Monetary Illusion

We always wish for money
We always wish for fame
We think we have the answers
Some things ain't ever gonna change
--John Waite

Prior to the advent of money, people traded a portion of their production (i.e., income) to further their standards of living. Someone who chopped wood for living, for instance, might trade some wood for bread produced by the baker. The exchange rate (i.e., price) might have been 20 loaves of bread per half cord of wood.

Money simplified these transactions. Instead of tracking hundreds of product-for-product exchange rates, people could track product-for-dollar (or any paper currency) exchange rates. The price of that half cord of wood and 20 loaves of bread may have been $40. Fungibility was also improved, as it became easier to price potential trades that had previously been difficult to estimate.

Over the years, one drawback of pricing goods in dollars has been that people forget that the key to general standard of living is not the quantity of money in circulation. Instead, wealth is grounded in production--production of goods deemed valuable to consumers. The greater the production of goods deemed valuable to consumers in advancing their interests, the greater the general standard of living.

Measuring the value of production in terms of money obscures this reality. Economic activity or wealth gauged in dollar terms can be misleading because it is possible to change the amount of dollars in circulation. If/when the number of dollars is changed, then it is likely that some degree of mispricing will follow--until people can accurately determine how many dollars are representing production. This determination may require significant time and may be difficult if the quantity of dollars is frequently changing.

Moreover, those who happen to get control of newly printed money have an advantage since early users can purchase more goods per dollar before people are able to accurately adjust prices to account for the increased money supply. This phenomenon might be labelled first user advantage.

In a situation like the present one where the quantity of dollars is steadily rising, it is likely that many people think that they are better off than they really are. They are assessing economic position in terms of proliferating paper dollars rather than in tangible resources. Plus, some of their economic position is being lost to the first users of those dollars who take possession of scarce resources at low prices.

People would do well to remember that general standard of living ultimately depends on production of resources deemed valuable to consumers, not on monetary manipulation.