume what you obtained in a trade, you want to preserve for future use; the arrowheads are better than the fish. Portability is desirable to carry around, transfer and store; the arrowheads are better than the oats or the fish. Uniformity -from units- is another desirable quality; all the different items should have equal or very similar characteristics; like the grains of oats and the arrowheads. An important characteristic of the goods that the actions of the traders end up identifying as a good medium of exchange is its limited supply; it cannot be superabundant, like air or water. It cannot be too scarce, like diamonds, that there is not enough to “circulate” from hand to hand. It must have attained its position as a commodity in itself. Because the good has these characteristics, it will be demanded as a commodity on its own, plus it will be demanded by the market as it serves as a “medium of exchange”.

                Once the Second Mystery is recognized, we can begin to accept that money is the result of human action, but not of human design. It is then easy to understand the history of money that transforms from the like of cocoa beans, to dry grains of cereals, pretty shells, beads of semi-precious stones like jade or turquoise, arrowheads, gold and silver dust and nuggets, and coins.

NUMBERS, ACCOUNTING AND UNITS IN THE MARKET

Are you familiar with the origin of the numbering systems that emerged in different cultures? It is very likely they were not invented by great mathematicians. They emerged out of the practical needs of the participants in the market. Archaeologists working in the ancient sites of Mesopotamia, Chaldea and Babylon discovered 5,500 years old clay tablets inscribed with what today would be called “accounting ledgers”. Many recorded merchants’ operations and others registered the farmer’s harvests for taxing purposes. Numbers come accompanied by units or standards of measure, such as “ephahs” and “cubits”. Units appeared for measuring lengths, distances, weights, and liquids.

Numbering systems were first used for accounting in trade

The appearance of numbering systems is parallel to the emergence of money. It starts with collecting similar units, such as pebbles or grains. Then, they are grouped in “tallies”; five is a common number mirroring our fingers, followed by ten or twenty. Romans used five, Hindus and Arabs used ten, Mayans and other cultures used twenty adding toes. In the Mesopotamian region twelve was used, mirroring the number of parts of the fingers in one hand excluding the thumb. A few cultures discovered the useful “zero”, such as the Mayans and Hindu. The use of zero allowed the use of just a few symbols repeated in periods, which allowed complex operations with very large quantities. Because computers are not as sophisticated as humans, they only use two numbers: zero and one assisted by the speed of electrical impulses.

The first units of money as coins appeared 2,500 years ago in the same area of the Fertile Crescent originated in the gold and silver mines of ancient Lydia, present day Turkey. King Alyattes and his son King Croesus were miners and smelters in the city of Sardis. They melted their product with equal weights in standard circular molds producing equal disks. They were selling metal by standard weight units at the going exchange ratio. But the mysteries of the market practices evolved them into what we now know as coins. Gold and silver dust, grains and nuggets were already a common form of payment by weight. Their innovative product took a life of its own and became a unit of price by the actions of buyers and sellers. Transactions became efficient, fast, and fair once the parties agreed to trade. This was possible only because the quality of the metal disks was reliable and consistent. A generalized system of trust and honesty rules the ambient of any market.

King Croesus gets the credit for “inventing” one of the most important elements of the market: money. He was just an honest and creative enterprising miner and smelter. Call it serendipity, call it the spontaneous order, but don’t call it “deliberate design”. The Emperor Cyrus “The Great” of Persia conquered Lydia on his way to war with Athens and he thought the disks were so efficient that he took over the idea and all of Croesus’ operation. Cyrus appointed Croesus Satrap to govern the province and from then on, the mining of precious metals and “minting” of coins became a royal prerogative and monopoly. It was an abuse of power that is still burdening us.

Cyrus The Great - King of Kings

The standard disks of metal with their measure of gold and silver created the first known monetary systems. Each King began to stamp his effigy on one side and create its standard of weight. Croesus only meant his hammered seal of a bull’s head to be a brand and a symbol of quality. Diversity as other coins appeared created some confusion, but the money-changers of the market solved the problem by inventing the abacus and calculi, ancient “calculators”. They also used the scales to weigh the coins. Numbers became mathematics and the Rule of Three solved the problems of proportions. Eventually, this line of thinking led to algebra. The metals still had their own prices by weight, so coins could be traded by the market price of the metal. Coins could be cut and weighed to pay smaller amounts. If the market price of metals increased for any reason higher than the government set price for the money, coins were melted down. Money disappeared!

CONTROLLING THE MONETARY SYSTEM IS POWER

Why would kings get into providing money to the market? They claim it is a public service and an inherent obligation of the government to serve the people. To prevent competition, kings declared coinage a royal monopoly. Private minting was declared illegal and counterfeit; culprits suffered severe punishments. There has to be something behind controlling money that governments love. An honest answer to the question solves the mystery.

Ancient Greek and Roman coins in gold and silver

 SEIGNIORAGE MEANS PROFIT FOR THE KING

 Kings discovered three ways to gain from controlling the monetary system. It has always been a business in disguise. The first one is called “seigniorage” which originally was the profit made by the king between his cost of mining, smelting and minting, and the price established for the coin in the kingdom. Competition between the market prices for metals, competition between coins minted by different kings, and the fact that precious metals are naturally scarce kept the avarice of kings from abusing “seigniorage”.

Handling or just keeping coins in large amounts and for trading over long distances is cumbersome and risky. Banks called “treasuries” appeared that offered to hold the inventory of gold of the king’s treasure and of private holders. The word originates in the Latin “thesaurus”, from “aurum” meaning gold. As a warranty document, the banks issued “receipts” for the deposit. The receipts eventually became paper money or bills in specific denominations.  The abuse by seigniorage was still limited as the bills represented the actual amount of gold reserves.

Massive printing of US Dollars, just paper and ink

INFLATION IS A TAX IN DISGUISE

The second discovery the ancient kings made is called debasement of the currency. This was done by melting the good coins in circulation that had specific alloys of gold and silver and then re-minting them with a higher proportion of the cheaper metal, or by adding an even cheaper third metal like copper. In the re-minting they would end up with more coins that by “law” had the same value as the old. They could spend the new amount of purchasing power before everybody noticed. This also had a limit because people would find out by the change in sound, hardness, and the different weight of the coins. Have you seen how Olympian champions “bite” their “gold” medals? Hardly anything is pure gold anymore, but in the old days, a bite would dent and mark anything made with a high content of pure gold. Jewelry is rarely made with pure gold because it easily bends, twists and does not hold its intended form. I don’t think the athlete winners of the medals really know the history behind the bite they take. Their medals don’t dent.

When the debasement became known in the market, people would hoard the good coins and continue using only the newly debased coins. In modern terms, the increase in the amount of money of lesser value in circulation is known as inflation. Today, when the government issues one $ 100.00 paper bill and its production cost is $ 0.06, it makes an instant profit of $ 99.94 that enlarges the money to spend by the treasury. Modern seigniorage by issuing paper currency is a significant source of revenue for governments and central banks. The inverse of seigniorage can occur in coins when the prices of metals increased. The government can lose money. It just happened. Just a few days ago, The United States Treasury stopped minting one cent coins, because each one costs four cents to manufacture. Gradually, all metal coins will disappear. In a greater part the loss is because inflation of the money in circulation creates “price inflation”. The apparent increase in the price of metals has been greatly the result of “price inflation” caused by the monetary inflation that has reduced the value of money.

King Louis XIV, "The Sun King"

The ancient kings discovered a third way to gain from controlling the issuing of money. Ben Franklin is famous for his phrase “The only certain things in life are death and taxes”. In terms of the citizen’s relationship to government, taxes are the cost of receiving the benefits it is supposed to provide. Taxes finance the security of the nation, the protection of the rights of citizens, and the creation and maintenance of the common infrastructure. There is always an inclination to have more for less cost, so any effort to increase taxes by the government will face skepticism and initial opposition from the taxpayers. Taxes are not popular and many an increase in taxes have been the source of much unrest and even popular revolts against governments throughout history. In order not to raise taxes and risk their thrones, the kings discovered “inflation”, officially but secretly done by the kings’ treasurers. The kings learned from the counterfeiters.

The Palace of Versailles from the gardens. When the fountains operated, Paris went dry

THE ROYAL COURT LIVES IN SPLENDOR

Inflating the number of coins in circulation by melting them, debasing the amount of high-value metal in the coins by adding a lower-value, and minting them again made them rich and powerful without raising taxes. Rich kings are splendid, magnificent, gracious, generous, magnanimous…until people realize what happened. The king and his court buy with the new fake money at the stable prices. The upper classes that make up the court and its entourage benefit from the “charity” and generosity of the king. The rest of the people witness how all the market prices begin to rise, reducing the purchasing power of the money they had. It also lowers the value of their savings and their property. The explanation is simple; the king and his court do not add any products to the inventory for sale in the market. There are just more buyers for the same amount of goods. Inevitably, prices rise. In fact, although it is difficult to conceive, what has happened is that the abundance of money made each unit less valuable, it depreciated.

THE PEOPLE LOSE THEIR WEALTH

Inflation also begins to erode the moral fabric of the people. Unrest and a crisis creates an opportunity for the government to grab more power. The Bible stories describe clearly several crisis created by inflation and the moral degradation that follows. But there is more. The Mesopotamian clay tablets that registered merchants’ records and taxes thousands of years ago, also registered two instruments of power grab. Price controls - really price fixing, and persecution of the merchants for raising the prices.

It is not necessary to be an economist to understand that these two policies serve as deflections of responsibility and are also outright lies. It was easy to create the deflection. Since the monopoly of precious metals and the issuing of money were usurped by the government, we associate money with the power of the state and not with the economic institutions of the market. Since the figure of the merchants is the most visible element of the market and they collect the prices, they are easily blamed. Just a few months ago, the culprits that created a nearly 10% of annual rate of inflation were proposing price controls, fines and expropriation of the businesses that operate in the market. Is inflation that mysterious?

UNITS, ACCOUNTING AND MONEY

 With the innovations of the units of measure, accounting, and money, our perception of what was evident in bartering was altered forever. They created the mysteries of prices and profits.

The characteristics of uniformity and divisibility of the mediums of exchange (“money” goods) led to emergence of prices expressed in monetary units. The units of money became units of accounting. Units of money received names. King Croesus disks of precious metals were named “staters”. The Persian gold coins were “darics” and the silver coins “siglos”. The more famous Roman coins were called “aureus” in gold, “denarius” in silver, and the “sestertius” that  was a brass coin. The silver denarius became the standard unit of weight and size for silver coinage for centuries. Cheaper copper coins appeared in many areas. The money used by the Temple of Jerusalem primarily consisted of the Tyrian shekel which was equivalent to approximately 14 grams of silver today. Two other biblical references to money are talents and minas. One talent was equivalent to sixty minas; one mina was worth 60 shekels.

Gradually, as monetary units began to circulate as units of precious metals, the equivalent market values for the metals established proportions with all other goods. The fisherman could devote his time to fishing and sell his catch by weight or units in exchange for coins of silver. He did not have to use all the coins received to buy what he needed. He did not even to buy anything; he could save the coins for future use. This is the characteristic of durability that made coins desirable. It did not take long for the division of labor to further divide the market between producers that would supply the goods available in the market, consumers that would only come to buy with the coins they had previously obtained by selling something, and the merchants that bought from the suppliers and sold to the consumers. Commerce appears with money and the market becomes a permanent institution, not just a casual gathering place of people looking for someone to barter with.

THE MERCHANTS APPEAR

Why do merchants appear as a permanent activity? The answer is simple. As middlemen they specialize in buying and in selling. They provide services to suppliers and to consumers. Merchants reduce the transaction costs of a market that operates bartering.

A few reminders are in place. Why do suppliers sell to the merchants? Because they benefit; otherwise they would not sell what they produce. It may be just because it saves them the time they would otherwise spend looking for buyers. They leave the market happy with the payment they received from the merchant. They know that the money received is worth more to them than what they sold. Why do consumers buy from the merchant? Because they benefit; otherwise they would not buy. It could be just because of the convenience of knowing where to go to get what they need. They leave the market happy with what they bought knowing it is worth more to them than the money they paid.

The merchant is happy too. He also benefits. He has followed the only rule he can in order to stay in business as a middleman. He has to buy at prices lower than the prices he charges. Or, he has to sell at prices higher that his cost. This is where accounting comes to play its role as the source of the biggest mystery in commerce. The merchants make a profit! Accounting makes it evident for everyone to see, including the taxman! If the fishmonger bought fish from the fisherman at 55 shekels and sold it at 70 shekels, he made a gross profit of 15 shekels. After he takes into account his expenses, such as the fees he pays to the king for the use of the space in the market plaza, the ice he uses to keep the fish fresh, some cleaning supplies, paper and twine to package the fish sold, he ends up with a net profit of 4 shekels. Just remember, if he does not have some amount left above his total cost, he can’t be a consumer, which was his sole reason to be in business.

ENVY CORRODES THE CONSUMERS AND DESTROYS THEIR HAPPINESS

Everyone was happy after all the transactions were completed. But something happened when the accountant and the taxman began talking about the merchants’ profits. Envy began to corrode the other participants (suppliers and consumers) because they did not get a profit in their pocket forgetting about the dose of happiness they had received. Since then, anytime the political actors need a scapegoat to blame for their errors in trying to manage the economic system and need a deflection, they animate the consumers to act against the merchants who stand accused of greed.

Recent Los Angeles Riots. Commerce burns 

The merchants’ profit is reasonable, but the fisherman begins to wonder if he should have asked for a higher price. The consumer begins to covet a share of the middleman’s profit. Had he been overcharged for the fish? The moral structure of trust and honesty that allows the market to work efficiently begins to crack. Pointing to the merchants’ profits has been the main excuse used by the political system to interfere trying to manage the economic system. The mystery has been considered so obscure since ancient times that merchants as middlemen have been declared culprits of most economic maladies. Are the prices just? Do merchants exploit the consumers? Who protects the producers and suppliers from abuse? Do merchants actually add value to what they sell? Why not eliminate the middlemen? To stop inflation, why not control the prices charged by merchants? Tax profits! Let the government take over the role of middleman and run the market! New Yorkers just voted for that! A big error they will pay the price for.

Over time, many errors of analysis become evident and get corrected. As the populations grow, the number of participants in the economic system increases. This invariably leads to competition between all participants. No one has enough power to influence the free market prices.

GREEDY INTENTIONS GET THWARTED – ANOTHER MYSTERY

In fact, the participants end up acting in the exact opposite direction of what they intended. When the consumer decides to buy, he will aim at paying the least possible. Because all consumers are competing against each other for a supply that is always limited, the consumer will end bidding up the prices until the limit he has established in his mind. Think of the auctions. The supplier wants to sell at the highest possible price for his product, but  to sell more to the merchant, he will end up offering lower prices to the limit he already knew. If the merchant wants to buy from the supplier, he will agree to prices higher than what he wanted, up to his limit. When he sells, if he wants to sell more, he will lower prices down to his limit. In a competitive market, every one of the participants ends up acting with prices in the opposite direction of their original intentions. Competition is the regulator, and its preservation is one of the few functions that the authorities have with respect to the economic system.

As the population increases, the economic system becomes more complex. Producers and suppliers become corporations with complex organizations that also use accounting to maintain control of costs. At their end, they must also make a profit to be happy. As the supply chains become more elaborate and diverse, professional buyers and sellers -middlemen- appear all along. They all become conscious of the profit goal as the only thing that will keep them in business. Their original misunderstanding of the profits of middlemen disappears. Unfortunately, this does not happen with the final consumers. They do not have an accounting of happiness that will prove to them that they also had received a benefit, even if it can’t be called a profit. Blinded by greed and envy, consumers have no clue that their share of the chains of profit can’t be described by numbers and accounting. Their profit, just as everyone else’s, can be described as an increase in happiness, satisfaction, benefit, welfare, wellness, enjoyment, utility, comfort, advantage, gain… But, for sure, it can’t be described by accounting with numbers. To a great extent, thinking about other people’s profits certainly spoils it, call it happiness or anything else.

            Someday, maybe in the distant future, the jazz singer Bobby McFerrin will be elevated to the Parthenon of the great philosophers or even be awarded the Nobel Prize in Literature. In 1988 he released an a cappella song in his album “Simple Pleasures” that describes the purpose of the theory I have explained as what is behind all the participants in a really free market.

The title counsels “Don’t Worry; Be Happy”.

Technology and energy have made the world smaller by reducing transaction costs