The Paradox of Money

A paradox is a statement that is self-contradictory or logically untenable, though based on a valid deduction from acceptable premises.

The world of money can be confusing, and two recent discussions got me thinking about how little people understand how money works.

But before that, let’s warm up with a mental exercise: You know Zeno's Dichotomy Paradox? In the fifth century B.C.E., Zeno offered arguments that led to conclusions contradicting what we all know from our physical experience. The Dichotomy Paradox is the one where a person can never actually reach their destination because they must cover half the distance, and then half of that distance, and so on ad infinitum. In other words, they never actually arrive at their destination although they are always getting closer. Now while you can follow this logic and it makes sense, at the same time you know that if you wanted to cross from one side of the street to another, you simply walk across and you have no trouble with half distance’s ad infinitum. And this is the paradox.

Similarly, when it comes to understanding money, our initial assumptions can often be misleading.

Now, back to the two discussions. Firstly, the Trump coin frenzy.

This coin was launched the day before the inauguration of President Trump. The coin's value skyrocketed overnight, only to crash down 40%. A friend asked this question: where does the money come from to pay out people who sell the coin at a higher price? For example, if someone buys the coin for $1000 and sells it for $10,000, where does the extra $9000 come from? This question seems reasonable at first glance, but it reveals a fundamental misunderstanding of how markets work.

The answer lies in understanding how open & free market dynamics work. When more people are buying than selling, the price goes up. When more people are selling than buying the price goes down. For you to buy the coin, you're buying it from someone who's looking to sell it to you at that price. If the price is not agreeable to both of you the sale does not take place.

This is the ‘value for value’ exchange that takes place during every transaction. Neither party is forced to trade with the other. And neither will any trade take place if one party does not value what they receive in the trade. For the trade to succeed both parties need to feel they will be better off after the trade than before the trade. If you later sell it for a higher price, you're finding a buyer who's willing to pay that price. If the price starts to go down, then more people are selling and flooding the market with the coin. If the coins are not selling, then the price will continue to drop until a buyer is found. If no buyer is found at any price then you are stuck with the coin.

So back to the Trump coin and the mystery of the extra $9000 - there's no central pot of money or vault; it's just an open marketplace of buyers and sellers trading with each other.

The second discussion was about interest payments on loans in world with fixed money supply. The question was: In a world with a fixed money supply (unlike what we have at the moment – but that’s for another day), where would the money come from to pay the interest on loans? The assumption here is that you borrow $500,000 to buy a home, and over a period of time you pay back $600,000. Now $100,000 has been created and where does that money come from?

Let’s answer this question by another example.

You go to buy a new car and the car you want is priced at $50,000. This price is made up of the all the costs taken to get the car into your hands, such as raw materials, manufacturing costs, labour costs, transportation costs, branding and marketing costs, rent, and the profit the dealership wants to make on the sale. Now if you don’t think the car is worth $50,000 you will choose a cheaper car at a price you are happy with, but the dealership still makes a profit on the sale of the cheaper car.

In the case of the interest paid on a loan, the interest is the PROFIT the lender makes on the loan. In fact if you look at the breakdown of the $500,000 loan you will see that admin fees, management fees and interest listed to make up the final real price of $600,000.

Just like the profit the car dealership makes on the sale of the car. This profit is what the lender feels is a good reflection of the risk undertaken in providing the loan. Therefore interest, like profit, does not create money out of thin air. It is a real cost that is part of the final sale price paid by the buyer.

While this is not a strictly business article it does involve money, and money is half of every transaction, and business is about successful transactions.