Guest Post: The Tangled Relationship Between Wealth & Money

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Submitted by John Michael Greer of Peak Prosperity,

One of the most dangerous mistakes possible to make in trying to understand the shape of the economic future is to think of the fundamental concepts of economics as simple and uncontroversial.  They aren’t. 

In economics, as in all other fields, the fundamentals are where disguised ideologies and unexamined presuppositions are most likely to hide out, precisely because nobody questions them.

In this and future essays here at Peak Prosperity, I will explore a number of things that seem, at first glance, very obvious and basic.  I hope you’ll bear with me, as there are lessons of crucial and deeply practical importance to anyone facing the challenging years ahead.

This is, above all, true of the first thing I want to talk about: the tangled relationship between wealth and money.

Our co-host here, Chris Martenson, likes to remind us all that money is not wealth, but a claim on wealth.  He’s quite right, and it’s important to understand why.

Money is a system of abstract tokens that complex societies use to manage the distribution of goods and services, and that’s all it is.  Money can consist of lumps of precious metal, pieces of paper decorated with the faces of dead politicians, digits in computer memory, or any number of other things, up to and including the sheer make-believe that underlies derivatives and the like. Important differences separate these various forms of money, depending on the ease or lack of same with which they can be manufactured, but everything that counts as money has one thing in common – it has only one of the two kinds of economic value.

The Two Kinds of Value

Economists call those use value and exchange value.

You already know about them, even if you don’t know the names.  Odds are, in fact, that you learned about them back in elementary school the first time that one of your classmates offered to trade you something for the cookies in your lunchbox.  You then had to choose between trading the cookies for whatever your classmate offered and eating them yourself.  The first of those choices treated the cookies primarily as a bearer of exchange value; the second treated them primarily as a bearer of use value.

All forms of real wealth – that is, all nonfinancial goods and services – have use value as well as exchange value.  They can be exchanged for other goods and services, financial or otherwise, but they also provide some direct benefit to the person who is able to obtain them.  All forms of money, by contrast, have exchange value but no use value. You can’t do a thing with them except trade them for something that has use value (or for some other kind of money that can be traded for things with use value).

Most people realize this.  Or, more precisely, most people think that they realize this.

It’s still embarrassingly common for people to forget that money isn’t true wealth, and to assume that as long as they have some sufficiently large quantity of some kind of money that’s likely to hold its exchange value over time, they’ll never want for wealth.  This assumption is understandably made, because in the relatively recent past, this has been true a good deal more often than not, which feeds the belief that it will always be true in the future. 

But that assumption is lethally flawed, and it’s important to understand why.

The Economic Relationship between Money and Wealth

For the last three hundred years, as industrial society emerged from older socioeconomic forms and became adept at finding ways to use the immense economic windfall provided by fossil fuel energy, there have been two principal brakes on economic growth.

The first has been the rate at which new technologies have been developed to produce goods and services using energy derived from fossil fuels. The Industrial Revolution didn’t get started in the first place until inventors and entrepreneurs found ways to put the first generation of steam engines to work making goods and providing services.  At every step along the road from that tentative beginning to today’s extravagantly fueled high-tech societies, the rate of economic growth has been largely a function of the rate at which new inventions have appeared and linked up with the business models that were needed to integrate them into the productive economy.  That’s the source of the innovation-centered strategy that leads most industrial societies to fund basic and applied research as lavishly as they can afford.

The second major brake on economic growth is the relationship between the economy of goods and services, on the one hand, and the economy of money on the other.  Just as wealth and money are not the same, as we’ve seen, the economic processes that center on them are not the same.  The printing and circulation of money is not the same thing as the production and distribution of nonfinancial goods and services, and ignoring the difference between them confuses much more than it reveals.  In my book The Wealth of Nature, I called the economy of goods and services the 'secondary economy,' and the economy of money the 'tertiary economy,' with nature itself – the ultimate source of all wealth – as the 'primary economy.'  For the purposes of this essay and those to come, though, we’ll use simpler labels and call them the 'wealth economy' and the 'money economy'.

During this three-hundred-year timespan, when the money economy stayed in sync with the wealth economy, economic growth normally followed.  When the two economies got out of sync, on the other hand, growth normally faltered or went into reverse. There were (and are) two ways that the money supply can slip out of its proper relationship with the wealth economy. 

The first occurs when growth in the money supply outstrips growth in the production of real wealth, so that the more money is available to compete for any given good or service, and prices normally go up.  That’s inflation.

The second occurs when growth in the money supply fails to keep up with growth in the production of real wealth, so that less money is available to purchase any given good or service, and prices normally go down.  That’s deflation. 

Fighting to Keep the Economies in Sync

In either case, the imbalance hinders the ability of the wealth economy to keep producing goods and services, mostly by throwing a monkey wrench into the machinery of investment — the process by which the money economy allots extra wealth to the producers of wealth to assist them in expanding their ability to create real, nonfinancial goods and services. Whether it’s inflation or deflation that chucks the wrench into the gears, the result is flagging or negative growth.

It’s the hope of keeping inflation and deflation in check that motivates the obsessive tinkering with economics on the part of so many of the world’s governments these days. However poorly that tinkering works out in practice (and it usually works out very poorly, indeed) the politicians can at least claim to citizens that they’re doing something to get economic growth back on track.

Most economists, and for that matter most people who consider economic issues, think and act as though these two factors — the rate of innovation and the money economy’s habit of getting out of sync with the underlying economy of real wealth — are still the only factors that can get in the way of growth. That’s why proposals for putting an end to the current economic mess focus so narrowly on more innovation, on the one hand, and finding some way to gimmick the money economy so that it no longer drags on the wealth economy, on the other. 

Now, of course, scarcely any two people agree on what measures will get the two economies in sync again. Similarly there’s no general agreement over where government support for innovation ought to go. But there’s near-universal agreement that getting these two factors to work right is the way out of the ongoing global economic crisis.

The Tangled Web We've Woven

The disagreements between partisans of various economic schemes, and between proponents of various new technologies, make it easy to miss the fact that something is happening that’s clean outside the box of contemporary economic thought.

The wealth economy and the money economy are certainly out of sync just now, but the problem isn’t in the money economy; it’s in the wealth economy.

The production of real goods and services has run up against limits that are not financial in nature, and today’s economic orthodoxies can’t even imagine that possibility, much less respond to it in any useful fashion.

In Part II: Slamming Face-First into the Limits to Growth we explain why, given our misguided efforts to solve the wrong problems, you can no longer assume that having enough money – of any kind – will guarantee that you will have enough wealth.  Distortions in the money supply driven by the shenanigans of central bankers are not the only force twisting the relationship between money and growth.  The key factor now is a contraction in the wealth economy driven by the economic effects of the exhaustion of easily accessible resources. 

There simply is too much money chasing a limited (and, in some cases, shrinking) supply of real wealth. 

Click here to read Part II of this report (free executive summary; enrollment required for full access).