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  • The Physics of Money and Value

    A standard definition is that Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as:

    ·         A medium of exchange; a unit of account

    ·         A store of value

    ·         Occasionally in the past, a standard of deferred payment

    Any kind of object or secure verifiable record that fulfills these functions can serve as money.

    That is the standard definition, but what is important to you is not the preservation of money, but the preservation of value. Money itself is a human construct, even according to the standard definition it is dependent on the humans using it to give it definition within some economic context. What we need to do if we are going to break free of the manipulations of the Federal Reserve, the bankers and politicians is to clear our heads of anthropocentric definitions of money and look to the solid foundations of physics which provide less subjective definitions of value. It turns out this isn’t as hard as it might seem and rest assured that this will be more common sense than hard work. First, let’s modify the standard definition of money by stating that:

    Money is a method of measurement of value.

    But what is value?

    Value is the potential to do useful work.

    You use money to make things happen. To move yourself into a house, to get food, to pay for heating and cooling your home. Physics and thermodynamics give us a way to understand what value is objectively rather than through distorted anthropocentric economic theories. There is no concept known as ‘money’ in physics, but there are measurements and laws which govern the fundamental units of the physical world, the real world wherein you and I live and what is necessary to accomplish useful work.  While ‘money’ can be made worthless in the blink of an eye through human whim (through currency devaluation, or even by changing the exchange rate of that best money, gold), the laws of physics are conservative and give us a more solid foundation. Bear with us through some science 101 so we can get to some underlying economic truths you will find nowhere else. We promise to translate the science into plain English quickly. Here are the two Laws of Physics that apply:

    1) First Law Conservation of Mass-Energy: Matter and energy is neither created or destroyed.

     dM + dE = 0 (where M is the mass and E is the Energy). The little ‘d’ for those not mathematical is the symbolic way of saying differential change.

    2) Second Law  Law of Entropy – Within a closed system, order can only degrade (or stay the same for a reversible process) but not improve without an outside energy source.

     dS >= dQ/T (where S is the entropy, Q is the energy per mass and T is the reference temperature)

    3) Gibb’s Free Energy – Nothing happens in the world without a negative change in Free Energy. This isn’t a law, but really a mixture of the first two laws.

    dG = dH – T dS  

    (Where G is Free Energy and is understood to mean energy that is free and available to do work, H is the enthalpy or internal energy, T is the reference temperature and S is the entropy)

     

    The G term, Free Energy, is what is important and represents value both in the world of physics and in economics, the ability to make things happen! Now we need to translate these three physical laws into plain English that you can understand and show how they lead to a common sense concept of value which will help you preserve your assets and income within an economic situation spiked with fraud and statistical noise.

     

    1) First Law: Mass and Energy are valuable commodities that will always have some intrinsic  value and can’t be destroyed. The prime example of this is gold, which is valued for its mass physical properties, rarity, density etc. Oil is another example, which has value both as mass (carbon and hydrogen) but more importantly as an energy source. Even bare dirt can have value as real estate. So the First Law of Physics is the first approximation we have to value (as seen by the age old adoption of gold as a monetary standard).  But this First Law isn’t sufficient to bring us into the modern age because we know most of our personal wealth is not tied up in gold or oil or even in physical commodities like bushels of corn. We know even solid physical assets like real estate can be devalued as they have been since the 2007 subprime crisis, so while the First Law is important it cannot be the sum total Law of Value;  we have to account for the information value of money.

    2) Second Law: the Law of Entropy and Disorder.  It turns out that the Second Law of Physics, the law of entropy, is also the Law of Information because the opposite of disorder is order, or information. Negative entropy, negentropy, or order evolving systems would be information. We won’t go into all the history of how information was tied to entropy through the field of statistics, other than to say there is a vast science called information theory based on the Second Law  thermodynamics.

    The physics definition of entropy is at first confusing to laymen because it says in a nutshell that everything falls apart eventually. The way we get around the disorder predicted by the Second Law is to use the sun (or occasionally nuclear energy) to reverse the effects of decline – that’s why trees grow in sunlight as energy is used to displace the disorder to the universe. That’s why we can use the power from electrical plants to run our computers and concentrate ever greater amounts of information

    But you don’t care about physics or about growing trees, what you care about how this affects your portfolio and the value of money. What is important to notice is that the Second Law is an inequality. That is, dS >=dQ/ T/D. What that means to you in a practical sense is that unlike a fixed element like gold, the amount of information in a system is dynamic, it has no fixed value, and what value it does have tends to degrade with time. That means money can have both a fixed commodity component as well as a variable informational component and in varying proportions. It is the variability of the informational component that subjects your finances to the greatest risk of theft by the state.

    Our money is by political design for the most part now pure information, fiat money, created from the ether. We barely even bother with flimsy paper money anymore, but rely on bits of information in bank computers and cyberspace. Our Federal Reserve has created half trillion dollar in currency creation to backstop European banks at a keystroke. Unlike commodity money, digital fiat money (information money) can appreciate, or depreciate, on the whims of the Federal Reserve as it ‘prints’ more greenbacks (though it doesn’t even bother to print bills anymore). Our money can also change value based on rumors and regulations.

    In normal situations when Central Banks aren’t printing money to prop up failing sovereign debt and private banks, the market works out the informational value of money on a daily basis through day to day minor transactions and stock markets. However, intervention by politicians and central banks has completely dislocated this value discovery process, attempting to create money by fiat.

    Our conundrum is that we know commodity money like gold, oil and even bushels of corn have value, but our bankers have convinced us that pure information in the form of digital accounting entries is real money in the modern age. So who is right?

    Well they both are, but to nail this down in terms of physics we need to explore the final relationship, which is sometimes called a third law.

    3)  Gibb’s Free Energy equation, or by other names in chemistry and other fields. This states in English that no reaction occurs unless there is a negative change in the Free Energy of the system, defined as a change in the energy per unit mass plus the change in information content. This is something you haven’t read in an economics book, but is critical to your financial understanding of inflationary processes. In essence, it is the addition of the first two laws:

    Nothing happens unless there is a negative change in the mass and/or energy and/or information of a system.

    In other words, you have to exchange some combination of physical commodity (gold), energy (oil) and/or information (an engine design, digital data).  All we’re doing is formalizing what you new intuitively already, but that bankers and politicians have tried to obscure. Another way to say this is there is no free lunch, you have to expend resources, energy and brains to make things happen. It is the hard to pin down informational value that makes things so slippery. We can demonstrate the concept quickly:

    If you wanted to feel rich in these uncertain times, which would you rather have? 

    ·         $200,000 in the bank drawing 1% interest, or

    ·         $50,000 in cash, a paid off home, a basement of groceries, a bunker of heating oil and a small pile of gold?

    Now, each individual situation is different, but what is clear is that the person who owned a mix of commodities and cash could logically lay claim to having the same wealth as the person with just cash. Who is in reality better off is subjective (the subjective Second Law inequality relationship). But what we have just shown you is that your wealth can be a combination of Mass (like gold), Energy (fuel oil) and/or Information (a digital bank account). This is just a restatement in economics terms of the Gibb’s Free Energy equation; you can make things happen if you have a gradient of wealth made of mass, energy and information that you can ‘spend’. No big deal you may think, but it leads to a Eureka moment when it comes to the practical question of how to preserve your wealth.

    Wealth is the ability to make things happen. It can be composed of elements of mass/energy, and elements of information. The mass/energy elements of your wealth are relatively hard to steal, but the informational wealth in the form of fiat money and paper financial instruments can be stolen at the whim of government, the Federal Reserve, or by digital thieves in a nanosecond.

    Which would you rather have in uncertain times?



    Comments

    Daxton Brown www.futurnamics.com 2011-11-08
    You won't see a discussion of the physics of money coming from any of the Keynesians. There is no such thing as a free lunch.
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