Wednesday, March 26, 2008

My Socialist Experiment

When I was growing up, this idea that 'our country was poor' puzzled me. How can we be poor I thought, the government print the money don't they? So how can they have all the money and still be poor? After days of thinking over this, I came to the conclusion that perhaps printing money costs, about the same amount of money that's being printed. That is for example, it costs the value of Rs.10 to print a Ten Rupee note. I remember asking my dad if this was the case, he said no, money is just paper he told me. I Can't remember if I followed up on the question, but I'm pretty sure he did not satisfactorily answer my questions.

This is about the time I invented my own version of socialism (I was really very young, honestly.) Deanist-Socialism was simple. Under my plan, every citizen in the country will receive a fixed amount of money at the end of every month courtesy the government. That way, there's no real need to work and we can live happily ever after.

I can't quite remember what I did with my theory, but finding answers to why oh why governments didn't just print money and distribute lead me to many realizations. First among them - not many people understand 'money'. For a long time, I didn't either.

So in my quest to understand this thing called money better, I began reading by coincidence (now this is much much later) the likes of Friedman, Rothbard, Mises and (eventually) the likes of Mankiw, Cowen and other contemporary practitioners. Having gone through all of this, I feel like I have the basics covered. But seeing media reports, listening to local politicians and even what some of our Central Bankers say, it seems many doesn't even have these basics covered.

So in the near future, (possibly tomorrow, I'm sleepy now) this blog will have Inflation for Dummies by dummies post to dispel some of the myths that's being perpetuated when talking about Cost of Living and particularly inflation in Sri Lanka.

But first, a few more of those realizations..

#2) Wealth is not Money. If it were, my little socialist experiment would have worked, to make it's people more wealthy, all a government has to do was print money and distribute them. Wealth, put it bluntly, is stuff or things we value (some of which could be money) and can be defined as the productive capacity of the economy.

But why doesn't governments do this? why don't they just print the money and distribute? The answer, is to do with the value of money.

#3) Paper-money has no intrinsic value. It's just paper. Turns out dad was right, the kind of money we use is just paper (fiat money). The only reason why you would accept it in exchange for payment for something is because we have the confidence that in the future, some other person would take it to exchange with something we value. If anyone doesn't think they can exchange this paper for something valuable in the future, they would not accept it.

For example, right now, I have with me a 20 Rupee Indian-Note in my purse, signed by a few friends and given to me as a souvenir. In India, this would have bought be breakfast. But here, in Sri Lanka, this would buy me nothing. The Indian rupee has (almost) no value here. (unless at a money-exchanger) The value of money, like any thing else is determined by the forces of it's supply and demand.

Realizing these two things, and the notion of value of money is perhaps the key to understanding inflation.

No comments: