Saturday, September 27, 2008

Fetishism of money and defusing the world financial mess: re-define money as a unit of account

Fetishism of money and defusing the world financial mess: re-define money as a unit of account

One definition says that money is anything accepted as payment for goods and services and repayment of debts. [Frederic S., (2007). The Economics of Money, Banking, and Financial Markets (Alternate Edition). Boston: Addison Wesley, 8.]
The synonym is ‘currency’ which is a standard, a unit of account, a store of value and a medium of exchange.

Modern financial transactions have indulged in fetishism of money, treating money as a commodity.

The commodity called money has undergone may processes not unlike an agricultural product, say, tomato, which by processing through agro-processing industry gets packaged as ketchup. All such processed ‘money’ products are bought and sold in financial markets such as stock exchanges, central banks, IMF.

One such process of transformation of money is called ‘derivative.

‘Derivative’ is actually a technical term in differential calculus, a branch of mathematics. Derivative in calculus – is the reverse of integration and, -- is a measurement of change in a function as the value of inputs change. A crude example is how a graph which is curved is made into a linear approximation; so, a horizontal S-shaped curve -- ~ -- can be shown as a downward-sloping line drawn as a tanget to that function.

A financial derivative is an instrument which changes in response to changes in the underlying variables. Examples of derivatives in financial markets are: participatory notes, mutual funds, futures, forwards, puts, options, swaps. Financial derivatives have taken many shapes and forms and are based on a variety of assets not excluding inflation derivatives: commodities, equities, stock market indexes, consumer price index, bonds, interest rates, exchange rates.

The financial derivatives are the root cause for a 60 trillion economy resulting in a 6,000 trillion dollar financial marketplace. The players in the marketplace (including the recently collapsed or rescued entities such as Lehmann Brothers, Merrill Lynch, Washington Mutual, American International Group) transact in these derivatives.
Instead of reducing risk for the players, these market players have placed themselves at risk of bankruptcy or simply going out of business when faced with the prospect of defaulting on promised payment schedules.

Now what Uncle Sam is attempting is a quick-fix to rescue these market players who have placed themselves at risk by their own market follies, dealing with fetishism of money, that is, money as a commodity which has changed beyond its original form and function – simply as a unit of exchange to facilitate barter transactions.

The basic problem which Uncle Sam is NOT addressing is the fact that 60 trillion dollar economy has been transformed into a ballooned 6000 trillion dollar financial derivatives marketplace.

This is the structural reform needed: money has to be put back to its original function, as a unit of account to facilitate barter transactions. If I have cotton to sell and want to buy a Nano, I should simply use money to settle the deal and not be put through the fancy financial instruments set up as mortgage loans or as personal debts to be repaid using complex interest rate computations and equated monthly repayment schedules.

The justification for designing a processed money product called a ‘financial derivative’ is to manage risk, to reduce the risk for one party.

In Hindu tradition, the word artha has two meanings: ‘wealth’ and ‘meaning’. This is a profound semantic equivalence. Artha is meaningful only when it is related to the creation of wealth. Today’s financial derivatives do NOT create wealth but indulge only in playing games with money and its allotropic modifications called financial derivatives.

An old-fashioned 18th century book of Economics, is called Adam Smith’s ‘An Inquiry into the Nature and Causes of the Wealth of Nations.’ Smith was talking of money as a measure of creating wealth. An example cited is that a butcher, a baker, and a brewer provide goods and services to each other out of self-interest; these economic activities result -- because of an ‘invisible hand’ -- in a surprise: creation of wealth for all three. Simply put, artha is the result of peoples’ actions, work as it is called in old-fashioned economics.

There is no substitute for work to produce employment and to create wealth. The financial marketplace players are creating an illusion of wealth thinking that they have transformed the world into a 6000 trillion dollar marketplace. It is actually worth only 60 trillion dollars, that is, on the basis of the value of the underlying goods and services available.

The G20 nations (including India) may be called upon to set up a new brand of IMF, something like a super-SEBI to regulate the world’s financial marketplace. But they are doomed to failure so long as they fail to understand that the butcher, baker and brewer are the real producers of wealth, not the Goldman Sachs, not the Mauritius-based participatory note issuers.

I agree with Prof. Vaidyanathan. India has to teach artha to Uncle Sam and the other G19 of the G20.


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