MIDAS' MISTAKE

Most people assume that money has real value. That's the fallacy I call "Midas' Mistake".

There was a real king named Midas but the name usually refers to a mythical character in Greek legend. The mythical Midas wished that everything he touched would turn to gold, and his wish was granted. Everything turned to gold -- including his wife and daughter, and the food he tried to eat.

Midas forgot that money -- even gold -- has no value of its own. It's only a token we use to count the production and consumption of goods and services, and it has value only when it represents the production of goods and services.

In the simplest form of economy goods are traded directly -- half of my fish for half of your berries, or whatever. The rate of exchange depends on how many fish I have and how many berries you have, and how much you want fish and I want berries.

But as economies developed some goods were accepted as a standard of value, to the point where they were used as money. At one time Roman soldiers were paid in salt, Maya Indians of Central America used cocoa beans as currency, and Chinese traders pressed tea leaves into cakes that were used as money in central Asia.

The first forms of money had real value. Roman soldiers used salt, the Maya used some of their own cocoa beans and Chinese traders drank some of their own tea. After the concept was established, people accepted money that had only symbolic value. Natives on the island of Truk, in the South Pacific, used huge stones as money and many Indians of central North America used wampum made of seashells.

Symbolic money is the standard today but some standards are so well established that we forget they are only symbolic. Even gold and silver are symbolic money, because for practical purposes they have very little real value. Unless I make computers or other high-tech electronic gear and need gold to plate electrical contacts, I have no more real use for a pound of gold than I have for a pound of printed paper.

Money is useful because it's widely accepted, because it's easy to store and because it keeps indefinitely.

If I catch a fish I must eat or trade it before it spoils. To trade it I must find someone who has something I want, and who wants a fish.

But anybody with money can buy my fish, and anybody who has anything I want will accept money. If I don't want anything right now, I can keep the money until I need it.

At one time I might have kept gold in a strongbox but now we keep money in countless forms. I may keep it as art or gold or jewels, as paper in my pocket, as an account in a bank or in deeds that represent ownership of property.

Conceptually, they are all the same. Once we accept the concept of symbolic money, we also accept all the symbolic forms we can agree on.

But whatever its form, symbolic money has no value other than our agreement to accept it. It's just a token and the real wealth is the fish or the berries or the shoes or the helicopter or whatever. As Quesnay and Smith argued, real wealth is the goods we use and it is created as the goods are produced.

If money is a token that represents goods, then all the money in an economy should be just enough to buy all the goods in that economy. The balance is never exact but the idea is acknowledged in the principle of "supply and demand".

When goods and money are in balance, prices are normal. When goods are plentiful or money is scarce, prices drop. When money is plentiful or goods are scarce, prices rise.

The balance is maintained because goods are always being produced and consumed. As we eat one farmer's potatoes, another farmer is producing another crop. As my shoes wear out, a shoemaker is making a new pair. The economy is big, and most consumption and production balances out.

In actual fact the money remains while the goods come and go but for conceptual purposes we can say that money is created as goods are created and that it decays as the goods are consumed. As Quesnay and Smith argued, the man who creates the goods creates the wealth.

But not all goods are wealth. The potatoes that Marshall spoke of are wealth because they offer an unqualified benefit to many people. The lawyer's brief will benefit some people at the expense of others and it may have value to those who benefit, but it is not wealth.

I may be able to exchange it for money but it has no practical value outside its context. I can't eat it, I can't wear it and I can't live in it. It may be as desirable as a winning lottery ticket, but it does not increase the store of wealth shared by the community.

Obviously the farmer's potatoes and the lawyer's brief are two distinct kinds of "goods" and we have to distinguish between them. Goods such as potatoes --- and computers and automobiles and canned peas -- produce an economic benefit to the community. Other goods, such as lawyers' briefs and recorded music and the services of the policeman who walks the beat, may produce social or other benefits but they are an economic cost. Let's describe the two types of goods as "{benefit} goods" and "{cost} goods".

As a general rule we could say that if an increase in the supply of a good or service would reduce the overall cost of living, that good or service is a {benefit}. If an increase in the supply of a good or service would increase the cost of living, that good or service is a {cost].

{Benefit} goods are wealth. {Cost} goods may have cash value, but they are not wealth.

An economy that produced only {benefit} goods would be boring but it could survive. One that produced only {cost} goods would be interesting but the inhabitants would have no food, clothing or shelter. We need a combination of {benefit} and {cost} goods, and the ratio of one to the other is crucial.

A surplus of {benefit} goods is no problem but it is a waste. Many {cost} goods serve a valuable function, and we might as well have all of them we can afford.

But too many {cost} goods is an economic disaster. When we look at numbers in the GNP {cost} goods look the same as {benefit} goods, but in real life they are a cost and if we produce too many of them we will go broke.

Most material goods are {benefits}. Even if we can't use a surplus ourselves, the goods can be used somewhere and we can sell them.

Some intellectual goods like designs for new machinery, some computer programs and books on farming may be {benefits} but other intellectual goods -- like most of the services of lawyers and governments -- are {costs}.

Some goods may bridge the gap. While most government services are a {cost}, others may be a {benefit}. While high-end medicine like heart transplants is a {cost}, low end medicine like general sanitation and flu vaccines are a {benefit}

But while we categorize goods and services as {cost} and {benefit} we have to remember that just because something is an economic {cost} rather than a {benefit} does not mean we don't want it. In economic terms I have to consider a heart transplant a {cost}, but if I need one myself I would certainly consider it a {benefit}.

{Cost} goods are not wealth but the people who produce them consume wealth. If they do not produce wealth themselves then the wealth they consume must have been produced by others. Much of our wealth is shared through the process I call the {cascade}. This is often confused with the process known as the {multiplier} but is in fact quite different from it.

The concept of the {multiplier} has been attributed to English economist John Maynard Keynes but Keynes himself attributes it to economist R. F. Kahn, writing in the {Economic Journal} which Keynes edited. The idea has also been attributed to English/American economist Sir Ralph Hawtry.

The {multiplier} exists because one person's expense is another person's income, and because most of us spend most of the money we earn.

A farmer who grows potatoes, for example, has to buy a tractor and fuel and seed and fertilizer and other equipment and supplies to work with, and he must feed, clothe and house himself and his family.

The people who make the tractor and supply the fuel have expenses and families too, and so do the people who supply the fertilizer and the seed, and those who build the farmer's house and make his clothes and raise the beef he eats with his potatoes.

If the farmer spends 90% of his income on business and living expenses then he will pass on 90 cents of each dollar he earns to others. If they all spend 90% of their income each will pass on 81 cents of the farmer's original dollar to others, and so forth. If everybody spends 90%, then each dollar the farmer is paid for his potatoes will produce $10 in new business in the economy.

But the {multiplier} applies only to the money the farmer is paid for his potatoes, and that is just a fraction of the amount the consumers will pay for them in stores. The difference between what the farmer earns and what the consumer pays is the result of the {cascade}.

This starts when the farmer brings potatoes in from the field and someone is paid to inspect and grade them. Someone else trucks them to a processing plant, where other people wash them and package them in five and ten-pound bags. Someone else hauls the bags to a store, where clerks put them on display and cashiers check them out.

Each operation adds value to the potatoes, because it's easier for a consumer to buy washed and packaged potatoes at a corner store than to buy them from the farmer's field. Each operation also adds cost, because all the people who process the potatoes have to be paid.

But while we have more people working and earning money, the {cascade} produces no more potatoes and no new wealth has been created.

That's the important distinction between the {multiplier} and the {cascade} because most of the money in the {multiplier} is spent for {benefit} goods, which in turn create their own {multipliers} and {cascades}.

The money the farmer spends for his tractor, for example, is part of the {multiplier} and, because the tractor itself is {benefit} goods, it produces its own {multiplier}.

Before the tractor can be manufactured people have to make the parts for it and before they can do that someone has to make the steel. Before that other people have to mine the coal and the iron ore, and before they can do that someone has to make the mining machines, and so-on. The {multiplier} goes back as far as you care to track it, and it creates {benefit} goods at every step.

And the tractor also produces a {cascade} which pays the trucker who hauls it to the dealership and the salesman who sells it and so forth.

The {cascade} is a vital part of the economy but it does not produce new wealth. The cashier in the supermarket will pass on some of her income to her hair dresser and others but, because the money she receives as salary is part of the {cascade} created by the farmer's potatoes, the money she spends is a continuation of the same {cascade}. Conceptually, the money she spends represents a share of te farmer's potatoes.

The dollars the cashier pays her hairdresser look like the dollars the farmer is paid for his potatoes, but in fact they are quite different. That may sound strange but in fact the idea that some dollars can be different from others is not new.

American bankers, for example, call the money they keep on deposit at the Federal Reserve "{high powered} money", because for every $1 they keep in the Fed they can lend $10 to their customers.

Money created by the production of goods can itself create more money, through the {multiplier} and the {cascade}, and because of that it must be considered different from the money created by the {cascade}. Let's call the money generated by the production of wealth "{root}" dollars, and the money created by the {cascade} "{derived}" dollars.

The dollars the farmer is paid for his potatoes are {root} dollars because they start the process. The dollars the hairdresser gets from the cashier who rings the potatoes out of the supermarket are {derived}. They have the same exchange value in the store but, because they are the product of the {cascade}, they are not as important to the economy as the {root} dollars that begin the {cascade}.

Figures from the United States illustrate that point. Only about 3% of the population of the United States lives on farms, but the food and fiber industries, which depend on farm crops, employ 22% of the work force and make up 20% of the US GNP. Obviously, the money earned by the 3% is a crucial part of the economy.

Producers of {benefit} goods create wealth, and producers of {cost} goods take a share of it. If we don't have enough producers of {benefit} goods we won't have enough wealth to distribute, but here again Midas' mistake can lead us astray.

We need {benefit} goods more than we need {cost} goods but as a general rule the people who produce {cost} goods earn more money than the people who produce {benefit} goods. A lawyer is paid more than a farmer, a politician is paid more than a factory worker and a professional athlete is paid more than a skilled craftsman.

It's no surprise, in a culture where money is the only counter we respect, that so many people choose to produce {cost} goods rather than {benefit} goods. For more than 20 years the brightest young Canadians have turned away from useful work toward the big money jobs that are an economic cost to the community, rather than an economic {benefit}.

We still need food, clothing, cars and other manufactured goods but, because producers of {cost} goods earn lots of {derived} dollars, we think we can afford to import them.

That sounds like a good idea because the people who actually produce goods are not well paid. When you pay $100 for something in a store the store takes about $50 of the total to pay for wages, rent, promotion and profit. The wholesaler and the distributor take about $25 for their expenses and profit, and the manufacturer and his suppliers get less than $25.

Since most of the money we spend for consumer goods goes to the people in the {cascade} rather than those who make the goods, it sounds like a good idea to import most of the goods we use. If middlemen make more profits than producers, why not let foreigners produce the goods and Canadians work as middle men?

But the dollars in the {cascade} are created by the producers, and the producers of imported goods live in other countries. When goods are imported there is no wealth created in Canada, and all imported goods and the jobs they create must be considered {costs} rather than {benefits}.

Within reasonable limits the cost of imports is acceptable but there is an additional problem because imports also displace the production that actually creates wealth within Canada. Imports begin a {cascade} that increases costs, but they do not create the {multiplier} that would produce more {root} dollars. If we don't produce real wealth ourselves, we have no real wealth to share among us and the wealth we share must be borrowed. More about that later.

Some importers say this is natural selection -- that foreign producers are taking over because they are more fit to survive -- but that argument ignores the facts of natural selection.

In an earlier time adult tigers were more fit to survive than human babies. Babies never learned to defend themselves against tigers but humanity survived the evolutionary mill because adult men hunted and killed any animal that attacked a human.

We do not protect the producers who create our wealth and Canadians now import about 60% of all the consumer goods we buy.

When we import goods we export money. Even if most of the money we spend at the retail level stays in Canada, at least 15% of all our consumer dollars leave the country. Consumer spending accounts for two thirds of our GNP, so in total we export more than 10% of all the cash we earn every year.

If it were just 10% of the total that would not be too bad, but this is no ordinary 10%. This is the "{root}" money that is created by the production of wealth, and from which other money is {derived}.

Because the money that we send overseas is a small percentage of the apparent total of money in the system, Canadian governments thought they could borrow to make up the difference. With an economy that turns over nearly $600 billion a year it should be no problem to borrow $10 or $20 billion at a time.

And it would not, if Canada produced enough {benefit} goods to sustain itself. But again remember that consumer goods make up about 60% of our whole economy and we import about 60% of consumer goods. We actually produce very little real wealth.

Governments make no distinction between {benefit} goods and {cost} goods, and they think money earned by the production of {cost} goods is wealth. It is partly because of this that they find it easy to justify waste.

What does it matter that the government wastes money, if the waste produces a {multiplier} effect that creates wealth for the whole economy? If that were true, government waste would be a positive virtue!

Governments now pretend to know that we can't afford endless waste but they have not learned the most important lesson, that dollars are not wealth. It it were, we could print a few million of them for every Canadian and we could all retire.

But money looks like wealth and several provincial governments hope that lotteries, casinos and slot machines will produce wealth and bring the government revenue that taxes can no longer produce.

Even some local governments once believed the theory that casinos would be an "economic engine" to produce wealth in their community but it didn't happen. In fact the casinos drain money away from legitimate business, and create economic hardship in the towns where they are located.

The Province of Ontario hopes to gain $1.3 billion next year in revenue from Casino Rama near Orillia and others at Niagara Falls and Windsor. If that were {root} money it would be good news, but casino profits are not {root} money. Because casinos produce no real wealth, the dollars governments collect from them are {derived}. Casinos redistribute wealth, but they add nothing to the economy.

Midas thought gold itself would have value, but he was wrong. Governments and others are wrong to think that any dollars, from any source, have real value.

Money has value only if it represents real wealth, and the closer it is to the production of that wealth the more value it has. Real wealth is represented by the {root} dollars that are earned by the production of real goods. We need {derived} dollars too but, like the relationship between {cost} and {benefit} goods, the relationship between {root} and {derived} dollars is vital.

The {root} dollars are the wealth, the {derived} dollars distribute it. The higher the ratio of {root} to {derived} dollars the more real wealth we have for each Canadian to share. When we generate more {derived} dollars we have more money in circulation but, because we have no more wealth to share, all our money loses value.

And we have a third type of money which I call {imagined} money. This is legal money but it is literally created by imagination.

When you borrow money from a bank the bank does not actually have the money to lend you. Banks in the U.S. have to keep $1 on deposit in the Federal Reserve for every $10 they lend to customers but Canada runs on a "zero reserve" basis, and Canadian banks just have to keep an average balance of zero in the bank of Canada.

When you borrow money the bank writes you a cheque or whatever, and the money is created at that point. The bank does not actually have the money, but it is betting that enough money will come in from deposits and repayment of other loans to cover the cheque.

Like {derived} money, {imagined} money is not created by the production of goods. Unlike {derived} money, {imagined} money can start a {cascade}.

{Derived} money can't start a {cascade} because it's already part of one, and when {derived} money is passed from hand to hand the movement is a continuation of a {cascade} that started with {root} money. {Imagined} money is new to the system and, because it is not part of an established {cascade}, it starts a new one of its own.

That creates a serious danger because {imagined} money does not represent real wealth, and money {derived} from {imagined} money does not represent real wealth.

That means {imagined} money may upset the balance of goods and money that keeps prices stable. Orthodox economists think that bank loans and credit sales make no difference to the economy because loans are balanced by debts and because in theory they will eventually be paid off in real money. There is obviously no problem if I buy a car or a TV set on credit, but what if I borrow a billion dollars?

The money is new, and even if I will repay it some day it's here now and it upsets the balance. The long-term effect of a big loan will depend on what I do with the money.

If I use a billion dollars of {imagined} money to build a factory or a block of apartment houses or a fleet of fishing boats it will be good for the economy, because I will spend the money to hire workers and buy components and raw materials.

The loan will increase the total of money in the economy, but if I use the new money to build something useful I create new real wealth and the balance between money and material wealth is maintained.

In this case the {imagined} money acts like {root} money and in effect the loan just shifts the sequence slightly to create the money before, rather than as, the goods are produced.

But what if I use the billion {imagined} dollars to buy goods that already exist? Suppose I borrow the billion to buy apartment houses or a factory or a fleet of fishing boats that someone else built ten years ago? Now we have an extra billion dollars in cash added to the economy, and no new wealth has been produced.

Further, because this billion dollars is new to the economy it creates a {cascade} which, in effect, multiplies its value. Now we have perhaps $10 billion new dollars in the economy, but no real wealth has been created.

The balance between wealth and money has changed and in the long run all money will lose enough value, through inflation, to restore the balance.

Even a billion dollar loan would not make much difference to Canada's national economy, but we are not dealing with a single billion dollar loan. As wheeler-dealers buy, take over and merge companies Canadian banks may issue dozens of multi-billion dollar loans in a year. Because {imagined} money creates a {cascade}, the total effect will be tens or hundreds of billions of dollars.

The flood of money creates inflation, which gives the borrower a bonus which makes it easy to pay the loan off. Because the borrower profits from inflation he can pay off the first loan and borrow another billion, to buy another established business and start another round of inflation.

When I borrow to build something new the bank advances money on my production and the ultimate result will be more wealth to be shared by all. When I borrow to buy existing property the bank agrees to share everybody else's production with me. That's not valid, because they don't own the production they offer to share.

Governments know that unlimited loans by banks could upset the economy and they try to control the creation of money through the interest rates set by central banks. The idea sounds good but it assumes that the problem is a surplus of money. In fact it may be a shortage of locally-produced goods, and a high interest rate may exacerbate the problem because it pushes entrepreneurs away from long-term projects and into fields that will produce a faster return.

If I want to sell gibblgooks, for example, it might take me a year or so to build a factory to produce them, to design the product and to train the workers to make them. Imported gibblgooks may cost more in the long run, but if I choose to import them I don't have to design them or build the factory or train the workers and I can get a faster return on my money.

When interest rates are high a fast return is more important than a high return, so I will go for the imports.

That's counter-productive because the problem is that we have too much money in circulation already, and not enough real wealth. The high interest rates that are supposed to reduce inflation almost certainly have a negative effect on employment, but if they drive entrepreneurs into high profit business they may not stop inflation.

We all handle money every day but few of us really understand it. We don't have to, in our daily life.

But when we look at the economy we have to remember that money is not wealth. It's just a token, and the real wealth is the food we raise and the goods we manufacture. When we value money, rather than the wealth that it represents, we lose sight of reality. When we give up our farms and factories to go into business that produces only {cost} goods, we give up the source of our wealth and we condemn most Canadians to poverty.

back to Summary Page