Tuesday, October 8, 2019

Study Cases

Money in a POW Camp

An unusual form of commodity money developed in some Nazi prisoner of
war (POW) camps during World War II.

The Red Cross supplied the prisoners with various goods—food, clothing,
cigarettes, and so on. Yet these rations were allocated without close attention
to personal preferences, so the allocations were often inefficient. One
prisoner might have preferred chocolate, while another might have preferred
cheese, and a third might have wanted a new shirt. The differing tastes and
endowments of the prisoners led them to trade with one another.

Barter was an inconvenient way to allocate these resources, however,

because it required the double coincidence of wants. In other words, a barter
system was not the easiest way to ensure that each prisoner received the
goods he valued most. Even the limited economy of the POW camp needed
money to facilitate exchange.

Eventually, cigarettes became the established “currency” in which prices

were quoted and with which trades were made. A shirt, for example, cost
about 80 cigarettes. Services were also quoted in cigarettes: some prisoners
offered to do other prisoners’ laundry for two cigarettes per garment. Even
nonsmokers were happy to accept cigarettes in exchange, knowing they
could trade the cigarettes in the future for some good they did enjoy. Within
the POW camp the cigarette became the store of value, the unit of account,
and the medium of exchange

Money and Social Conventions on the Island of Yap

The economy of Yap, a small island in the Pacific, once had a type of money
that was something between commodity and fiat money. The traditional
medium of exchange in Yap was fei, stone wheels up to 12 feet in diameter.
These stones had holes in the center so that they could be carried on poles
and used for exchange.

Large stone wheels are not a convenient form of money. The stones were
heavy, so it took substantial effort for a new owner to take his fei home after

1
 Tuesday, October 8, 2019
completing a transaction. Although the monetary system facilitated
exchange, it did so at great cost.

Eventually, it became common practice for the new owner of the fei not to
bother to take physical possession of the stone. Instead, the new owner
accepted a claim to the fei without moving it. In future bargains, he traded
this claim for goods that he wanted. Having physical possession of the stone
became less important than having legal claim to it.

This practice was put to a test when a valuable stone was lost at sea during a
storm. Because the owner lost his money by accident rather than through
negligence, everyone agreed that his claim to the fei remained valid.
Generations later, when no one alive had ever seen this stone, the claim to
this fei was still valued in exchange.

Even today, stone money is still valued on the island. But it is not the
medium of exchange used for most routine transactions. For that purpose,
the 11,000 residents of Yap use something more prosaic: the U.S. dollar.

Bitcoin: The Strange Case of a Digital Money

In 2009, the world was introduced to a new and unusual asset, called
bitcoin. Conceived by an anonymous computer expert (or group of experts)
who goes by the name Satoshi Nakamoto, bitcoin is intended to be a form of
money that exists only in electronic form. Individuals originally obtain
bitcoins by using computers to solve complex mathematical problems. The
bitcoin protocol is designed to limit the number of bitcoins that can ever be
“mined” in this way to 21 million units (though experts disagree whether the
number of bitcoins is truly limited). After the bitcoins are created, they can
be used in exchange. They can be bought and sold for U.S. dollars and other
currencies on organised bitcoin exchanges, where the exchange rate is set by
supply and demand. You can use bitcoins to buy things from any vendor
who is willing to accept them.

As a form of money, bitcoins are neither commodity money nor fiat money.
Unlike commodity money, they have no intrinsic value. You can’t use
bitcoins for anything other than exchange. Unlike fiat money, they are not
created by government decree. Indeed, many fans of bitcoin embrace the
fact that this electronic cash exists apart from government. (Some users of it
are engaged in illicit transactions such as the drug trade and, therefore, like

2
 Tuesday, October 8, 2019
the anonymity that bitcoin transactions offer.) Bitcoins have value only to
the extent that people accept the social convention of taking them in
exchange. From this perspective, the modern bitcoin resembles the primitive
money of Yap.

Throughout its brief history, the value of a bitcoin, as measured by its price
in U.S. dollars, has fluctuated wildly. Throughout 2010, the price of a
bitcoin ranged from 5 cents to 39 cents. In 2011 the price rose to above $1,
and in 2013 it briefly rose above $1,000 before falling below $500 in 2014.
Over the next few years, it skyrocketed, reaching more than $15,000 in
2017. Gold is often considered a risky asset, but the day-to-day volatility of
bitcoin prices has been several times the volatility of gold prices.

The long-term success of bitcoin depends on whether it succeeds in

performing the functions of money: a store of value, a unit of account, and a
medium of exchange. Many economists are skeptical that it will do these
tasks well. Bitcoin’s volatility makes it a risky way to hold wealth and an
inconvenient measure in which to post prices. At least so far, few retailers
accept it in exchange, and those that do have only a small volume of bitcoin
transactions.

Advocates of bitcoin see it as the money of the future. Another possibility,

however, is that it is a speculative fad that will eventually run its course.

How Do Credit Cards and Debit Cards Fit into the Monetary System?

Many people use credit or debit cards to make purchases. Because money is
the medium of exchange, one might naturally wonder how these cards fit
into the measurement and analysis of money.

Let’s start with credit cards. One might guess that credit cards are part of the
economy’s stock of money. In fact, however, measures of the money stock
do not take credit cards into account because credit cards are not really a
method of payment but a method of deferring payment. When you buy an
item with a credit card, the bank that issued the card pays the store what it is
due. Later, you repay the bank. When the time comes to pay your credit card
bill, you will likely do so by transferring funds from your checking account,
either electronically or by writing a check. The balance in this checking
account is part of the economy’s stock of money.

3
 Tuesday, October 8, 2019
The story is different with debit cards, which automatically withdraw funds
from a bank account to pay for items bought. Rather than allowing users to
postpone payment for their purchases, a debit card gives users immediate
access to deposits in their bank accounts. Using a debit card is like writing a
check. The account balances that lie behind debit cards are included in
measures of the quantity of money.

Even though credit cards are not a form of money, they are still important
for analysing the monetary system. Because people with credit cards can pay
many of their bills all at once at the end of the month, rather than
sporadically as they make purchases, they may hold less money on average
than people without credit cards. Thus, the increased popularity of credit
cards may reduce the amount of money that people choose to hold. In other
words, credit cards are not part of the supply of money, but they may affect
the demand for money.

Source: Macroeconomics 10th Edition by N. Gregory Mankiw