…because if it isn’t, it’s “Trade Goods”.
First, though, let’s go back a few steps. The issue is value.
We observe things happening in the physical world — cannon balls and forest fires, electron beams and light rays, collisions and chemical reactions — and we invent a unifying abstraction: energy. There ain’t no such thing, at least if you interpret “thing” as something palpable and detectable, but we can detect it by its effects. If we calculate the energy state before an event, we can predict what will happen with remarkable exactitude, especially if we take into consideration higher-level abstractions such as entropy.
We observe things happening in the socioeconomic sphere — trade and commerce, employment and bazaars, the exchange of goods and services — and we invent a unifying abstraction: value. Like energy, value isn’t something palpable; a book called Values of America is not a field guide, calling for expeditions with camera and binoculars. But if you calculate the value(s) involved, you can come up with a fair prediction of what will happen.
You can’t catch an “energy” and put it in a cage; you can’t photograph a “value” and get published in National Geographic; both are abstracts. At that point the analogy crashes in an acrid cloud of fail. Energy can be neither created nor destroyed, and that makes the analysis relatively easy. The energy state before and after the event is the same, in total, and it becomes a matter of accounting for which portion of the energy went where. Value is created and destroyed all the time — about the only thing you can say about it is that the total value before and after the event is highly unlikely to be the same. That makes working the equations a lot harder than for energy, and while we have very good tools for calculating energy, we don’t have a good set of equations and laws for “value”.
That’s because value is a human perception. It is in many ways a synonym for “want” (mostly in the sense of “desire”, sometimes in the sense of “lack”). There is no such thing as intrinsic value, that is, value existing outside human perception. A thing has value because people want it,and for no other reason, and different people have different wants and preferences. This makes determining value complex, IMHO a priori impossible.
What we can do is determine relative values in individual cases, and the result is called trade. If A has X and B has Y, each determines the value of X and Y according to his or her own wants and preferences. If A finds that Y is preferable to — has more value than — X, and B wants X more than he wants Y, they exchange, swap, trade. After the event, each participant is more satisfied, has less want, than before it.
It is sometimes missed, or misinterpreted, that A and B do not exist alone in a vacuum. They are part of a society composed of many individuals, each having things and wants. That society thus has some total of value, composed of the values determined by its members of the things they have and want. When A and B trade in the case above, both are happier, more pleased, less wanting — richer or wealthier (the terms are equivalent at this point) — and the total value of the society has increased.
Now, the society containing A and B has many Xs and Ys, and the needs and wants of its members are complex functions of what they have, what they want, and what’s available. In a small, simple society it might be possible for all the members to evaluate all the goods each member has, and determine their relative value and therefore what and how to trade. In a larger, more complex society this quickly becomes impossible, because the problem is factorial, what the computer programmers call “NP-Complex” — that is, it depends not just on the number of items, but on each item’s relationship to all the others.
The solution — in reality a stopgap, but the best thing available — is money. Value is an abstraction; money is an abstraction of value, but unlike most abstractions makes value more concrete. It is an approximation of value that can be written down or stated without the nebulosity of personal perceptions, which reduces the complexity of evaluation of the things for the people in the society. The problem becomes combinatorial rather than factorial, goes from NP-Complex to NP-Simple, and brothers and sisters, that is for all practical purposes the difference between infinite and finite.
But how to assign a money amount to a value, which depends on perception and varies from person to person? Extend the concept of trade to multiple exchanges. That’s a market. Each person bids — that is, assigns a money amount — on each item of interest; the people who have the items in question accept or reject the assignment according to their own interests and perceptions; and the society settles on a price for the item(s). It isn’t fixed — it’s a human perception thing, after all — but looking at it from far enough away that individual trades blur into a single picture, the price becomes a fair approximation of the average value the society places on the thing being priced. (Note that this really applies only to common items, things that many people bid on and trade. How singular, unique, or extraordinary items are priced is beyond the scope of this essay.)The system only works if money has no value of its own. Money is a figure of merit, an approximation of value that serves as a guide for participants in the society to simplify deciding whether to trade or not. A difficulty arises from the fact that, to satisfy the need of the individuals in the society for something they can touch and hold, money must be expressed by a thing, a tangible, perceptible item. If the item used as money itself has value it simply becomes another trade item, another X in the decision process, and the problem starts growing back toward NP-Complex. In the real world, this difficulty has been overcome by making the price vs. value function of the “money” item very simple, based on (almost) everybody having the same perception of its value. Even then there are problems. The total value, the wealth, of the society has been converted into money prices, and if the money itself is a desirable item it can and will be sequestered under the control of people who value it, and be lost to the society as a whole — “The love of money is the root of all evil.”
This introduces a contradiction. A has X; B has money — that is, B has currency, a store of the items used to represent money. Shall they trade? In order to decide, they must know the function that assigns price to value, and A in particular needs to know that the money can be re-used for another trade. The currency is valueless in itself; A must be assured that it represents value, which he can later use to trade for Z. The only way to provide such assurance is for the society to agree on the “value” (really the price-to-value function) of the currency, that is, how much money the currency represents. That agreement is arbitrary, whether it is decided by market activity or the decree of some potentate — that is, it is so because it is declared to be so: Let there be lucre! The word we use for such a declaration is the Latin imperative form of “to be” — fiat.
So money, an abstract figure of merit representing an approximation of value, is represented in tangible form by currency, the merit function of which is arbitrarily declared by somebody or -bodies, it having no merit function (“value”) of its own. If its value is not determined by declaration — by fiat — it must have value in and of itself, and it is simply another trade good, albeit (sometimes) a simple one; that burdens trade and markets with crippling complexity. It isn’t money if it isn’t fiat money.