Lots of things churning around in my head today. Mike Sankowski at Monetary Realism had a great post a couple days ago discussing two different functions of money, its use as a medium of account (MOA) and its use as the medium of exchange (MOE). Art Shipman at his blog was also exploring this topic. I think this is a very important subject that gets to the heart of much of the disagreement/confusion amongst the various economic schools of thought.
I think of MOA as "dollar sign" and MOE as "dollar". Obviously they are related but they are not equivalent. One is describing the price of something, the other is a proxy for a credit which can be redeemed for something. The price of something simply tells you how many of the credits you need to obtain it. Most everything in our economy today can get a dollar sign attached to it, or assigned to it. We refer to that as its value or worth. Its not the only measure of value nor is the claim that it is the best measure of value but it IS the value, within this system, we can agree to use to somehow promote exchange of goods within this system. Additionally it allows us to come up with measurements of activity, like GDP, so we can have some sense of what is going on in between us. It is NOT a qualitative measure but simply a quantification based on an agreed quantifier. One complicating element is that "the dollar" our MOE also has a price component to it, due to the trading within currency markets. So our MOE has a MOA component to it. Things with dollars signs can generate dollars for the holders of these things, even if they are not directly sold.
It appears to me that what has resulted within our economy is actually the presence of two economies, separate but intertwined. Banks, financial institutions and the very rich deal with assets that trade as money like and only use the MOA aspect of our money. They are priced in dollars, placed on the asset side of balance sheets or sit in trading accounts and act as wealth, generating income (MOE) for their holders. The rest of us simply receive MOE each week or month and use this to purchase goods, services or some of those fancy MOA things from the other economy. The MOA side of the economy competes for our MOE. The solvency of financial institutions plus the level of borrowing an individual can take on are greatly influenced by the MOA. As a borrower holds more MOA they can borrow more MOE. Additionally as a bank holds a greater amount of MOA they can suffer more and more people failing to pay their MOE (loan losses) before being insolvent.
One problem with the MOA side of the economy is that it suffers from a fallacy of composition. Those values they use on the asset side of their balance sheets cannot possibly be true for all those assets at once. Their value is dependent upon only a certain percentage of them being liquidated at any one time. Allowing all these things to hold a value they cannot possibly hold at once seems a very serious problem. All layers of transactions based on those values will simply add more and more instability to all the balance sheets carrying that asset or its derivative. The more layers you add, the more balance sheets that become dependent on that asset value, the more affect a small price disruption will have.
The MOA side of the economy is capable of growing to levels which can never be supported by the MOE side, since prices can simply reflect desire and not ability. Additionally they can shrink well below levels which support adequate MOE generation for their holders when panics ensue. An economy relying too heavily on the MOA side will be fragile.
We have an economy now that is too oriented around our MOA.