A careless boy has broken the baker’s shop window. The baker is angry. Now he will need to spend his hard-earned money on replacing the window rather than buying himself a new pair of shoes. The glazier, however, is happy.
We intuitively understand that this (presumed) accident in which value has been destroyed is an economic loss. But the fallacy of the broken window concerns the belief that it is still good for ‘the economy’ that the glazier gets paid. Why do people believe this? Does it relate to the nature of money and society?
In Bastiat’s parable, the baker just happens to have some money, supposedly because he has produced and sold something like bread. If the window had remained intact, the overall wealth of the world could have increased by a pair of shoes, as the baker could have used the same money to order them from the shoemaker. This opportunity cost is Bastiat’s economic and logical argument, in a context where money seems scarce and difficult to obtain, like bread, shoes and window repairs.
Of course, most of the time money appears to be precious like this. However, imagine that it was the ba(n)ker himself who created what we call ‘money’ these days, essentially, a symbolic token that others accept in exchange for their goods and services. In this case, the baker has not added any real value to the world. He merely takes it from the glazier or the shoemaker and offers to give them bread afterwards in exchange for the token. If the window breaks, there is no real opportunity cost, as the baker can issue another token to buy himself those nice shoes. All he has to do is honour his promise of reciprocity by accepting the tokens as payment for bread.
Compare this to a situation in which the baker creates ‘commodity money’, such as barley that he stores in the shop. The baker invests his limited time and energy in producing a certain amount of barley first. So, when he offers it to the shoemaker, the shoemaker knows that the baker has made an economic decision akin to his own decision to make a new pair of shoes instead of something else. This means that if the window breaks, there is a real opportunity cost: the barley will go to the glazier and the new shoes won’t be made. Still, by making an excellent bread that the glazier will want to buy, the baker can recover his investment as well as his dream of a new pair of shoes.
These two kinds of exchange systems are very different. They’re actually opposites, in the sense that one requires a previous investment and the other one a subsequent investment; one is based on the demand for money, and the other one on the demand for goods; one makes reciprocity desirable, whereas the other one makes it a moral obligation. Yet from a sociocentric perspective, the two appear to be the same: it is good that people get paid with anything that is regarded as money.
Hence, the broken window fallacy stems from a more fundamental monetary fallacy. To use Bastiat’s terms, it is seen that a symbolic token can be used to purchase shoes and window repairs. This expenditure runs what is called ‘the economy’. But the world is in fact worse off than if the baker had made some bread and exchanged it directly for those things. There is a constructive alternative that remains unseen, and that relates to a monetary product we want to save rather than spend.
In a society, those who want to spend money rely on others who want to save it; but those who want to save it only do so because they are able to spend it. Money is thus theorised to have the properties of being a medium of exchange and a store of value in a form of circular reasoning: money is a medium of exchange because it is a store of value, and it is a store of value because it is a medium of exchange.
As seen above, however, this confusion relates to what I have called a sociocentric perspective. Objectively speaking, there are two kinds of tokens that can mediate exchanges: one that originates precisely to mediate an exchange, and another one that originates as a store of value. The first only appears to store value because certain norms encourage others to accept it, whereas the second derives its acceptance from the fact that it actually stores and adds value.
Therefore, to be precise, we should refer to the first one as credit. Indeed, the symbolic tokens are promises of reciprocity that make their holder a creditor of the baker in the normative context of a society. The baker is backing these promises with bread, so he will have to limit their issuance – or else the shoemaker, the glazier or other members of the society will be left with nothing but a legal claim against the baker. This artificial scarcity creates the perception that the tokens are precious and that value is stored in them. However, only the second kind of tokens are money, moneta, a reminder of something already known or done.
This original investment is what makes barley preferable to a mere promise, enabling an evidence-based interaction that has no social boundaries: the real economy. In Bastiat’s parable, there is an opportunity cost for the buyer of shoes if the window breaks, but the same applies to the seller. Assuming that the shoemaker is rational, he will avoid taking credit from the baker when he can take money from an outsider. He would rather exchange his craft for something comparable in value, something that he will want to save because it attracts similar investments from anyone, not only from members of a society.
Thus, money has a disruptive effect on the traditional landscape of human societies. In Bastiat’s society, we would expect the baker to try to persuade the shoemaker to accept his credit over a foreigner’s money – otherwise he won’t get the nice shoes! The baker may talk about loyalty and the shoemaker’s duty to help his neighbours. He may even threaten to break the shoemaker’s window and confiscate the barley if he decides to trade with this stranger. This will be good for ‘society’ because the glazier, again, will be paid.
This analogy shows that money is fundamentally about partner choice, and that credit restricts such a choice. Societies use the power of symbols to channel resources toward their own members, away from the real economy in which human beings interact openly. They often begin by minting ‘good money‘, such as gold coins or gold-backed notes with a nominal value tied to the image of an Emperor or a God. This reliance on money facilitates trade when laws are not so effective and actual trust is required. Then they begin to reduce this backing until the ‘good money’ becomes pure credit, such as the ‘fiat money’ (‘let it be money’) we use in these days of powerful nation-states.
This kind of deceptive, collective exploitation relies on the fallacy of calling those two different things – credit and money – by the same name, a fallacy rooted in our confused beliefs. Money relies on natural facts that all human beings recognise, whereas credit relies on a ‘social fact’, a declaration that only some people recognise. This is why the study of money is so interesting. It reveals much about human nature, language and the mind.
The arrival of Bitcoin and the subsequent explosion of cryptocurrencies has brought the present topic to the fore. Certainly, if anyone with a computer can create money that exists freely on the internet, then much about our traditional social values is undermined. Money does not need to be any sort of commodity nor does it need institutions, as these two narratives fail.
What, then, is money? In the previous sections I have used the example of barley. I could also have used gold or other precious metals. These things are ‘hard money’ that cannot exist in cyberspace. However, things change when we consider that the value of those assets is not in their industrial or decorative utility, but in their signalling utility.
Money is a kind of transferrable signal. As I showed above, what’s important is not that the barley has an ‘intrinsic value’ due to the fact that it’s needed for bread and other products. What matters is the baker’s investment in and of itself. Barley can be called money because it is good at registering this prior investment. This makes it a trustworthy signal directed at other investors. The signal says that the baker is special, and gives them a reason to choose him as an exchange partner.
Barley is precious, unique, durable, fungible and divisible. These properties attract the investments of others whose time and energy are also precious. By seeking this form of property, they are looking to be chosen as partners, to be special. Likewise, what makes precious metals valuable is not their industrial or decorative utility but their signalling utility. Even if an individual finds a gold nugget by chance (that is, without employing meaningful time and energy), she knows that, almost always, this requires work. In principle, it doesn’t matter that she has not made this prior investment, but she can require it from others before she hands gold to them.
This note is not the place to discuss the functioning of Bitcoin, but if you are familiar with it, you may have realised that this is what makes a bitcoin or any of its subunits valuable. The internet is a medium of communication, and Bitcoin reproduces the signalling function of money on this electronic medium by making certain numbers transferable and precious. This Platonic scarcity is what makes Bitcoin the apex of money; it is achieved via an investment of computational energy called proof of work. The proof of work is not unique to Bitcoin but can be implemented by any similar program, which can be run by any number of computers that communicate over the internet.
Like any computer program, Bitcoin can be copied and edited. This means that many cryptocurrencies can be considered copies of Bitcoin, which raises the question of whether they can all be considered money. In light of the present analysis, the answer is yes: a proof-of-work cryptocurrency can be considered money because it is designed to signal a prior investment of energy, and therefore has an immediate potential for circulation.
Still, Bastiat’s argument does not only apply to the distinction between money and credit; it also applies to the distinction between forms of money. Imagine that the baker’s society preferred to transact in barley. The baker produces barley instead of gold coins and uses it to buy shoes, even though the shoemaker is better off making the deal with an outsider who offers gold coins. Now, imagine that what was being exchanged were mere numbers, a balance in two different accounting ledgers. In this case, any preference for a particular substance is reduced to zero, so it makes even less sense to choose an accounting ledger that is less precious.
Indeed, Bitcoin is the best form of money because it created the possibility of making numbers precious, and in doing so, it became necessarily the most precious. In such a Platonic realm, there is no logical room for alternative stores of value.
Money is a signal that makes the signaller special, yet so are the many cultural symbols that people identify with the world over. We have evolved to perceive real value in these irrational symbols, which is a fallacy that produces a lack of economic understanding. Thus, many people view the current menagerie of cryptocurrencies as valuable tokens because people can agree to use them as means of payment. But this sociocentric perspective is even more fallacious in cyberspace. There can only be one internet money, just as there is only one internet. Every attempt to deviate from this natural tendency is an anti-economic decision akin to the fallacy of the broken window.
- The ba(n)ker here issues an IOU that banks normally lend to others rather than spend directly. Because these IOUs can be backed by assets, some theorists believe that banks do not create money out of nothing. However, these ‘assets’, such as the British pound or the dollar, provide no final settlement, unlike bread or barley. They are themselves IOUs in a social, normative context that theorists mistake for a natural context. ↑
- The shoemaker may well make the shoes in expectation of future demand, but this would begin to reverse the system by putting goods and services before money (see endnote 7). It would also be a net cost, as the shoemaker could have employed the same time and energy to obtain commodity money from someone else who demands a different product. This is the basic problem of efficient resource allocation that concerns economics, and that makes economics a science by tying it to reality. ↑
- The first system consists of final exchanges in which the recipient gets something of value that he could not produce, and privileges the baker for his ability to invest in it. By contrast, the second system consists of delayed exchanges in which the recipient gets an IOU. This privileges the baker for no particular reason. When the window breaks, purchasing power is merely transferred to the glazier; effectively, the baker in Bastiat’s parable has repaired a broken window. ↑
- This problem relates to the confusion of currency with money (e.g. Greco, 2001; Kelleher, 2021; Krawisz, 2014). It arises especially in the study of money origins, in the form of metallism (store of value) versus chartalism (medium of exchange). Theorists debate whether monetary value has substance or whether it is simply debt that is institutionally recorded. However, theorists take a sociocentric perspective that prevents an objective view of this social phenomenon, with the metallists still claiming that for something to be money, it has to be ‘generally accepted’ (see endnote 6). ↑
- These measures are the basis of legal tender laws, which state the obligation to accept certain tokens as payment for any debts incurred. In this way, the tokens are not only declared as valuable but actually become valuable in a world of debt and taxes. Similarly, the belief that war is ‘good for the economy’ is simply a statement on the demand for a nation’s currency that is arbitrarily imposed after destruction or the threat of it. Consider the rise of the Roman Empire and the subsequent devaluation of its currency. The current devaluation of the US dollar follows the Bretton Woods agreement, the Iraq War, and other similar attempts at establishing the dollar as the world’s reserve currency. ↑
- Interestingly, the narrative that money is a commodity fails because theorists insist in making the social or cultural argument that for something to be money, it must circulate and perform the function of being a medium of exchange. But what does this ‘general acceptance’ mean, especially in a world where we order from Amazon with a smartphone? One can imagine a situation in which money is not generally accepted and does not circulate at all; or, conversely, a situation in which people agree to transact with something that cannot be money, such as rocks, dollars or ether. Money can be distinguished from non-money in that it has been secured for the purpose of exchange, which does not imply that it must be exchanged to become money. ↑
- This view of signals relates to my proposed biological definition of language, in which I describe the error of adopting a sociocentric perspective of human behaviour in general. Consider, for instance, Linton’s definition of money as an ‘information system we use to deploy human effort’ (Greco, 2001; Lietaer, 2013). In this view, the shoemaker’s need to sell shoes is put centre stage. ‘Money’ is then a process of matching this offer with somebody’s want within the group of people called ‘we’, and then issuing the corresponding record of the trade. This is the broken window fallacy in a different suit. What matters is that the shoemaker (or the glazier!) gets paid, not the unseen possibilities of economic growth as represented by the new pair of shoes. ↑
- The proof of work neatly resembles the search for gold. Different computers compete in finding a solution to a numerical problem, which will result in new bitcoins awarded to them. It is statistically possible, though not very likely, that one of these ‘miners’ will find the solution without doing any significant work, in the same way as it is possible to come across a nugget of gold. ↑
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