Money Is Not Wealth

Exploring a pervasive misconception

Of all the common misconceptions about money, this is the deepest and most pervasive. It taps into the very psychology that makes money the most powerful tool in the world. Money works in large part because, for most practical purposes, you can assume that money and wealth are the same thing and be very successful in life.

The problem is, it's a completely false premise. And without purging that assumption from your mental framework, understanding money and economics at a fundamental level is impossible.

Luckily, money is such an effective tool that it can continue to "mostly" function even without anyone understanding it at a fundamental level. It's a lot like gravity in that regard. You don't need to understand general relativity to learn how to walk. But unlike gravity, money is a powerful tool that can easily be used to exploit the less knowledgeable. That's why the general acceptance of this particular false idea is such a tragedy; it enables theft and exploitation on a global scale, and leaves the victims unable to identify the perpetrators or understand their methods.

Money as a Social Technology

So let's unpack this misconception. We can start with a simple example. You've been shipwrecked on a desert island with only the clothes on your back. After a day under the blistering sun, you're presented with two options: a billion dollars in cash, or a case of bottled water. Which one do you choose? If you chose the water, congratulations. You survived because you were able to differentiate money from real wealth.

Now run the same experiment, but place yourself in the water aisle at Costco. Suddenly you choose differently. This shows a few key requirements for money to be useful. One, you need the real wealth, the actual goods and services. If there is no bottled water on that island, all the money in the world won't do you a lick of good. Two, you need someone willing to exchange the real wealth for your money. If you're alone on that island and you find a bottle of water, you don't need money to drink it, you just help yourself. Both requirements are essential.

This shows us that money is a social technology. Understanding the purpose and function of this technology is critical to dispensing with misconceptions like "money=wealth".

Money and Civilization

What's the difference between a subsistence hunter/gatherer lifestyle and the modern civilization we all enjoy today? Specialization of labor, and complex supply chains. And what enables those civilizational necessities? Money.

In a subsistence situation, everything you have is created start-to-finish by you or by your immediate family or tribe. Everyone has to be a sort of jack-of-all-trades, at least at a group level. If you want a shelter, you collect the natural materials and build it yourself. If you need clothes, you collect the fibers or skins, process them, and use the fabric to sew your own outfit.

Contrast that with the electronic device you're using to read these words right now. How many people does it take to build a smartphone? Millions. Can one person do it? Absolutely not. You could give anyone in the world an entire lifetime and there's no way they could mine, process, and assemble the raw materials into a functional smartphone. It's simply too complex, too many processes and too much specialized knowledge and machinery needed. Not to mention doing it at a cost that most people on the planet can afford. That miracle is only possible because millions of people specialize in one tiny specific task related to making one part of a complex item, over and over again. The efficiency of only doing one specific task instead of being a generalist is what makes civilization possible.

But there's a problem. The person who's doing one specific task to make part of one widget still needs to eat, have a place to live, clothes to wear, etc. But how do you get all that while working a full time job making widgets? You can't do it all yourself, you need to buy those things from someone else who, similarly, specializes in those necessities of life. You need money. Money is what makes the whole thing work.

Money and Barter

So what exactly is money and how does it work? In a subsistence society, you can use barter to trade with strangers. You give them some fish, they give you some clothing, everyone is happy. But barter has major problems, and doesn't work at all in complex supply chains with specialized workers. Specialized jobs don't produce valuable finished goods that can be bartered. When you solder circuit boards all day, you can't go to your local farmer and trade ten "solder circuit board" for a dozen eggs.

Enter money. Money solves multiple problems that arise with barter. For one, it creates a way to compare extremely dissimilar things. How many fish is a pound of butter worth? How many eggs? With barter, every good or service has to be priced in relation to every other good or service it's exchanged for. This is impossibly cumbersome and inefficient. Having money as a unit of account is as essential to trade as having a uniform inch is to building a house. A single carpenter might be able to use the width of his hand to measure boards, but get two carpenters working together and that "handbreadth" no longer works.

Second, money solves the problem of not having the correct item to barter with. If your neighbor has butter and you have fish, but your neighbor hates fish and will only accept a chicken, barter won't work. But if you can just pay him with money, he can go buy whatever he prefers.

Third, money creates a way to value and reimburse specialized work. That's arguably the most important aspect.

The Social Contract Underlying Money

So what makes money function? Why would someone accept a piece of paper with a picture of a dead president in exchange for a very real and very valuable good or service? Well, the obvious answer is that they can be certain they'll be able to exchange that piece of paper with someone else and get an equally valuable good or service in the future. This is circular logic though, and leads some economists to mistakenly attribute the value of money to a "collective delusion". But since every known advanced civilization has used some form of money, calling it a delusion is both inaccurate and boorishly pretentious.

To understand the real mechanism behind the phenomenon, we have to consider how money is acquired. As anyone who has ever earned an honest wage knows, getting a paycheck requires two things. One, producing a valuable good or service. And two, giving that good or service to someone else instead of immediately consuming it yourself.

The first point is self-explanatory. If what you produce isn't valuable, no one will buy it.

The second point needs a bit more explanation. Money is a social technology, it's only valuable in a purely monetary sense when there's someone else to trade with. When you make yourself a few eggs for breakfast, you don't pay yourself for frying the eggs. Obviously. But if you eat your eggs, then go to your job as a short-order cook at the local diner, you may spend the morning getting paid to do exactly what you did "for free" at home. The difference is in the deferred consumption.

When you do a favor for someone, morality and the spirit of fairness dictates that they would be willing to return the favor in the future when you need something from them. That's how it works in a family or small community. People "owe each other one," and favors are reciprocated regularly without any money changing hands in a kind of informal credit system. But if one person starts to take advantage of others' generosity and requests a lot of favors, but always fails to reciprocate when asked, people catch on quickly. The parasitic behavior will be met with increasing unwillingness to help from members of the family or community, and in extreme cases, even exile from the community itself.

This informal credit system is the simplest and most fundamental form of money, and we can learn the basic principle behind why money works by observing it. We can see that a person accumulates "credits" by contributing productive value to others without getting anything in return. The "credits" are informal mental ledger credits that represent "this person has done something productive and valuable for someone else, which means he deserves to receive something valuable in the future." If a person contributes generously enough to the community, he will build up so much "credit" with everyone that he can expect generous help in return from any member of the community.

The shortcomings of this informal credit system are that one, it doesn't provide a unit of measurement to compare different goods and services accurately. This can lead to misunderstanding and disputes when different people don't value services the same way. Someone can feel that they are contributing more to the community than they're getting back in return. And two, it relies heavily on trust, and only works between people who interact on a regular basis. It would be foolish to provide favors to a stranger of unknown reputation, or someone who's just traveling through the area, because in either case there's no expectation of establishing a reciprocal relationship with that individual.

Money is just a way to formalize and expand that local, informal mental ledger. It's a way to keep track, on a societal level, who has contributed their fair share to the community and is deserving of reciprocal treatment. When someone buys something from you, although you don't consciously think through what's happening, on a subconscious level you're participating in a societal dialogue that goes something like this: "This person has money, which means they're a capable, generous, reciprocal person who has contributed more to the community than they've taken. Fairness dictates that they deserve something of value as a reward for their pro-social behavior. By taking their money, and giving them something of value, I can perpetuate the cycle of rewarding people who generously and capably do work that benefits others, and that will be beneficial to me personally and also to society as a whole. By having the money they give me, I can then also signal to others that I'm the same type of generous, reciprocal, productive person, and I can expect to be rewarded for that in the future when I try to exchange this money for valuable goods and services."

So the money has value, not because of some inherent quality of the paper or gold or mental "credit," but because it represents past productive behavior, but without immediate consumption. The money itself is not wealth, it's just an abstract representation, a kind of scorecard or ledger entry, of the real wealth that the holder of the money has already produced.

Money and Capital Formation

This dialogue or unwritten contract is the foundation of modern civilization. It's powerful, because deferred consumption is the mechanism of capital formation, and capital formation is the foundation of complex supply chains and technological progress.

You might be able to catch enough fish to feed your family with a crude rod and line. But building a modern fishing trawler (a valuable capital good) takes thousands of people working together for a long time. All that hard work doesn't result in any fish being caught throughout the process, and all those people could instead be out fishing and catching a lot of fish to eat. But by deferring that consumption and instead putting that effort into building a capital good, you end up with a huge fishing trawler. Once it's finished, a few of those thousands of people can catch more fish in a week than all the thousands of them combined could have caught over the whole time it took to build the trawler. That makes fishing much easier and more effective in the future, making food much more plentiful and increasing the standard of living for the whole society. And money is what makes all that possible on a global scale.

Final Thoughts

Given how critical this system is to civilization, any attack on money and its function is an existential threat. Unfortunately, a failure to understand the true nature of money leads to reliance on less nuanced or completely false ideas like "money=wealth". And that gives psychological cover to parasitic anti-social behavior like creating money and giving it away to buy votes, and all sorts of other destructive and dishonest shenanigans. Understanding that money is not wealth exposes the folly of all these schemes that purport to make people wealthier simply by creating more money. Believing that money is wealth makes the MMT clowns and the Keynesian grifters sound at least marginally credible. But those are specific misconceptions that need their own detailed explanation.

For now, reprogramming your mental framework to draw a strong distinction between money and real wealth will give you a solid foundation to understand economics, and to critique the many incorrect theories presented by the parasitical elements who wish to muddy the waters and avoid scrutiny of their anti-civilizational exploitation.