Currency, Money & Markets – 1

Much has been said in praise of the new web-series about Harshad Mehta, aptly titled “Scam 1992”. The title is apt because it doesn’t put the man who is the central figure, Harshad Mehta, at the centre. Though the show is about financial markets, I do not think that many people quite get what a money market is. If I’d have to venture further, I do not think many understand what a stock market is either. To make it even more blasphemous, the assertion to be made is that the majority do not quite understand what the word market means.

A professor who is also the principal of a college in my hometown once posed a question to test how fundamentally sound I was. He wanted me to articulate the difference between trade, commerce & business. At that moment, I must confess, I had no answer to the question. In the wake of the web-series “Scam 1992”, it felt timely to write down my thoughts on things. It is human nature, by virtue of generations of evolution, to want to have things one doesn’t have today. If there are multiple people engaged in this quest to acquire what they don’t have, it is only a matter of time that they find one another. In that manner, when two people who each find what they don’t have as a surplus of what someone else has, trade happens. When two people are willing to take on mutual loss of wealth to acquire something that they value more than they were willing to let go, that is what we can call trade. The cost of finding such transactions would be high if the participants in trade would have to go around asking. A platform for trading to happen is what one could call an exchange. It still won’t be a market as trading isn’t the same as buying & selling. Trade can exist in pre-monetary societies. Money isn’t a pre-condition for society to exist. Money is necessary for creating a standardised system of trade.

A standardised system is the same as using the metric system to measure things like mass, weight, length & temperature and so on, to name a few. When we measure the mass of anything, and say it weighs a certain number of grams, we must understand that we derive the value of a gram from something else. This something else, much like how Spinoza articulates is the definition of God, has to be a truism. At some level of articulation, it has to be undefinable and we must know the limit where we just have a commonly accepted truth based on which we construct further ideas. Until recently, the Bureau of International Standards kept in storage a few pieces of platinum whose average mass was taken as 1000 grams. After Avogadro came up with the constant, that a certain number of atomic particles make up one gram, the number of particles it took to get to a gram had essentially become a truism. It remains a truism because protons, neutrons & electrons don’t change. Hence, today we measure the gram using the number of atomic particles in any material.

In a pre-standard society, trade would be highly arbitrary, based on the norms accepted in that society. If weight comparison were the norm, someone trading cotton for wheat would give up a relatively larger amount of cotton for an equivalent weight of wheat. This comparison would be different if the cotton weren’t combed and was instead sold as the far denser cotton bloom. Trade was fairly arbitrary and it is very easy for at least one of the two parties to think they’ve been duped. Hunter-gatherer societies were edged out by societies that practised agriculture to obtain output with lower amounts of randomness. After agricultural societies became commonplace, the nomadic folk who used to look for newer pastures got edged out by those with the know-how on using the same land over and over again. The search for reducing randomness moved on from the realm of agricultural output to the realm of finding new lands, as the newer pasture could be less nutritious and offer lower output. There is grave risk to the individual in falling prey to randomness, but it is in such articulation of risk & randomness that society advances. The paradox is that randomness means that every possible outcome is equally likely, yet the outcome of every outcome isn’t desirable. Randomness is fair because it is impartial, but it is also unfair for the same reason.

We do not make decisions based on the outcome alone; but rather on the outcomes of the outcomes. Daniel Kahneman & Amos Tversky had demonstrated this through their study on heuristics and how humans think about things before arriving at a decision. Hence it should be no surprise that humans favour the outcomes which are relatively lesser in randomness. A system of standardisation of trade, where commerce now becomes part of lexicon, is borne out of the necessity. A pre-monetary society is now a monetary society. Yet, the necessity of a standardised system isn’t sufficient. To something is a few feet away, it’d mean that the length of a foot is constant. This circles back to Avogadro’s constant with a new friend in tag – Occam’s razor. Whichever outcome has the least amount of assumptions is preferred. Money based on the decimal system with the linearity assumption eventually edged out the gold coin economy, where the quality of the gold had to be known for commerce to take place. This is when currency came into existence & subsequently led to the birth of the banking institutions.

The concept of linearity is rather simple. We start counting from zero and add the same amount to obtain the next number every time. We add a unit, and denote it with the symbol 1, making it a digit. Adding 1 to zero is 1. Adding 1 to 1 is 2, and so on it goes till we reach 9. Unlike the roman numeral system where counting began with 1 and had a symbol ‘X’ to denote what comes after 9, the decimal system which begins at zero merely creates another digit. After 9, we begin with zero again, but with 1 on its left-hand side. Now, we have 10 instead of X. If we were to apply this same counting system to money as well, we will have created a system on which commerce can take place. Yet, we are not in the realm of business. Trade begins with recognising value in owning something for giving up something else.

We must understand that the value of 100 rupees is not 100 rupees. The value of 100 rupees is what someone else is willing to give up getting the same 100 rupees. Rupee is a currency, a manifestation of money. The value of currency has to be measured based on something everyone wants to acquire. For the most part, gold and other bullion metals create this standard. Although, that is quickly changing to become energy that runs society. A market exists where trading with money as a basis creates two discernibly different categories – buyers & sellers. Buyer is willing to give up money for goods; conversely, a seller is one who is willing to give up goods for money. If we were to treat currency as a commodity, not money, there we get the money market that Harshad Mehta seemed to dabble in.

Money markets exist with money as a pre-condition. Added to that, there needs to be a central bank that controls how much money there is in an economy. A way to also effect monetary policy through the central bank is to have a market that estimates the value of the currency, the money of that country. The randomness is now a function of volatility, affected by the volume of commerce that happens in the country.

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