Money Doesn't Solve The Double Coincidence Of Wants Problem
07 Jul 2024There is the misconception that money solves the double coincidence of wants problem imposed by “barter”. The argument appears to be straightforward.
The problem statement
Person A has produced bread and Person B has produced milk. Person A wants milk, but Person B does not want bread. Because of barter, there is the double coincidence of wants problem. Except, the problem has nothing to do with the system used to perform trade whatsoever!
In this case the actual problem of trade not occurring originates from the fact that both Person A and Person B speculatively produced products, with the hope that their product would be useful to the other and it turns out one of the parties actually wants the other’s product, but the other does not.
Let us introduce money!
Now you might say, we could introduce money to this scenario. We say that both Person A and Person B start with $10.
Person A spends his $10 on buying milk. Problem solved right? Except, if Person A wants to buy more milk, he will have to earn $10 and since all he produced is bread, he can’t sell his bread.
Introducing a different form of exchange does nothing to solve this problem. In fact, it just hides it somewhere where it can’t be seen. Yet paradoxically, the system is supposed to be in equilibrium. The “equilibrium” exists in a different form. For every buyer, there is a seller. Therefore, thanks to money, all trade is in “equilibrium”. But who gets to be the buyer and who gets to be the seller?
Obviously, the person with money gets to decide, when, where, how, on what and how much of his money he is going to spend. The necessary information for Person A to make good production decisions can simply be withheld by Person B and that withholding of information can be used against Person A to drive them into debt. After all, Person A has to read the wishes of Person B off their lips.
Person A could produce cheese and then Person B refuses. Person A could produce a dozen different products, all at their own expense and yet, despite significant effort being put into performing trade, Person B refuses, simply because they know a simple trick. Person A has produced: cheese, wine, bread, beef, pasta, soup, cookies and many more things. Person B responds, I am willing to enter a trade, $10 for everything you have.
Person A could accept and then be able to buy more milk, however, then Person A realizes that the deal isn’t worth it. Just the cheese alone required significant quantities of milk. He knew he wouldn’t be able to buy back enough milk to recoup the milk used to make the cheese. So he did what any sane person would do in such a situation and walk away and never engage in the division of labor with this person again.
What we are seeing is the refusal to provide liquidity services. The problem is that a universal medium of exchange ends up becoming a “polluted” medium. The medium of exchange needs to be replenished and substituted to bridge over the excessive amount of delayed decision making. In the above scenario the money system is taken hostage by a single individual, but in reality the money system slowly degrades over time and trade becomes more and more stagnant as more and more people delay decision making. If delayed decision making leads to deflation, then it will be a self fulfilling prophecy until enough liquidity producers have left the market to the point where inflation sets in and liquidity services are compensated through price increases again. The system is inherently chaotic. To remain stable, it must be kept in motion at all times…
The coincidence of wants problem has not been solved at all, instead, delayed decision making allows the coincidence of wants to be delayed. In other words, the illiquid solution space has been transformed into a liquid solution space, in which a greedy strategy can be applied, but this strategy is not an exact solution. The actual equilibrium has been delayed into the future and in theory it can be delayed forever. The equilibria that economists take for granted, may never come or if they come, they must be brought about manually, not by relying on powerful solvers.
The great irony of course is that there are money system designs that punish delaying decision making and encourage equilibrium formation, and they are being derided for the misconception of punishing saving, because most economists don’t even acknowledge delayed decision making as a concept at all. A tax on delayed decision making is considered a tax on saving instead. The assumption that delayed decision making doesn’t exist, implies that the tax would never get paid, making it a no-op. That is, it somehow has an effect on saving, yet it also doesn’t, perplexing. There is a fundamental inconsistency in how neoclassicals think about money. Exogenous (outside) money does not make sense unless there is a corresponding shadow account. It is endogenous (inside) money in disguise.
The inability to compensate liquidity services creates the need for perfect planning
More importantly, the above scenario concerns itself with speculative producers. Such producers can act in the absence of complete information or perfect cooperation at the expense of losses in efficiency. Now, the easiest way to get around this constraint is to simply never make a mistake. In a way, neoclassical economics is actually better described as “mistake-free” economics or perfect economics.
So, how would one implement such an economy? Of course, there is only one way known to man: central planning. We must create a perfect plan for the economy so that speculative production becomes obsolete. Suddenly one becomes aware of how shockingly litte difference there is between neoclassical and marxist economics. Okay, I may be overselling this. They still differ in other aspects.
As already mentioned in the previous blog post, the quality of the plan depends on the quality of information about both the present and the future and the ability to execute the plan in cooperation with others. This is costly. Planning and negotiation costs are cognitive costs, but they also take up physical resources and they also incur opportunity costs. Therefore it is not obvious that a perfectly efficient plan would end up being better than an ad-hoc strategy that is dynamic and cognitively inexpensive.
However, by founding an economy on the basis of barter, “spot exchange”, the coincidence of delivery schedules or whatever other arbitrary restriction one comes up to ensure nice properties, one has already artificially limited the design space and implementation options for the economy.
If the introduction of money in such a theory causes no lifting of restrictions and the barter assumptions are strictly held onto, then the theory of money solving the double coincidence of wants problem is by definition false. After all, if one can create the most optimal central plan in the monetary economy, one could have created the same plan in the barter economy and done away with money. On the other hand, if perfect planning is impossible, then the monetary system does not simply fix the problems of barter and remain otherwise the same, the systems are different by their very nature. Money and the speculative production process are deeply intertwined.
Multi-way barter and barter clubs have the same benefits as money when it comes to the coincidence of wants
Rather than double coincidence, where barter occurs between two people, we can imagine a more general economy where \(n\) people enter a simultaneous \(n\)-way barter trade. An official (oh no, please no governments!) is appointed to choose a numeraire or unit of account such as grains and oversee the process. All prices are set in 100g of grains. People present their goods and prospective buyers negotiate a price in grains. Once the first round of barter is concluded, the official confirms that every participant has sold and bought products of equal grain value and that nobody has positive or negative balances. If not, then new rounds are commenced until the budget constraint has been met for every participant. Small discrepancies can be adjusted by borrowing or lending grains. Debtors get priority access to being the first to sell their commodities to help them pay their debts. This trading process has almost all the benefits of a conventional money system when it comes to the coincidence of wants, but it requires an official to oversee the process.
A Treatise on Political Economy
The scenario outlined in the problem statement is a classical example of a single good being abundant in relation to other goods and plays into the classical argument presented by Jean Baptiste Say. However, the problem is not the fact that the correct good cannot be produced, but rather that it is unknown which good should be produced.
In the case of a barter economy, the exchange process presupposes that the correct production decisions have already been made as otherwise no exchange occurs. The need for a perfect plan is absolute in the barter case. In the case of a monetary economy, the exchange process can speculatively be initiated one sidedly where one party has produced the correct good, but the other party has not.
Therefore the interruption of the exchange process happens in the middle of the process, not before the process has occured. This means that money does not solve the double coincidence of wants. Whether the double coincidence of wants has been solved or not can only be deterimined after the initial act of selling. In a way, it is like a criminal investigation where a murder can only be investigated after it has been committed.
“Sales cannot be said to be dull because money is scarce, but because other products are so. There is always money enough to conduct the circulation and mutual interchange of other values, when those values really exist. Should the increase of traffic require more money to facilitate it, the want is easily supplied, and is a strong indication of prosperity a proof that a great abundance of values has been created, which it is wished to exchange for other values. In such cases, merchants know well enough how to find substitutes for the product serving as the medium of exchange or money and money itself soon pours in, for this reason, that all produce naturally gravitates to that place where it is most in demand. It is a good sign when the business is too great for the money; just in the same way as it is a good sign when the goods are too plentiful for the warehouses. When a superabundant article can find no vent, the scarcity of money has so little to do with the obstruction of its sale, that the sellers would gladly receive its value in goods for their own consumption at the current price of the day: they would not ask for money, or have any occasion for that product, since the only use they could make of it would be to convert it forthwith into articles of their own consumption.” - Jean Baptiste Say [0]
In Say’s famous work “A Treatise on Political Economy” Say argues that money cannot be a constraint to the production process, because a substitute for money can be found in proportion to the amount of commodities that have been produced. Therefore any problems in the exchange process must be the product of an error in the speculative production process. The key point here is that the exact method of exchange does not matter. Substitution is possible, therefore any monetary constraint will be papered over by the utilization of a different method. Given a perfect central plan, the method of exchange is irrelevant. However, is such a perfect central plan even possible? If not, then the speculative production process and its errors will be shaped by the implementation details of the exchange process and competing exchange processes will have to fill in the gaps.
Let us focus on the first sentence again, where Say talks about how sales are dull, because other products are scarce. Other products are scarce because of an error in the speculative production process and the error is due to the fact that future buyers are not forwarding information about what needs to be produced ahead of time so that the right product can be produced.
One way to rephrase this statement is to say that information (=money) is scarce indeed, since money is primarily an information carrier, a representative of value, without being value itself. We run again and again into the same conundrum. The production plan must be perfect, lest Say’s argument does not apply, since the flow of information and therefore money is essential in guiding production that can result in sales.
“It is worth while to remark, that a product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus, the mere circumstance of the creation of one product immediately opens a vent for other products.” - Jean Baptiste Say [0]
It should be taken for granted that producers intend to sell their products for they are not autark or self sufficient or they have abandoned the ability to remain self sufficient voluntarily, but the part about money that follows…
“Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable.” - Jean Baptiste Say [0]
The value of money is perishable?!? Are we sure there is not some kind of error? Consider the case where money was no longer perishable and no inflation occured. According Jean Baptiste Say, a successful seller would have no incentive to dispose of his money quickly, but isn’t that the very scarcity of money that he claimed is impossible? Such scarcity would force the hand of the other market participants to abandon the current money and substitute it for new money that does… perish? Is this really the “Say” that everyone talks about when they mention “Say’s Law”? Was his intention really to say that money must always inflate and lose value?
If that is the case, then anyone who advocates for Bitcoin, Gold or any form of deflationary money on the basis of Say’s Law must have misunderstood what Say wanted to convey. A deflationary medium of exchange creates the need for perfect planning since there is no regularization occuring on the agent level that prevents the accumulation of money balances. If nothing is done to prevent accumulation, then the only strategy for producers is to cease providing liquidity services when their warehouses fill up with unsold inventory, since they are unaware of a perfect central plan in their speculative mode of production.
The arguments presented by Say have an oddly Keynesian ring to them in that they do not debunk Keynes at all when it comes to recommending inflation rate targeting. Austrian Economists relying on Jean Baptiste Say should rethink their “alliance” since it debunks the idea that the central bank setting interest rates has any influence over the economy at all. A malinvestment based business cycle theory driven by interest rate manipulation would be worked around just as much as a scarcity of money.
Say’s Law rephrased
If we want to make Say’s Law applicable in every situation, then the answer is that every seller must inform their buyers of the future products that they desire, but conveying such information is equivalent to forwarding the money that was used to facilitate the purchase of the sold product.
Therefore the hidden assumption is that the seller has already created a perfect plan for the buyer to respond to the moment he decided to accept the buyer’s money as otherwise that money would be worthless. If the seller does not have such a perfect plan, then he should have refused the buyer’s money. Under these constraints, there is no difference between barter and money and people do not hold money balances for long periods of time. Instead they spend the money balances relatively quickly, probably within the same day on which they acquired the money.
The need for perfect plans gives rise to simplifying assumptions or the attempt to create them using powerful solvers
Most of what I have written was just a justification for the previous article, which I have written a long time ago. Economists don’t want to deal with anything I wrote above when they develop their liquid models. They make simplifying assumptions that guarantee obvious global maxima that are easy to achieve using analytical methods or convex optimization approaches to end up with unique solutions.
However, the illiquid world does not play so nice. What Say has done is to shift the problem around into the planning of producing the correct good. If the choice of production is clever enough, people with money will not resist acquiring it with their money, but the problem was that these people delayed their decision making. The information needed to make the correct decision was not available to begin with. A seller would need to know his customers better than they know themselves.
[0] https://socialsciences.mcmaster.ca/econ/ugcm/3ll3/say/treatise.pdf