Saturday, April 10, 2021

Model Justification for "Trade Between Ontologies Needs Hard Money"

The essay "Hard Money, Soft Money, and Economic Ontologies" described the differences between hard physical money and soft ethereal money in a very general way. It then went on to build on the concept that trade between ontologies depends upon physical money. Here we will use a model to demonstrate why this might be correct and add some reservations related to valuation over time periods.

We will build the model by using what might (at first) be considered a two sector model. To dismiss the model as a simple two sector economic presentation would be to miss the essence of the concepts presented. This model is about two ways of economic thinking driven by two different circumstances positioned in the minds of decision makers in each of two ontologies. We use the word ontology in place of 'sectors' to emphasize that the two groupings have, for good reasons, different time-related concepts of 'money'.

The Model

Imagine a national economy with the majority population dependent upon manufacturing and regionally located some distance away from the food producing agricultural region. It doesn't take much imagination to draw borders around each region and then imagine transportation between regions. Each region forms an ontology. The assigned circumstance of two distinct economic bases will lead to two different ways of thinking about money. We will keep it simple by allowing both regions/ontologies to use the same currency under a single government.

We will inject a little real world reality into the model by including seasonality. The agricultural region only produces one supply per year and only needs one supply of each of several crop production inputs each year. (I am thinking of machinery, fuel, fertilizer, etc.) Seasonality drives the difference in economic thinking that divides the two ontologies.

We can imagine the chaos introduced if money changes value from year to year, especially if the value of money goes down. [Notice how the role of an owner/decision maker slips in here] Farmers, acting as owners, sell a crop once a year for a price that allows them to recover the cost of growing. Failure to recover the cost of production leaves farmers unable to buy supplies needed to produce the next crop. Seasonality is the dominate constraint of the Ag ontology. 

We will inject a little more real world reality into the model by refusing seasonality for the manufacturing ontology. This lack of seasonality allows the decision makers in the manufacturing ontology to be much less dependent upon the long term value of money. This ontology can quickly change prices and manufacturing schedules in response to monetary value changes. This ability to be economically quick allows the entire sector to act as if they were consumers rather than suppliers with a long building chain.

Inject Real World Changes into this Model

Let's take a look at three possible events and judge for ourselves how decision makers in each ontology might react:

The First Event

In the first event, one of several crops in the Ag ontology suffers a 50% below average yield, leaving the nation (and both ontologies) short of normal food supplies. Absent external supplies, the first thing that likely happens is the the suffering crop will experience product price increases that act to shift demand toward substitute products. The average price of food will probably rise due to the competition for remaining supplies of the constrained product. There is no reason the think that this event would change the supply of money, nor is there any reason to think that the price of manufactured products should increase. On the contrary, the price of manufactured products might fall due to food consumers wishing to spend more on food on the average rather than on manufactured products.

The decision makers here would be customers and farmers (farmers who presumably will seek higher average prices to do nothing more than regain the cost of production). It is hard to see which ontology might truly benefit from these conditions.

This this seems to be a hard money example. Real world people adjust to changing conditions by spending limited resources (money is a resource) as each owner individually decides.

The Second Event

In the second event, the manufacturing ontology decides to raise average prices on the supplies needed by agriculture. It does't matter why prices might rise, nor which decision makers have their way, only that prices rise across a spectrum of products needed for agricultural production.

The likely effect of this price rise would be to create an insufficiency in the income from last seasons crop which is needed to buy inputs for this years crop. The reader can imagine what this might do to farm budgets if the increase was in double digits for year after year. Farm decision makers would be forced into a search for financial solutions across a broad spectrum of inter-relationships, and then need to ultimately decide if holding this years crop for sale next year is more profitable than selling followed by growing a replacement crop.

Decision making farmers would look at this example as a soft money situation. The value of money has changed,  not the needed transfer of real labor hours and physical materials. They would see the situation as one wherein consumers are failing to replace the inputs just consumed. Therefore, the price signal sent is 'reduce production'.

[Some readers might think of this event as an example of 'inflation'. I'll not go into the general concept of a sustained increase in the average price level in this essay.]

The Third Event

For the third and final event, the national government decides to undertake a new project or program and plans to borrow from the central bank (thereby creating money) to make the first payment. [Subsequent payments might come (at least partly) from increased tax revenues generated by the addition of more money flowing within the economy but that is not part of this example.]

The creation of money and subsequent spending into the private sector in this example results in an obvious increase in the money supply owned by the private sector (as theorized by MMT). As a base case, this should bring about an increase in measured GDP and a small increase in the velocity of money (the ratio of GDP to money supply). [This increase in velocity would flow from the reality that in the steady state economy, part of the money supply is at rest at all times. (In other words, part of the money supply is not used at all during any particular measurement period.) The creation of  new money, when spent, would result in a money flow that would not occur otherwise, thereby temporarily adding to the steady state flow.] This velocity signal could easily be made invisible in the monetary data noise generated by a central bank managing interest rates and money supply.

It is easy to theorize how private sector decision makers in both ontologies would analyze this event. Government is planning to destabilize the economy by employing workers and consuming resources, as if a new consumer had come onto the scene. Government will pay for this by creating money. People will change their present work habits and there will be increased competition for available resources. Those closest to the new program will benefit first and probably more than those not so close.

By creating money out of thin air, money has taken on an ethereal aspect. Decision makers in both ontologies would view this as a soft money event but what should decision makers do? If suppliers of materials raise prices in anticipation of bigger demand, subsequent users/builders (downsteamers who use materials to build for resale) may cut back consumption--unless downstreamers also agree with the optimistic assessment. It should not be forgotten that this projected price rise would force downstreamers to invest more money (which they might not yet have) into the building process. It seems to this author that every decision maker will  need to analyze the situation carefully and anticipate the effects as they might particularly flow to him.

This soft money event acts to destabilize the economy.

We have not specified how government will spend this new money. Details matter here. It is easy to see that politics will decide who the initial winners will be. 

So, Does Trade Between Ontologies Need Hard Money (With Stable Value)?

The first event demonstrated the need for hard money in supply systems that function over longer time periods. Ownership was important here. Owners who build products incrementally over time prefer steady-value monetary conditions between time-distanced sale events. Owners who build products over shorter time spans are less concerned with a stable monetary value.

The second event was a clear example of a value of money change during a measurement period. It was disruptive to an ontology dependent upon recovering the entire cost of production in real physical terms during every cycle repetition. 

The third event was a clear example of money creation. How this money was to be used and who might benefit was not specified. Competition for available resources was increased and the stable economy destabilized.

One lesson learned from the third event was nearly the opposite of that learned from the first event; a lesson about money as a rationing tool. Since this essay is about the use of money between ontologies, we won't build upon this lesson.

The combined effects of these examples seems to reinforce the idea that an exchange event completes the supply side story for one owner and the beginning of a new physical money holding period for one owner. Money is seen to be a place holder for valuing past accomplishments and, at the same time, an enabler of future efforts by it's owner.

The answer to the question seems to be yes and no. 'Yes' because a trade using money leaves the accepting money owner to assume the future value risk of the physical object 'money'. 'No' because the prospective owner of money is freely able to accept money which carries an unstable valuation. It should be obvious that there can be no trade using money if neither potential trader owns money in the first place.


We should not be saying "Trade between ontologies needs hard money.", we  should say "Trade between ontologies is a trade of two physical products, one of which is money." Deciding if the money part of the trade is only pseudo-physical or will retain value over time is to delve into further questions.

But if money is physical, it's 'hard' isn't it?


In the common vernacular, when differentiating the ability of money to retain value over time, 'hard money' is preferred over 'soft money'. Hence, physical gold may be favored over fiat. 

Economist often argue whether fiat money represents debt or whether money represents an obligation. This is a choice between two kinds of ethereal representation because neither debt nor obligation represents a physically present object. However, even here, the ethereal can be made much more physically real by linking debt and obligation to a contract that can fail, thereby delivering a real loss to the owner.

In my opinion, to own money is to own a risk of change in exchangeable value. This would make it best to consider money as a physical asset; an asset to be avoided if the desire is to trade one valuable item for a second valuable item if the trading was not done so quickly that it could be considered as being a barter trade in fiat disguise.]

(c) Roger Sparks 2021

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