Thursday, June 25, 2009

Wealth of Nations: Book 1: Chapter 5: Of the real and nominal Price of Commodities, or of their Price in Labour, and their Price in Money

Chapter 5 in Book 1 is a rather dense chapter in the concepts presented. Initially the theory put forth is that the true measure of value of any thing is labor. How much time would you do whatever you do to produce enough products, services or money to get what you want. Imagine for a moment you mow lawns for a living. In a barter society you might agree to mow lawn for a butcher in exchange for one steak he cuts up every week. His time of steak prep is maybe 20 minutes (I don't know much about being a butcher and am just throwing out numbers) and you know it would take one hour to mow his lawn every week. We could conclude that in real value his labor is three times more valuable than yours.

Money comes in as a necessary and convenient way to approximate value. You may not always want steak, and the value of the steak may change over time so you both would be better off if you had some impartial neutral item to trade with. Thus money is really this abstract scoring system. You can't eat money, it provides poor housing, won't keep you warm etc. Intrinsically it bears little value. But in the context of the trades it serves a useful tool towards trade. Think of monopoly money for a second. Absent a game of monopoly it is worthless, but in the course of the game you might value having a $500 monopoly bill more than one or two dollars of real money. So I guess context matters.

He then went on to talk about the real and nominal values of commodities. He spent a long time explaining how corn has been valued over time and while year to year may fluctuate wildly, over time it has retained its value quite well. Comparing college rents in Elizabethan times with the 1770s, what previously was 33% now was over 66% even though the amount of corn requested was the same. So commodities can retain value over time more than money.

He finishes showing how different commodities, namely gold, silver and copper, interplay in the formation and use as currency compared to their bullion state. While the value of the metals might not match the comparative value of the coins. So to use an American example if a nickel is 5 times a penny always, it is irrelevant to the comparative value of nickel bars to copper bars. It is important however to keep the value of the coin higher than the metal to prevent people from smelting their nickels and pennies for raw materials to sell.

Overall I think the most important things in a modern context given we use paper money and in some cases digital money, is the role that commodities have and to think of our labor as being a real measure of value. Think of your daily expenses, and think of how much you make an hour at your job, and ask yourself when you buy something, if you would be willing to work X minutes for that same thing. It is an interesting way to look at value.

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