5. Break It and You Bought It.
Being fooled by hidden costs is the source of a lot of economic confusion. War is often spoken of as an economic stimulant. World War II “pulled America out of the Depression.” Germany and Japan experienced “economic miracles” after the war. Somebody is not counting the cost of getting killed and wounded. Besides, if destruction were the key to greater economic productivity, every investor on Wall Street would be learning Albanian.
6. Good Is Not as Good as Better.
Almost as bad as costs that go unnoticed are benefits that get too much attention. It’s great if everybody has a job. Computers are taking jobs away. We could guarantee full employment if we removed computers—and electricity, too—from the telephone companies and hired people to run all over town and fly around the world, telling our friends and business associates what we want to say.
When James Watt invented that steam engine, thousands of ten-year-old boys who had been hauling coal carts were put out of work. However, this left them free to do other things, such as live to be eleven.
7. The Past Is Past.
Another thing that gets too much attention is money that’s already been spent. In economics this is called “sunk costs.” It doesn’t matter that you blew everything you made selling Apple at $1,000 a share on a scheme to genetically engineer squid. What matters is whether you can make any money off those squid now or convince people that the squid will make money in the future, so that those people will buy the fool company. This is called “marginal thinking,” and on Wall Street it means almost the exact opposite of what we usually mean when we call someone a marginal thinker.
8. Build It and They Will Come.
Ralph Waldo Emerson was referring to better mousetraps, and the idea that the world would beat a path to your door for one tells us something about home hygiene in the nineteenth century. The underlying notion is stated formally in economics as Say’s Law (after French economist Jean Baptiste Say, 1767–1832): “Supply creates its own demand.” More is better. Any increase in productivity in a society causes that society to get enough richer to buy the things that are produced.
This works even in an economy as screwed up as Cuba’s. The Cuban authorities allowed limited free-market sales of food, and this increased food production. Despite the extreme poverty of Cubans, that food did not sit around unsold.
9. Everybody Gets Paid.
People want to get something for what they do, although what they want to get may not be money—it may be sex or salvation or an opportunity to apply marxist theory to rock and roll. Everything is a business.
This is the “public choice” theory of economics. One of its founders, James M. Buchanan, won the 1986 Nobel Prize in economics for his work on understanding politics as an economic activity. Politicians don’t measure profits in cash. The gain that they want is an increase in power. Thus the socialists of Sweden and Cuba are just as greedy as the pirates of Wall Street and Albania.
In order to increase their “power income,” politicians have to pass more legislation, expand bureaucracies, and broaden the scope of government power. This power income is what the Swedish cabinet minister Marita Ulvskog was really talking about when she told me, “You have to give something to voters.” Of course, that something can be, if you like, measured in money—your money, the money that government costs you in taxes, deficits, or currency inflation. Anyway, a politician who claims he’s going to cut the size of government is saying he’s going to creep up on himself and steal his own wallet.
10. Everybody’s an Expert.
Of all the principles of economics, the one that’s most important to making us richer (or more powerful or whatever) is specialization, or “division of labor.” Milton Friedman uses a pencil as an example. A pencil is a simple object, but there’s not a single person in the world who can make one. That person would need to be a miner to get the graphite, a chemical engineer to turn graphite into pencil lead, a lumberjack to cut the cedar trees, and a carpenter to shape the pencil casing. He’d need to know how to make yellow paint, how to spray it on, and how to make a paint sprayer. He’d have to go back to the mines to get the ore to make the metal for the thingy that holds the eraser, then build a smelter, a rolling plant, and a machine-tool factory to produce equipment to crimp the thingy in place. And he’d have to grow a rubber tree in his backyard. All this would take a lot of money. Yet a pencil sells for nine cents.
The implications of division of labor are surprising, but only if we don’t think about them. If we do think about them, they are, like most economic principles, a matter of common sense. There are, however, a few things about economics that don’t seem to make sense at all. Todd G. Buchholz, in his book New Ideas from Dead Economists, says, “An insolent natural scientist once asked a famous economist to name one economic rule that isn’t either obvious or unimportant.” The reply was “Ricardo’s Law of Comparative Advantage.”
The English economist David Ricardo (1772–1823) postulated this: If you can do X better than you can do Z, and there’s a second person who can do Z better than he can do X, but can also do both X and Z better than you can, then an economy should not encourage that second person to do both things. You and he (and society as a whole) will profit more if you each do what you do best.
Let us decide, for the sake of an example, that one legal thriller is equal to one pop song as a Benefit to Society. (One thriller or one song = 1 unit of BS.) John Grisham is a better writer than Courtney Love. John Grisham is also (assuming he plays the comb and wax paper or something) a better musician than Courtney Love. Say John Grisham is 100 times the writer Courtney Love is, and say he’s 10 times the musician. Then say that John Grisham can either write 100 legal thrillers in a year (I’ll bet he can) or compose 50 songs. This would mean that Courtney Love could write either 1 thriller or compose 5 songs in the same period.
If John Grisham spends 50 percent of his time scribbling predictable plots and 50 percent of his time blowing into a kazoo, the result will be 50 thrillers and 25 songs for a total of 75 BS units. If Courtney Love spends 50 percent of her time annoying a word processor and 50 percent of her time making noise in a recording studio, the result will be 1 half-completed thriller and 2.5 songs for a total of 3 BS. The grand total Benefit to Society will be 78 units.
If John Grisham spends 100 percent of his time inventing dumb adventures for two-dimensional characters and Courtney Love spends 100 percent of her time calling cats, the result will be 100 thrillers and 5 songs for a total Benefit to Society of 105 BS.
(Just to make things more confusing, note that Courtney Love loses 40 percent of her productivity by splitting her time between art and music, while John Grisham loses only 25 percent of his productivity. She has the “comparative advantage” in making music because her opportunity costs will be higher if she doesn’t stick to what she does best.)
David Ricardo applied the Law of Comparative Advantage to questions of foreign trade. The Japanese make better CD players than we do, and they may be able to make better pop music, but we both profit by buying our CDs from Sony and letting Courtney Love tour Japan. And if she stays there, America has a definite advantage.
Comparative advantage is a rare example of the counterintuitive in economics. It’s also unusual because it requires a little arithmetic to understand. We think of economics as strangled in math because of the formulas and graphs filling most economics textbooks. But you can (and I did) search the entire founding volume of economics, Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations, without encountering a mathematical formula. In New Ideas, Buchholz quotes Alfred Marshall, the preeminent economist of the late nineteenth century (and a mathematician):
(1) Use mathematics as a shorthand language, rather than as an engine of inquiry. (2) Keep to them until you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics.
We don’t n
eed to know math to understand economics, because economics isn’t about abstract principles, it’s about microwave ovens, cow howitzers, steam engines, wet knitting, snowboards, mousetraps, and Courtney Love on permanent tour in Japan. And this brings us to one more economic exception to common sense and a thing that requires all sorts of mathematics from us every day: money.
Why is this soiled, crumpled, overdecorated piece of paper bearing a picture of a rather disreputable president worth fifty dollars, while this clean, soft, white, and cleverly folded piece of paper is worth so little that I just wiped my nose on it? And what exactly is a “dollar”? If it’s a thing that I want, why do I prefer to have fifty grimy old dollars instead of one nice new one? This isn’t true of other things—puppies, for instance.
But money is not a puppy; it’s not a specific thing. Money is a symbol of things in general, a symbol of how much you want things, and a symbol of how many things you’re going to get. Money is a mathematical shorthand for value (and per Alfred Marshall, we seem to burn the stuff).
But what is value? The brief answer is “complicated.” Value varies according to time, place, circumstance, and whether the puppy ruined the rug. Plus, there are some things upon which it is difficult to place a value. This is why we don’t use money to measure all of our exchanges. Kids get food, clothing, and shelter from parents, and in return, parents get…kids. Important emotional, philosophical, and legal distinctions are made between sex and paying for sex, even if the socially approved sex costs dinner and a movie.
We need economic goods all the time, but we don’t always need money for them, and it’s a good thing, since for most of human existence, there wasn’t any. Money didn’t exist, or, rather, everything that existed was money. If I sold you a cow for six goats, you were charging it on your Goat Card.
Anything that’s used to measure value, if it has value itself, is “commodity money.” Societies that didn’t have fifty-dollar bills picked one or two commodities as proto-simoleons. The Aztecs used cocoa beans for money, North Africans used salt (hence “salary”), medieval Norwegians used butter and dried cod, and their ATM machines were a mess.
Some commodities are better as money than others. Movie stars would make bad money. Carrying a couple around would be a bother, and you’d have to hack a leg off to make change. Precious metals, however, make good money and have been used that way for more than 5,000 years.
Metal commodity money is portioned out by weight. A coin is just a hunk of metal stamped to indicate its heft. From weighing money to making coins is a simple step, but a couple thousand years passed before the step was taken. Nobody trusted anybody else to do the stamping.
When coins were invented, the distrust proved to be well-founded. The first Western coins were minted by the kingdom of Lydia, in what is now Turkey, and were made of a gold-silver alloy called electrum. It’s hard for anyone but a chemist (and there weren’t any) to tell how much gold is in a piece of electrum versus how much silver. The king of Lydia, Croesus, became proverbial for his wealth.
In China, the weight of bronze “cash” was supposed to be guaranteed by death penalties. A lot of people must have gone to the chair. A horse cost 4,500 “1-cash” coins during the Han dynasty (206 B.C. to A.D. 220) and 25,000 cash during the Tang dynasty (618-A.D. 907).
Kings, emperors, and, indeed, Swedish cabinet ministers have expenses. It is to a government’s advantage to pay for those expenses with funny money. One reason that money violates common sense is that governments do tricky things with it.
Another reason that money violates common sense is that we don’t have to use real commodities as money. We can use pieces of paper promising to deliver those real commodities. This is “fiduciary money,” from the Latin word fiducia, trust.
In Europe, paper money developed privately in the thirteenth century from bills of exchange traded among Italian merchants and from receipts given by goldsmiths to whom hard money had been entrusted for safekeeping. We still use such private money when we cash a traveler’s check.
Public fiduciary money was first printed, predictably enough, in Sweden. Swedish commodity money came in the form of copper plates. Thus, in Sweden, a large fortune was a large fortune. In 1656 the Stockholm Banco began issuing more convenient paper notes. The bank issued too many notes, and the Swedish government went broke—for the same reason that the Swedish government is broke today.
In 1716, Scotsman John Law helped the French government establish the Banque Royale, issuing notes backed by the value of France’s land holdings west of the Mississippi. Banque Royale issued too many notes, and the French government went broke—for the same reason the French government is broke today. (Meanwhile, with the fates looking toward bank scandals of the distant future, John Law was created “duc d’Arkansas.”)
But the most extensive Western experiment with paper money took place right here. In 1775 the Second Continental Congress not only created paper money but passed a law against refusing to accept it. The Continental Congress issued too many notes and…a pattern begins to emerge.
All fiduciary money is backed by a commodity, even if the backers are lying about the amount of that commodity. Historically the commodity most often chosen has been gold. By the nineteenth century, the major currencies of the world were based on gold, led by the most major currency: the British pound. This was a period of monetary stability and, not coincidentally, economic growth. There are people who think we should go back on the gold standard, and not all of them have skinny sideburns, large belt buckles, and live on armed compounds in Idaho. Money ought to be worth something, and gold seems as good as whatever.
But there’s that endlessly perplexing relationship between money and value. The high value of gold is a social convention, a habit left over from the days when all bright, unblemished things (people included) were rare. Gold may go out of fashion. A generation may come along that, to the surprise of its parents, regards gold as gross or immoral, the way current twenty-year-olds regard milk-fed veal. And gold is a product. Different ways to get huge new amounts of it may be discovered. This happened to the Spanish. When they conquered the New World, they obtained tons of gold, melted it down, and sent it to the mint. It never occurred to them that they were just creating more money, not more things to spend it on. Between 1500 and 1600, prices in Spain went up 400 percent.
Presented with the enormous wealth of America’s oceans, fields, and forests, Spain took the gold. It was as if someone robbed a bank and stole nothing but deposit slips.
Gold is an irrational basis for currency, but the real problem with fiduciary money—from a government standpoint—is that it’s inconvenient. A currency that can be converted into a commodity limits the amount of currency that can be printed. A government has to have at least some of the commodity or the world makes a laughingstock out of its banknotes—“Not worth a Continental.”
So if a government can lie about the amount of a commodity that is backing its currency—as the Stockholm Banco, Banque Royale, and Continental Congress did—why can’t a government lie about everything? Instead of passing a law saying one dollar equals X amount of gold, why not pass a law saying one dollar equals one dollar? This is “fiat money” (from the Latin for being forced to drive a cheap, unreliable car), and it’s almost the only kind of national currency left in the world.
Fiat money is backed by nothing but faith that a government won’t keep printing money until we’re using it in place of something more important, such as Kleenex. Concerning this faith, the experiences of Wiemar Germany, Carter America, and Yeltsin Russia make agnostics of us all. The only thing that protects us from completely worthless money is our ability to buy and sell. We can move our stock of wealth from the imaginary value of dollars to the fictitious value of yen to the mythical value of stock shares to the illusory value of real estate, and so forth. Our freedom to not use a particular kind of money keeps the issuers of that money—honest wouldn’t be the word—moderate in their dishone
sty.
I subjected myself to a large dose of economic theory because I’d finally realized that money was as important as love or death. I thought I would learn all about money. But money turns out to be strange, insubstantial, and practically impossible to define. Then I began to understand that economic theory was really about value. But value is something that’s personal and relative, and changes all the time. Money can’t be valued. And value can’t be priced. I should never have worried that I didn’t know what I was talking about. Economics is an entire scientific discipline of not knowing what you’re talking about.
Trying to observe economic practice showed me that I needed to learn some economic principles, and trying to examine economic principles showed me that I’d better look at the practice again.
If I was going to continue trying to understand economics, I had to go back to reality—a remarkable example of which is Russia. In contemporary Russia, there are all kinds of economics, good and bad, capitalist and socialist. The economic activity is being conducted under conditions of anarchistic freedom and totalitarian restraint. The people who make the laws have too much power, and yet no power seems able to stem the lawlessness. Russia, as a case study, is wonderful. Unless, of course, you’re a Russian.