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The Physics of Economy and Money

July 5, 2015

The economy has become a very complex system in its own right  and money in its turn has become enmeshed in complexity but the way to develop an understanding of each of them does not have to start off with-in the current complexity. In fact we will be much better off by first getting an understanding of the basics, or physics, of both of them because the complexity is, after all, built on the basics.

Money is a by-product of a functioning economy, no economy no money. Thus we need to first understand the physics of an economy before we can develop an understanding of the physics of money.

Historically the money we use in the economy has been either a fiat currency or a commodity based currency. The general category of fiat currencies connects directly with the physics of money consequently we will only be dealing with fiat currencies here. The commodity based currencies do not relate so directly with the physics of money so they will not be dealt with here.

An economy consists of voluntary exchanges of ownership. These voluntary exchanges are in fact the only economic activities in an economy. They fall into three distinct groupings:

G1: Completed, voluntary exchanges of ownership of goods and/or services
G2: In process, voluntary exchanges of ownership of goods and/or services
G3: Potential, voluntary exchanges of ownership of goods and/or services.

Money can be either be an honest representation of the value of a good or service or a dishonest one. Honest money is a by-product of G1 activities only. G2 and G3 activities cannot result in honest money.

There are inherent difficulties in carrying out voluntary exchanges in ownership however and money was invented in order to overcome them. Once money had been invented its use became to all intents and purposes essential. Why is this? Because the use of money enabled the economic integrity of an exchange of ownership to be maintained whilst removing the constraint of, one exchange partner only, on the number of exchange partners involved. The  removal of this constraint allowed for an expansion in possible exchange partners thus opening the way to greatly increased economic activity. Through the use of money an exchange became, in a sense, a set of exchanges between one person and a community of persons.

How  exactly does money enable this?

To answer this question it is first necessary to unpack the various components of what I term an economic event which is nothing but a completed voluntary exchange of ownership. But we need to unpack a simple economic event first, which is an event that happens without the involvement of money.

A simple economic event

A simple economic event comprises both physical and a mental elements as follows:

Physically

– two parties, A & B, and
– two different items to be exchanged, IA & IB, and
– two exchange processes, A physically gives ownership of IA to B and, B physically gives ownership IB to A

Mentally

– in A’s head values, AVia and AVib, for IA and IB respectively
– in B’s head values, BVia and BVib, for IA and IB respectively

For a simple voluntary exchange to be completed it is clear that for A, AVia must = AVib, , and  for B, BVia must = BVib, otherwise the exchange of ownership would not happen and whether AVia = BVib, or not,  is irrelevant.
As stated above the problem with such simple economic events is that they are not simple to arrange. Why? Because A must be willing to exchange what they have with what B has available to exchange. In other words their respective needs and wants must match exactly with what is available for exchange. Now within any large collection of people there might be two people whose needs exactly match but locating them is difficult.This difficulty puts a natural damper on economic activity.

This problem would be lessened however if the supply and receipt roles of B in the simple exchange could be separated from one and other.  This would enable them to be taken up by two different parties C & D thus opening up many different exchange possibilities. From an economic perspective all that is necessary for this separation to be acceptable is that it should not damage the economic integrity of the simple economic event. In other words the value of what C supplies to A should be exactly the same as what A supplies to D. If that could be ensured then the economic integrity of this, now more complex economic event, would remain unchanged from that of the simple economic event.

A complex economic event

How is a complex economic event created from a simple economic event?

Quite simply by making an independent recording, IR, of the value of IC which both A and C are prepared to accept as being the truth. A could then take ownership of IC by exchanging it with C for IR.

Now as such a recording is standing-in for the economic value of an exchanged item it has to have the face value of that item as well as be owned by the person who claims to own the item. The IR recordings can be produced anywhere but they will only have economic relevance once the appropriate person takes ownership of them.

The socially accepted form of such recordings is known as money. So, in money terms, A gives money M, of face value IR, to C in exchange for item IC.

This is all very well but where does A get M from in the first place?

A gets ownership of M in either one of two ways.

1. A could have received M in exchange for a good or service that A supplied into the economy. M is thus honest money in that it represents the value of a real good or service supplied by A. In this case when M is handed to C in exchange for IC M is equivalent to that good or service and the payment would create an economic event.

2. On the other hand M could have been newly issued into A’s ownership as debt. In this case M would only have  its face value as it does not yet represent the value of a real good or service supplied by A. To complete the creation of the economic event A  needs at some point, to supply into the economy a good or service to the value of M, so that M can honestly become a stand-in for a good or service. In other words A’s use of newly issued M would automatically oblige A to supply, at some point, goods or services to the value of M into the economy. The money received from the sale would automatically discharge A’s newly issued M debt. Unless this happens A’s use of newly issued M is dishonest.

The logical implications of point 2 above

1. If money is involved, and point 2 above is adhered to, we can use the term ‘economic event’ not only for simple exchanges of ownership but also for complex exchanges of ownership because, taken together, the exchanges yield the same result in economic terms as a single, completed, simple voluntary exchange of ownership.

2. Any economically active person need never be short of enough money to make a purchase because any short-fall could be covered by issuing them with new money as non-interest paying debt  which debt would be settled as soon as they sold something into the economy of equivalent value.

3. Realising this change to the money system is, because of modern ICT, quite feasible. It would however require major political will to drive it. An outline of what is required is given in zzzzzzzzzz

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