ECON103: Unit 6 Essay - Money is a social construct

These phrases are simply wrong when thought about from first principles because money and its properties are ultimately rooted in the physical world. The idea that they are completely social constructs or are shared hallucinations is based on a foundation that believes they can exist independently, unaffected by the laws of the physical world. That their entire use is simply a function of the human mind.

While it is true that there is an element of it being a social construction given that anything can technically be treated as money as long as individuals agree to do so, economic reality will set in with its consequences quickly, making this argument that money is a social construct fall apart. The main physical properties that determine the fitness of a money are durability, portability, recognizability/verifiability, scarcity, fungibility and divisibility. The best monies perform well in these attributes. To pick a money that fails to perform one of these functions well will cause issues between individuals and the larger free market economy because trade will not be executed properly or efficiently.

For example if we all “socially hallucinate” that leaves are money, the market will quickly realize they are not durable, and are not scarce. So if you attempt to “save” your leaves, it is easy for them to get destroyed or decay over time because they are not durable, and so people will not want to use them to save long-term wealth if the risk of losing them is high. Leaves are also not scarce, they can be found easily anywhere. As soon as people figure this out, everyone will try to collect as many leaves as they possibly can, attempting to increase their purchasing power greatly relative to the market. However because it is so easy for anyone to get more leaves, the total supply of leaves in the market will increase drastically, and cause inflation in the price of real goods and services. People would eventually end up with massive piles of leaves that have little purchasing power. Sellers would continually hyperinflate their prices, and it would become nigh impossible to reliably measure and set prices that will be stable over a longer period of time, causing a breakdown in the trading/pricing mechanism between buyers and sellers. The eventual long-term outcome of everyone “hallucinating” leaves to be money would be the breakdown of the larger market economy, the inability for individuals to reliably trade with each other, and the realization that it is not a good long-term store of value. People would be woken up by the physical constraints of leaves to be used as money and the hallucination would stop. People would rationally decide that leaves are no longer a good form of money, and they would stop using it as money.

The world has gone through many different forms of money throughout history such as glass beads, seashells, precious metals, etc. However over time civilizations converge more and more towards one type of money, as having fewer (ideally one) currencies allows for a larger and more sophisticated market. It allows more specialization of labour, more trading opportunities with more buyers and sellers, and lower time preference behaviour. Money can be thought of as a language. It is difficult for several market participants to trade and organize with each other if they all use a different form of money. It becomes difficult to agree upon a common exchange rate of purchasing power. If one money is also less divisible than another, it becomes inefficient if not impossible to trade at all. If we used cars as money, It would be difficult to divide up a car. I’d have to purchase something with the whole car or none of it, and a good that’s valued somewhere in between 0 - 1 car will be impossible to trade for fairly.

It is not a consequence of social constructs or shared hallucinations that civilizations eventually started to converge upon precious metals, specifically gold as the main currency and store of value. It is because of the physical properties of gold rooted in the real world that people chose to use gold as money. It was the best mix of all the previously mentioned properties of money.

Gold is durable. It doesn’t decay or get destroyed easily. So people can rely on it to store their long-term wealth.

Gold is portable (somewhat). Vast amounts of purchasing power can be carried from one place to another, although it is heavy so paper claims backed by gold came into existence.

Gold is recognizable. Whether visually, auditorily or chemically, it wasn’t too difficult to figure out if the gold you are trading is actually gold and can be trusted to be gold.

Gold is scarce. It is difficult to mine. It is difficult to copy or create, so it cannot be inflated easily. A lot of time and energy needs to be expended to yield gold, which inherently gives it value

Gold is fungible. Most people are willing to accept or trade an ounce of gold with any other ounce of gold.

Gold is divisible (somewhat). Can be melted down and divided up into exact proportions. However still difficult, so paper claims arose to fix this issue.

For 5000 years we used gold as money, and any deficiencies or inconveniences we solved by creating paper claims that were built on top of gold. This is not something a government or a group of people said we should collectively hallucinate about. It rose naturally through reason and rationality between individuals and civilizations because it was universally understood that gold held the best physical attributes to satisfy the needs of a good money.

Great answer! I really like the reference to first principles in your opening paragraph. A lovely way to start an essay. :pray: