Speaking at the Asia-Europe summit Chinese Premier Wen Jiabao recently said, “The biggest responsibility is to stabilise the financial order as soon as possible. We need to use all available tools to prevent the crisis from harming real economies.” The Premier's comment is hardly in isolation. Take, for example, an article recently published in the Times under the heading Banking crisis infects the real economy, or one from The Economist on Oct 9th titled The banking crisis overflows into the real economy. You will note the continued use of the phrase "real economy" in all of these articles - as though Wall Street and the banking sector could somehow be considered in isolation from that other place where people are born, work, eat, sleep and die.
I even met a student of economics and international relations (studying at the University of Vienna) who insisted that the entire banking crisis was ridiculous and that the whole problem was simply mass hysteria... a psychological problem. Her belief was that if everyone simply kept believing in the system that it would be fine. The problem was a lack of faith. Once again, I was surprised by the hidden implication that losses in the money markets were somehow unrelated to daily affairs - as though the bankers and stock brokers of the world were busying themselves by day playing an elaborate game of monopoly which bore no relation to the homes we live in or the food we eat.
However only those leading the meanest of subsistence lifestyles, completely divorced from any kind of trade, could be somehow immune to events of the markets. In the era of specialization we are all bound to the market. Firstly it is the place in which we sell our products and services (which are far too specific and specialized to be useful in such abundance to us as individuals) and secondly they are where we source all those things which we do not make ourselves - which for most of us is virtually everything.
And in the market place it invariably occurs that one individual might need the services of another, without having any services that the other person might want in exchange. The lawyer who wants a haircut, for example, can probably offer very little to the hairdresser in terms of legal advice, in exchange for the haircut. Instead the lawyer must find (and offer) the hair dresser something that the hairdresser does want. And even the hairdresser cannot necessarily offer the baker haircuts every day or every week in exchange for bread. Perhaps the baker is bald. So the hairdresser too needs something of value to offer the baker, the dentist and the plumber in exchange for their services (especially if all these later happen to be bald). Naturally people seek out products which are readily tradable to fulfill this purpose - a commodity which others will readily accept for their services - and this becomes money. Money is a readily tradeable commodity which emerges from the economy - a medium of exchange to help resolve the problem that all of the various business people above have - the double coincidence of wants.
However, although this function (a medium of exchange) is important and can hardly be overstated - perhaps money's most important role is much less obvious. For money, as Carl Menger pointed out, having emerged from the economy initially as a medium of exchange then starts to serve a very different purpose. Once money has emerged and one can readily trade goods for money and money for goods, it becomes possible to compare the prices that people pay for goods in the economy in terms of that common reference. Of course, people will pay different things for even the same goods. One person might pay $1.10 for a loaf of bread where another pays $1.20, but in sufficiently large markets where competition is present someone who happened to have a few hundred loaves of bread would probably be able to guage with a fair degree of accuracy how much he or she might be likely to sell that bread for based on the recent sales of similar products in the market. And so one might be able to estimate the potential monetary value of, for example, a few hundred loaves of bread or a box of beer or a house or a swimming pool.
The monetary value that we attribute to things (based on recent prices that they fetched in the market place) then makes it possible to compare the relative exchange values of different products and services in the economy and makes possible the otherwise impossible task of accounting. With a common unit of estimated value that can be attributed to each of the assets that a person holds, as well as a unit by which they might measure their revenues and expenses, it is possible to guage the profitability of one's activities. And when seen as an aggregate, the sum of the activities of all of the businesses in a particular region might be tallied to guage whether their activities have been profitable or not.
What exactly does profitable mean in this case though? Certainly, in the absence of inflation or deflation, someone running a profitable business will end up either with more money and/or controlling more capital at the end of the year than they had at the start. However, someone who toils to build up a business might well decide that, despite the fact that the business is making a "profit" from a purely monetary point of view, there is no sense in their continuing to invest time and effort in that business. Perhaps they have enough money already and would like to spend more time with their family and friends, and this is the reason that they decide to discontinue the activities of the business. In a purely Austrian sense of the word, the business in this case would not be profitable to the business owner since the cost of continuing business (less time spent with family and friends) outweighs the benefits (more money). So although money makes it possible to maintain accounts and guage the profitability of certain activities, there are most certainly many things that fall outside the realm of monetary calculation. Indeed, virtually anything that is not easily exchanged in the market place (such as time spent with one's family) will be difficult or impossible to place a monetary value on and thus impractical to include in one's accounts.
Of course, it is often said that everyone has their price and perhaps one could argue that the businessman above, for the right price, might be persuaded to continue the business. Perhaps if the business would turn a profit of at least $500,000 a year then he would be willing to sacrifice the extra time that he would have with his family in order to pay his son's way through a Havard law degree. So perhaps he could enter into the books an expense "Time not spent with family: ($500,000)". And perhaps for the business owner, this would be reasonable. If the business made more than $500,000 then he could say it was profitable (for him personally) and if it made less than $500,000 it was loss making (again, for him personall). Certainly the IRS would raise a few eyebrows at the accounting entry and he would be wise not to disclose this particular expense to a potential buyer of the company (who would see immediately that the business was worth much less to the present owner than they might otherwise have assumed, if they had seen a set of books that omitted this particular detail).
If we are to rule out the use of such creating accounting measures for the time then (which is not widespread in any case), the only thing that we can really say about profitable businesses in an economy is that the goods/services produced by these companies have a higher exchange value than that of the goods/services they consume. Companies that consume more than they produce are said to make a loss and companies that consume less than they produce are said to make a profit. Of course, the consumption and the production are expressed in monetary terms but that does not mean the companies are actually consuming money. What they consume is resources, such as steel, iron, health insurance, mathematical modelling services etc. And what they produce is no doubt some similar form of real, tangible good (maybe computers or apple pies).
When companies make a loss then, what goes missing from the economy is not money... indeed, if under our present banking system this happens from time to time this is entirely incidental and besides the point. More importantly for human concerns is the fact that the company consumed many more resources than it gave back to the economy. Those companies in our economy which make losses cost us (normally shareholders - but in the present day the government has taken it upon themselves to spread the pain far and wide, to be bourne by any productive citizen that they can get their paws on) and the cost is not merely monetary. The loss is not fictive or imaginary; it is not some wild hysteria or a lack of faith in the system - it is the loss of those real resources that the company consumed (steel, iron, health insurance and mathematical modelling services).
The creation of new money cannot fill the void that loss making companies (or banks) leave in their wake. Indeed, the losses that companies make are made on the basis of historical records and time, as we all know, only moves in one direction. There is no way, short of a time machine, to undo the losses that those companies make. The only thing that can be done is to try to prevent such companies from making losses again in the future, which is best achieved quite simply by dissolving the companies in question - freeing the resources that they consumed to be used by the remaining companies in the economy (which are profitable).
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