The Evolution of Money Chapters for Cluj

5/26/2018 The Evolution of Money Chapters for Cluj

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Lszl Mr

THE EVOLUTION OF MONEY

Selected Chapters for the Economic Psychology Class at Babes-Bolyai University, Cluj, !!"

1. Interest-bearing st!"#is$

Good ideas compete for capital, but capitals also compete for good ideas.

#obinson$s dream % &he nature of interest % &he protagonist appears on the scene % 'oney ascapital % &he role of psychology % &he self-reproduction of capital % &he perspective of thestoc(-fish % &he various forms of life

%. T$e birt$ # e!n&i! 'al(eExchange creates new economic value similarly to a car factory: it re-arranges the existingmaterial into a more useful form.

E)change creates value % &he principle of comparative advantages % &he problem ofe)change rates % &he idea of demand % E*uilibrium in the mar(et % Consumer surplus and

producer surplus % +utocatalysis in economy

). T$e nat(re # in'est&ent *e!isins

Every starting enterprise is more or less a bluff.

#obinson$s ne dream % ounding an enterprise % &he value of #obinson$s idea % #obinson

as an employee and an oner % #obinson becomes a majority oner % &he company beginsto or( % .t is not the company that produces the yield % /ecisions made by consumers andinvestors % #is( and yield, nothing else % #ichson$s dog

+. ,$ as a /s!$lgist aar*e* t$e Nbel /rize in e!n&i!s0

It is also rational if one does calculate upon ones own irrationality.

/iversification % &he beta % C+P', the Capital +sset Pricing 'odel % #is( see(ing, ris(avoidance % Prospect theory % C+P' and Prospect theory

. Mne t$e &ti'atr

Even if money does not mae you happy, prolonged and severe lac of money definitelymaes you unhappy.

E)ternal and intrinsic motivation % 0hen do you have enough money % /efensemechanisms % &he flo % 'oney and happiness % 'oney motivates to ma(e money


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1. Interest-bearing st!"#is$

Good ideas compete for capital, but capitals also compete for

good ideas.

+ccording to family legend, my grandfather dragged his brain a lot in the nd0orld 0ar hoto invest his little ealth2 .nvesting into an enterprise as out of the *uestion in thosedisturbed times2 3eeping it in money as not orthhile either, for it as sure to be inflated

4and it sure did, although even he could not foresee the orld record hyperinflation in5ungary after hich the street seepers sept up the valueless million, billion, and*uadrillion peng6 ban( notes2 5o should he save his possessions until the ar is over 7old

preserves its value, but it can be stolen easily2 Should he buy a house .t is difficult to steal,but can hardly ithstand bombing2 Should he buy a piece of land .t ithstands bombing, butdoes not tolerate nationali8ation too ell4he foresa this danger correctly ell in advance2Should he invest it in salt .t ithstands both bombing and nationali8ation, but it is veryheavy2

&here is no happy ending2 9either my grandfather, nor the family possessions survived thear2 &his short train of thought did survive, hoever, and no . also do something to help itlive on, this time as an e)ample of the competition among the various forms of money :orcapital, rather;2

&his is a boo( about the evolution of money, and e have (non since /arin that evolutionalays develops from the competition beteen different varieties2 Since /arin, hoever, ehave learnt many other things about ho life or(s2 Biology researchers of the past centuryand a half have succeeded not only in revealing many important details, li(e brea(ing the

genetic code, or solving the structure of /9+, but they have also given ansers to much morecomple) and larger scale *uestions< e have come to understand the nature of the mechanismunderlying life2

=iving beings aregenerated by things :genes; that are not alive in themselves, but together, inappropriately assembled groups are able to code the most varied living beings, and underappropriate environmental conditions, the beings they code really come into e)istence2 0iththis discovery, biology of the !thcentury discovered a mechanism that points much beyondthe form of life e call biological life2 .t may very ell be that the principles of operation ofso calledspiritual lifeor economic lifeare based on the very same logic as those of biologicallife2

2binsn3s *rea&

5istory drove my grandfather into a too complicated situation2 =uc(ily, a number ofeconomic mechanisms can be e)cellently demonstrated by much simpler e)amples, even bythat of an uninhabited island2 .f all the fables economists have ritten about #obinson erecompiled in a boo(, it ould be many times longer than /efoe$s original novel2 0hy shall enot start also ith him

>n this uninhabited island, the only source of food #obinson has is the fish daring to comeclose enough to the shore2 0hen #obinson in luc(y, he can bash them on the head ith hisclub, so he can eat them2 5oever, the fish are bris(, and #obinson can catch only five pieces

of fish a day by beating the ater all day4hich is just enough to earn his daily food2 &his is


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ho #obinson lives from one day to the ne)t2 5e is dead tired by the evening, and justtumbles over on his simple lair under a big tree, and daydreams a little before falling asleep2

&here are trees on the island, that bring no fruit, but from hich nice thic( rinds can be splitoff2 >ne could ma(e a primitive fishnet from these rinds, ith hich #obinson could catch asmuch as tenty fish a day2 .f he had a net li(e this, #obinson ould have to or( only onevery fourth day, and could do many other things on the other days2 Preparing such a net,hoever, ould ta(e thirty days4during hich #obinson ould starve to death2

+pparently, #obinson as to spend the rest of his life clubbing fish, for there is not muchchance of a British ship coming along and ta(ing him home2 But it is hard to live ithouthope, so #obinson continues to hope at the bottom of his heart and diligently beats the fishday by day, so that if miracle did happen, it ould find him alive2

>ne day, another #obinson, also living as a lonely castaay on a neighboring island, appearsune)pectedly on the scene2 &his second #obinson has some surplus fish, because he is mores(illed ith the club than our #obinson, and can catch as much as si) fish a day2 So he madesome stoc(fish by letting his unsalted fish dry naturally by sun and ind2 &hus, 1@! e)tra

pieces of stoc(fish accumulated in the course of times, hich he stored for uncertain times2

&his second #obinson4let$s call him #ichson4can see #obinson$s distress perfectly, andunderstands #obinson$s dream about the fishnet2 5e offers to lend him his on 1@! pieces ofstoc(fish ith the condition that #obinson ould spend the ne)t thirty days e)clusively by

preparing the fishnet, and from the ?1 stday he ould give #ichson five pieces of fish everyday for a year2

&he offer elicits mi)ed feelings in #obinson2 >n the one hand, he finds it impudent that#ichson as(s for 1@! pieces of fish monthly :in fact, even 1@@ in the ?1-day months; for 1months in e)change for a loan of 1@! pieces of stoc(fish2 >n the other hand, if #obinson

consents to the offer, in thirty days he ould have to spend only every other day fishing,because he could catch tenty pieces of fish a day, paying bac( ten and eating ten for todays2 +nd his situation ould be even better after a year2

#obinson is more and more inclined to rise above his moral indignation over #ichson$simpudence and accept the offer, nevertheless, he tries to negotiate a little2 But #ichson notonly appreciates #obinson$s great idea, but also sees his desperate situation, so he does notgive in2 #ichson e)plains ho much ris( he ta(es even ith an unconditional faith in#obinson$s trustorthiness and not even thin(ing of the possibility of #obinson not (eepingthe agreement2 #obinson might not even live for thirty more days, hile eating a substantialamount of #ichson$s fish, and leaving #ichson ith a half-ready, good-for-nothing fishnet2 .nthe heat of debate, #obinson *uic(ly ma(es fifty push-ups to prove his good physicalcondition, so #ichson does not have to fear not getting his fish, and even much more, bac(2

#obinson, hoever, is troubled by something else as ell2 .f he agrees, he ould have to giveup his hope to be saved by a British ship for a year, for being an English gentleman, he couldnot leave the island ithout having paid his debt2 &hus, #obinson proposes that if a Britishship appears, #ichson ill get #obinson$s fishnet, thus repaying all debt2 #ichson replies thatthe net is useless, unless somebody fishes ith it, so he insists on getting fish for his fish,rather than some ma(eshift stuff fabricated of rinds that is useless for him2 #ichson does notant to adopt #obinson$s invention, he has a different idea of getting along in the future2

+fter various spectacular shos :#obinson$s push-ups, #ichson$s moc(-anguish, etc2;, theyeventually sha(e hands and agree that from the thirty-first day #obinson ill pay 1@! piecesof fish every month, but if a British ship happens to appear, #obinson$s duty to pay is


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automatically terminated2 Eventually, #ichson further acceded to getting an fi)ed amount of1@! pieces of fish each month2

.n this business, #ichson ha8arded his 1@! pieces of fish in the hope of a long-term profit2 5egave all of it to #obinson immediately, because he did not ant to deal ith this issue in thene)t thirty days2 or #ichson, even this very promising business ould not be orth if he hadto spend his time ith chec(ing #obinson$s progress every day2 &rust is at the root of

business the ris(ier the business, all the more2

T$e nat(re # interest

.t is a popular lay opinion that interest is the price of using the money2 5oever, this vie isrong2 Using money is free< hen e spend money, e pay no fee for using it2, .t could beraised as an objection that one has to pay a fee for using money only if e use somebodyelse$s money2 But even in this case, money or(s differently from other things2 .f . have ane car . do not need right no, and lend it to someone ith the condition that . ant a

similar ne car hen . get it bac( tenty years from no, e feel it is fair2 But if . antedtwosimilar cars, .$d get *ueer loo(s2 et the very same thing happens hen . put my moneyin the ban(4even in times of inflation2

&he agreement beteen #obinson and #ichson points at the essence of interest better2 &he1@! pieces of lent fish ma(es it possible for #obinson to increase his fish-production sometime in the future, in our case, in thirty days2 #obinson thin(s it is orth paying some of thee)tra fish as an interest for the loan4not to tal( about his life becoming more comfortable2

.nterest is the fee for the immediate availability of the money 2 #obinson is illing to pay sucha hideous interest for 1@! pieces of fish not because he is using them, but because they areimmediatelyavailable2

0hat if #obinson (ne at the time of negotiation ith #ichson that there ill be another#ichson in a year ho ould be satisfied ith getting the five pieces of fish daily only forhalf a year after the thirtieth day &his other #ichson is not very inhibited, either, for heould also ant si) times as much fish as the loan, but he is very reliable and is sure to comein e)actly one year2 5oever, it is not certain that #obinson ill still be alive if he has tocontinue clubbing five pieces of fish every day for one more year in order to eat2 #obinson isoptimistic and strong even in a strained situation, but this #ichson is present here and no2or #obinson, it is orth paying more for not having to club fish for another full year2

or #obinson, 1@! pieces of borroed fish is orth more today than later2 .n technical terms,e can say #obinson has a time preference2 &his prompts him to be illing to pay even a very

high interest for the loan of the 1@! pieces of fish2 #ichson, of course, e)ploits this, even ifpeople fron on his behavior2 or there is another side to interest, beyond being the price ofthe time preference of the borroer2 >n the part of the loaner, interest is the price of thesacrifice of not consuming the produced goods for a longer period2

#ichson says he actually helps #obinson fulfill his dream, and nobody forces #obinson toma(e this deal2 #ichson is right in this, and he can be forced to behave more modestly only bythe concurrent #ichsons and the development of the financial mar(et2 By the time e meet#obinson and #ichson again a fe chapters later, all this ill already be available2 +s e$llsee, #ichson ill offer much more refined financial constructions to #obinson to reali8e hisne dream :actually, a fishing ship;2


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T$e /rtagnist a//ears n t$e s!ene

&here has been no ord about money yet, but e have tal(ed about interest already2 0ith thise have folloed the same approach usually ta(en by standard te)tboo(s in finance2rederic( S2 'ish(in$s idely used te)tboo( in finances begins to tal( about hat money is

only in the ?rd

chapter2 5e starts ith the situation hen a robber suddenly pops up and shoutsat us Dour life or your moneyF ell, in this case e do not as( him D0hat e)actly do youmean by moneyF 0e may even fare ill by acting uncomprehending, for the robber might, onthe spur of the moment, include our nec(lace or pair of ne shoes2 'eir 3ohn$s financialte)tboo( begins to discuss the concept of money in Chapter A ith the sentence D0e all (nohat money isF2

By this time, both authors have used the ord money several times2 +nd justly so, since edo understand its meaning2 et there is no agreement even among economists hat e)actlymoney is2 'oney is usually defined by some of its functions :means of payment, medium ofe)change, unit of settling of accounts, measure of assets, preserver of assets, means ofdelayed payment, etc2;, then list some things that used to embody these functions :beads,shells, tobacco, beer, salt, butter, (nife, animal s(in, hale-teeth, etc2; and some that still do:cash, ban( savings, ban( card, chec(, bonds, shares, options, insurance, etc;2

&he topic of our boo( regards a special aspect of money, namely, that money can bear money2Principally, this aspect may elicit the interest of a scientific-minded person2 .t is self-evidentfor a scientist that our concepts are developed through ell-selected and thoroughly studiedindividual e)emplars, and that the ealth of nature ill sooner or later produce e)ceptionseven to our best-defined and most general concepts2 &hus, e are not going to define theconcept of money e)actly, but e ill not use it in the strictest everyday meaning of theord, either2 +s a starting point, the concept of money ill include all of the above functions,

plus4as e$ll soon see4the fact that it can ta(e the form of capital as ell2

/o not be deceived by the fact that in everyday usage e generally see money in its veryconcrete form, li(e ban( notes or coins2 .n these forms money does not bear money2 'oney

bears money only if it appears in the form of capital2

Mne as !a/ital

+lmost any production tas( can be made easier by using more suitable instruments2 .n orderto ma(e such instruments, hoever, one has to sacrifice some of the present consumption forthe sa(e of the future2 .f #obinson can settle for four pieces of fish, he ill be able to ma(ehis fishnet on his on2 &here is a danger of his starving to death by the time the net is ready,

but if he endures this difficult period in his life, he may later come to the same position as#ichson2 +nother, less life threatening possibility is to resort to instruments produced byothers, but not consumed, li(e #ichson$s 1@! pieces of fish2

+ssets reserved from the outcome of a previous production for the sa(e of ma(ing futureproduction more effective either for ourselves or for others are called capital2 0hen moneyproduces interest :or other types of yield in more comple) financial constructions; to itsoner, it ill manifest itself as capital, but no capital is guaranteed to produce yield2 ore)ample, if #obinson does not survive the thirtieth day, #ichson$s capital ill be lost2

=et$s play ith the idea that there are many #obinsons on the islands2 or the time being, theyare all in fishing :this ill also change by the time e ne)t meet our heroes a fe chapters

later;, nevertheless, they are not totally ali(e2 #ichson, for e)ample, as more clever ith theclub and could bash si) fish a day2 or him, the loan-fish ould be orth less interest,


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because his time-preference as less, for he could have produced a fishnet ithout a loansooner or later :but, unfortunately, such an idea never occurred to him;2 +nother #obinsoncan eave a net much faster, so he ould need less loan-fish furthermore, he does not haveto invent the idea, it is enough for him if he just ta(es a loo( at the other #obinson$sinvention2

Hust imagine yourself to be in the luc(y position of having a thousand e)tra pieces ofstoc(fish2 0hich #obinson ould you prefer to lend it to +nd for ho much ou may not

be as hard hearted as the ban(ers and you may not ish to profit as much of your thousandpieces of fish as possibleI .n this case, thin( of your old daysI Hust thin( of Somerset'augham$s old, penniless character ho says he is not poor, he only lived too long for hisealth2

T$e rle # /s!$lg

+s soon as e thought of our old days, ris( as revalued higher2 Perhaps it ould be orth

ma(ing a deal ith the most s(illed and strongest #obinsons although they are illing to payless interest, but they are more certain to really pay it2 0e$ll soon reach the point e cane)perience in our relationships ith the ban(s daily< ban(s are the most illing to provideloans to those ho need it the least and can demonstrate this convincingly4if not ith push-ups, but some other means of displaying strength2

5oever, e are not alone in the stoc(fish-mar(et< others also have more or less stoc(fish,and they ould also li(e to have it produce more stoc(fish2 9ot only the #obinsons competefor the capital, but the capitals also compete for the #obinsons2 +nd the #obinsons ill

borro a loan from those ho lend it for the least interest2 &he situation is similar to therelationship beteen manufacturers and consumers on the mar(et< manufacturers try to getthe highest possible price for their products, but this is limited by the fact that they are not theonly manufacturers2 .n the case of similar *uality, consumers buy the products from themanufacturers ho sell them the cheapest2

By its very appearance in the orld, money creates a special mar(et, hich differs from theusual mar(et of manufacturers and consumers in one important aspect2 9amely, the usualmanufacturer is not in the least interested if the consumer spends his last penny on the productor has some money left for other goods2 &his is not true for #ichson2 5e is very muchinterested in #obinson$s general economic situation, and even in his health and psychologicalcondition :for e)ample, ho the appearance of a British ship changes #obinson$s psychiclife;2

&o be more e)act, #ichson is interested in the totalris( he is ta(ing by ma(ing a loan2 5e setsthe price of the loan against this ris(4and, of course, against his on illingness of ris(-ta(ing2 + young #ichson may ta(e greater ris(s in the hope of greater yield, hile an older#ichson ill probably ta(e smaller ris(s and ill be satisfied ith loer, but more certaininterest2 +t the same time, #obinson is not interested in #ichson$s general condition2 5avingreceived the fish-loan, #obinson ould not care less if #ichson starved to death the ne)t day2

&he concepts of capital and ris( are intimately intertined2 &he recognition of the role of ris(leads us to deal ith decisions related to capital as a special (ind of long term decision2 &he

presence of capital :the pure fact that a stoc( has accumulated someho some time ago;inspires one to ma(e totally different (inds of decisions than the daily decisions ofmanufacturers and consumers2 Understanding this psychological aspect ill be unavoidable inunderstanding ho capital operates2 &he importance of the *uestion is further indicated by thefact that psychologist /aniel 3ahneman on the !! 9obel Pri8e in Economics for his


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research in human ris(-perception mechanisms4the main results of his research ill bediscussed in Chapter J2

T$e sel#-re/r*(!tin # !a/ital

'oney has a very strong motivating poer, e are illing to do many things to get it2 &hus,hen money begins to act as a capital, it already has firm foundations2 'oney as a capital has

became *uite ingenious in utili8ing man$s psychological mechanisms in the service of its onsurvival and reproduction2 'oney ma(es its oner use it the most sensibly, preferably, to

produce more capital2 &his is ho capital reproduces itself2

.t ould seem from all this that money appearing in the form of capital almost behaves as if itere a living being that anted to reproduce itself2 &his, hoever, ould be a very superficialanalogy2 Save that there is also a much deeper parallelism beteen the forms of life appearingin biology and in economy2

0hen e tal( about living beings, e usually thin( of comple) organisms li(e elephants,

ater lilies, ants, or us, humans2 0hat proteins these creatures are composed of, and hothese proteins should be organi8ed into a living mechanism are determined by the genes2 0eusually do not consider genes as living beings, although it is genes that survive for really long

periods of time in more or less unchanged forms2 .ndividual living beings are born andbecome dead, and the period beteen the to events is embarrassingly short2

'oney, or to be more e)act, money ta(ing the form of capital is related to life in a similarsense as gene is< it generates a form of life2 &he comple) living beings that are produced bythe capital are the smaller and larger enterprises2 Capital can produce a stupendously diversevariation of enterprises just as much as genes can bring forth many forms of biological life4it cannot be seen yet, hoever, ho capital can achieve this2

T$e /ers/e!ti'e # t$e st!"#is$

Stoc(fish is a (ind of fish that as once caught from the sea, only to be consumed at a latertime2 ish as stoc( ere no longer simply fish, but an essential condition for life and the

possibility of obtaining more fish at the same time2 But the latter possibility is true only if thefish as not consumed for daily life immediately after obtaining it2 Still, in order to bereproduced, the stoc( :the capital; must be consumed sooner or later, and there is noguarantee that it ill be born again after consumption2 &his parado) is the very essence of thecapital2

Soon e ill say good bye to #obinson and the fish for a hile2 .n the folloing chapters eill turn to a more detailed study of the basic principles of life, and e ill need differentmodels for this2 But first, let us strip another s(in from this very simple model2 +fter all, ecan thin( of our little capital in our poc(et as stoc(fish that has become *uite flat in themeantime, its material has become paper-li(e, its color has become greenish :or some othercolor;, and finally, numbers and the image of an +merican president :or of a European

bridge; got printed on it2 &he point is, that e ill be able to fill our stomach by its help at alater time2

9o, let us e)amine the situation from the perspective of thisstoc(fish2 &his fish is no longera biological being that can reproduce itself by spaning2 &his fish found a completelydifferent tric( for reproduction2 &his strange abstract being becomes alive by being caught bysomebody someho< club, fishnet, fishing boat, or anything else2 +nd it is alive4


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theoretically even forever4until somebody consumes it as food2 >nly fish that has beencaught can be stoc(fish it does not matter ho many other fish sim in the ater2

&he ne)t step ill probably seem *uite absurd2 But let$s go on2 +s British politician =loyd7eorge said D/onKt be afraid to ta(e a big step if one is needed you canKt cross a chasm in tosmall jumps2F

Hust imagine that the commandment Dbe fruitful and multiplyF also applies to the abstractstoc(fish2 &herefore, it ill do everything it can to reproduce2 #eproduction in the case ofstoc(fish means that there are more fish in the form of being caught, but not yet eaten4ourabstract stoc(fish is alive only in this state2 &he commandment Dbe fruitful and multiplyF,hoever, does not only apply to a specific representative of the stoc(fish2 rom this

perspective, it is irrelevant hich individual stoc(fish is alive at a particular moment< one isjust li(e another2 .f #obinson eats one of them, only to have the strength to catch to more,all of the fish ill rush to be consumed, because this is ho they comply ith the higher orderthat applies to them2

9aturally, real living fish ill not jump under the club or rush to #obinson$s net, because thisould not promote their on reproduction2 .t is our abstract stoc(fish, the previously caught,

but not yet consumed fish :behaving in accordance ith the higher order that applies to them;,that ill do everything to be consumed by a strong #obinson, because their reproduction isonly possible if #obinson is able to catch more real, living fish he does not have to consumeimmediately2

+lthough #obinson eats the stoc(fish, he is not their enemy, but a condition for theire)istence2 &heir enemies :or rather< competitors; can be only those beings that are able toma(e #obinson attend to them, and not to the stoc(fish2 Since #obinson must eat from time totime, this concurrent being must be able to fill #obinson$s stomach2 .f this alternative beingcan also be put aside for future use, it ill also or( as stoc(fish do, thus it ill also be a

stoc(, even if not fish, but another form of capital2 .ndeed, there is a strong competitionamong the various forms of capital, thus, the conditions under hich survival rate isdetermined by natural selection have developed2 5ere, Lnatural selection$ also includes the#ichsons$ interest in or indifference toard a certain form of capital2 &his is ho theevolution of capital and of the various forms of enterprises, the DbeingsF created by capital,could start2

T$e 'ari(s #r&s # li#e

. used to or( in a technical research institute for ten years in an earlier period of my life2 .t

as there here . learnt that every ell-designed technical device can be used for much morepurposes than originally designed2 =et me mention just one e)ample2 Computers ereoriginally designed for performing comple) mathematical calculations2 &oday, hoever, themillions of computers in the orld spend only a fraction of their time ith actualmathematical calculations, e use them much more for editing te)ts, spreadsheeting,correspondence, retrieving information, and even for play2

Something similar happened to the structure forming the basis of life2 &he grand logic of thething proved to be able to operate completely different forms of life as ell2 .n this boo(, eare underta(ing to discover this logic, and the operation of this logic ill be e)amined in thecase of money2

.t is orth ta(ing a loo( at the main parallelisms among the various forms of life2 &here are afe e)pressions in &able 1 that are not very proper to use ithout any previous e)planation,


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li(e meme, cognitive schema, and replicator2 0e are going to e)plain each of them in detail,but for the time being, let us settle for seeing them together2 &he parallelisms summari8ed inthe table are bound to be made more convincing by the much more detailed tables inChapter 1@2

!iology "sychology Economythe replicator: gene meme capitalN

the beings: biologicalbeings

Dthought beingsFne of them is reducing cognitive dissonance, hichis independent of memes from the perspective of memes, it is an e)ternal psychologicalmechanism2

0e have not proved yet that money is a replicator4and e ill not do so for *uite a hile2 .nPart .. e ill get ac*uainted ith a fe economic and psychological mechanisms that illturn our to be the e)ternal mechanisms money as a replicator uses for the construction andoperation of its survival machines :smaller and greater enterprises;2

E4!$ange !reates 'al(e

.magine 'r2 Boo(ish once received a room bicycle as a gift2 5e tried it once of tice, but gotfrightened of the strange muscle deposits in his legs, so the bi(e is just getting dusty in acorner of his apartment2 +t the same time, 'r2 itness has a beautiful set of chess gettingdusty in his apartment although he tried to lift its nice figures, but found them too light2

>nce, 'r2 Boo(ish and 'r2 itness have a conversation and decide as a result that they oulde)change the to articles ith each other2 Both rub their hands that they have made ane)cellent e)change2 Both feel they became richer as a result of the e)change2 9o the*uestion is if the amount of goods in society have increased or not, i2e2, if any ne value has

been created by the e)change2 &he first reaction of most people is a definite no, as e haveonly one room bi(e and one set of chess both before and after the e)change, nothing ne iscreated2

5ad this been so, the good feelings of the to parties ould be just some vague psychologicalthing that is totally unimportant for economics2 &his is partly true2 rom the perspective ofeconomics it is unimportant hy 'r2 Boo(ish is more happy ith the nice set of chess thanith the room bicycle, and hy the attitude of 'r2 itness is just the reverse2 But once this isso, then it is literally true that both of them have become richer ith the e)change< they bothgained more than hat they paid2

Economics usually does not tal( about ne material goods, but about gains :or utilities; andcosts2 +nd similarly to all science, it vies its subject in a more general and abstract ay thaneveryday thin(ing does2 .n economics, everything is considered as utility if at least one person


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finds it useful for himself, and if he is illing to give up another useful thing in order toobtain it2 .n the economic sense, obtaining a car or a bottle of beer is a utility just as much ashealth, atching a movie, or sunbathing for an hour are2 Cost is all those utilities e sacrificefor the sa(e of obtaining another gain4and e do not tal( about material things only2

urthermore, economics does not tal( about ne material goods, because it ould be difficultto define hat comprises Dne materialF2 9ot a single ne atom is born in a shoe factory2 &heactivity of the factory called :and accepted by everybody as; production simply re-arrangesthe e)isting atoms into a ne, more useful form this is ho using up ra hide, tannin, andmany more things ill come out as shoes in the end2 +lmost all production produces utility byre-arranging e)isting materials into a more useful form2

&his is e)actly hat the e)change beteen 'r2 Boo(ish and 'r2 itness did< it broughtpreviously e)isting materials into a more useful arrangement2 .t also created ne value,similarly to a shoe factory2 .t also increased the amount of value in society, or its generalrichness2 &he ne product in the course of e)change as not the room bicycle or the set ofchess, but the fact that both objects found a place here their usefulness is greater than

before2 $hisne product does have real value or utility, this is hy e)change increased theealth of society2

.t is a common erroneous belief that an e)change is correct only if goods of e*ual value aree)changed2 +n e)change is neverthe e)change of e*ual values if it ere so, it ould be ofno sense2 .t ma(es sense only if both parties sacrifice something that is of less value to themin e)change for something that is more valuable for them2 .f . am a ba(er, . am glad to

provide my shoe-ma(er neighbor ith bread in e)change for shoes2 +nd not because bread isof no value to me2 .t does have a value, because . sacrifice something in producing it2 Even if. find the flour and other ingredients in the street, . sacrifice an hour of atching television orsunbathing hen ba(ing the bread2

&he room bicycle or the set of chess ere not totally useless for their previous oners, either,otherise, they ould have gotten rid of these dust-catchers a long time ago4somebodyould have been glad to ta(e them aay for a fe buc(s2 But both of them found anopportunity to e)change these objects for something that is really more valuable for them onlyno2

'r2 Boo(ish ould not have sold it to a merchant for a price that ould have been more thanenough to buy the same set of chess 'r2 itness gave him in e)change2 'r2 Boo(ish got it asa gift a long time ago from his aunt ho misjudged him, but ho is still dear to his heart2 &hesituation as the same ith 'r2 itness and his set of chess2 .n order for the e)change to ta(e

place, they had to discuss all this2 &his discussion opened the psychological possibility toard

the e)change< it as not only to objects that got e)changed, but to stories about the gifts asell2 +fterards, both of them could resolve their cognitive dissonance of anting to get ridof their dear gifts2 0e already (no that it is easily possible that years later 'r2 Boo(ish illtell the story of the beautiful set of chess to his grand children as Dyou (no, this is the one .received from +unt 'aryIF

&he informal conversation beteen 'r2 Boo(ish and 'r2 itness created real economic value2Similarly, the change created in the students$ heads, or the change brought about by thedoctor in his patients$ body have an economic value, and so does the psychological changethat ma(es it possible to reali8e an economic possibility2 &he discussion beteen 'r2 Boo(ishand 'r2 itness also increased the ealth in society2 .t ould have increased it even if for

some reason or other the actual e)change ould not have ta(en place, for the psychologicalchange did come about2 >nce e learn to notice such things, e$ll easily find more far


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reaching e)amples of the value-creating role of informal human relations and various otherpsychological mechanisms in the economy2

T$e /rin!i/le # !&/arati'e a*'antages

.magine an abstract, but illuminating mini society that has only three producers, +, B, and C,and they produce only to products, food :its unit is 1; and clothing :its unit is 1C;2 .n thismini society any unit of food can replace any other unit of food, and the situation is the sameith clothing2 5oever, the capabilities of the three producers are differentur first *uestion is< .magine that the producers are not so free after all, because there is adictator, /, in this society, ho dose not produce anything, just dictates2 / determines that the

hole society needs 1 amount of food a day to ma(e everybody sated, but any amount ofclothes ill go off2 .n fact, the more clothes people have, the happier they are2 / ishes toma(e his people as happy as possible2 0hom should he command to produce the single unitof food

Usually, the first thought of common sense is that it is +, for he can produce the necessaryfood *uic(ly :in a *uarter of a day;, then everybody can peacefully concentrate on clothes

production2 Everybody ould spend more time on producing 1, for + is the most efficient2But let$s do some calculation2

.f + produces 1, he can still produce :?QA;NJCRGC in the remaining three *uarters of histime, hile B and C produce only clothes, i2e2, ?1 units2 &hus, in sum, 1!C are produced inaddition to the 1 in a day2

.f B produces 1, he can produce C in addition, and together ith the J1 units of clothesproduced by + and C, the total production of clothes ill be 11C2

.f C produces 1, he can produce half a unit of clothes in addition, hile + and B produce?J units of clothes, so the total production of clothes ill be 112@ C2

&hus, the isest decision / can ma(e is order C to produce the necessary food, despite Cspending half of the day ith this tas(2 .f this as your first intuitive anser, you either havea very good sense for mathematics, or you are already sufficiently inoculated by economicthin(ing2

.n economic thin(ing the *uestion is not ho produces hat and ho fast, but hat onesacrifices in the process, ho much his cost of production is2 Producer + sacrifices the


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production of to units of clothes for the production of one unit of food, this sacrifice is oneunit for B, hile for C, it is only half a unit2 &his ay, it becomes clear immediately that Ccan produce food the most cheaply :i2e2, ith the least sacrifice;2 >nce e have ac*uired theorld of thought of economics, this ill not be the result of some obscure calculation, but itill be self-evident2

Clumsy little C, ho is the sloest in producing anything, is suddenly promoted to the mostefficient food producer2 .t as not / ho promoted him, because he has alays been there4not in the absolute sense, but in the sense that he is the one ho sacrifices the least for

producing food2 &he principle of comparative advantagesbecame manifest in our e)ample2&his principle states that it is not the absolute advantages, but the relative efficiency thatcounts in determining what is worth producing by whom2

.n international trade the principle of comparative advantages prevails2 .t is possible that afterthe investment of a huge green-house project, 7ermany could produce even coffee beans at aloer cost than Bra8il, but this is not a branch of industry that re*uires high precision, orhere 7ermany ould have a comparative advantage2 &hus, even if 7ermany had the money

for this project, she ould spend it on something else2.n our e)ample, + had absolute advantage in the production of all products, but had a relativedisadvantage against both B and C in producing food, because in producing food + ouldhave to sacrifice the production of more clothes than B or C2 +t the same time, + not only hasan absolute advantage, but a comparative advantage as ell in producing clothes2 But eventhis is not automatic< it may even happen that many people have a comparative advantageover the orld$s best2

.magine a layer hose hobby is typing, and ho does it so ell that he becomes orldchampion in typing2 Should he type his documents afterards &he anser is< not necessarily2.t depends on ho good a layer he is2 .f he is the 1!!thbest layer, he is certain to lose ith

typing his papers2 9o matter ho much he loves typing, his boss ill justly tell him to type athome as a hobby and not in the office for a class + lawyerssalary2

9otithstanding, it is not surprising that this layer chose to ma(e a living as a layer ratherthan as a typist2 &hat is the field here he has a comparative advantage, even if he is only the1!!thas a layer and the first as a typist2 urthermore, he ill find the competition as alayer less (een than as a typist2 .f three layers become better than him, he ill still be the1!?rd, not ma(ing much of a difference in his life2 9aturally, this does not mean that he canrela) as a layer at all2 .f he does not perform as e)pected of a layer in the 1!! thposition,sooner or later he$ll be paid only as the 1!!! thlayer and his boss ill not mind typing hison documents at a magical speed2 +nd if he performs even orse, he may type the

documents of others for a class + typist salary2 By that time that is here he$ll have acomparative advantage2

0e do not necessarily have to be the best in something2 >nly one person can be the best, ande are many2 urthermore, it is possible that even the best ill not do hat he is the best in,

because he may have a comparative advantage in something else2 0hat is important< eshould find the area here e have a comparative advantage over others2 &his is not alayseasy in a society here more than to things can be done2 .t is still orth it, because this isho e can best contribute not only to our on, but to society$s ell-being as ell2

&he principle of comparative advantages is actually a psychological principle, too2 .n apsychological adaptation< people in their choices generally consider the comparative

advantages rather than the absolute ones, although this is usually not a conscious approach20hen a great 5ungarian actor, 'i(ls 7Tbor died, &amTs #vbVr rote in memory of him


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D7irls e ere in love ith ere in love ith him2 &hey ere realists, so eventually theybecame our ives, but he occupied the first place in their hearts2 +nd it as all right2 0e erehappy ith the second place, because e all (ne that it is not only impossible to competeith him, but it is not necessary, eitherF2 =et$s be less elevated< e all had a comparativeadvantage even over 'i(ls 7Tbor, and ithout especially struggling for it2

&his Dmi(lsgTborF is a very scarce thing2 So are e, even if not as much so as theDmi(lsgTborF, but our comparative advantage :some in this, some in that; ensures that e arerelatively even more scarce in some things2 .f e can ma(e the best of it, girls do not have to

be painfully realists, our comparative advantage ill prevail in their choices2 &he principle ofcomparative advantages often or(s very ell as a psychological e)planatory principle2 &he

poer of the orld of thought of economics is shon by the fact that this far-reachingprinciple as not discovered by psychologists, but by a British economist, /avid #icardo in1J1"2

T$e /rble& # e4!$ange rates

&he promotion of C as the most efficient food producer as not caused by the logic ofdictatorship, but by that of economy2 9o, imagine a totally different society, a (ind ofcommunism here no dictator is needed, but people as good communists reali8e their onneeds correctly2 =et$s say these needs are as follosne of the candidates isBeachson$s holiday-ship enterprise he eventually set up4if not from #obinson$s ship, thenfrom another it does not matter to us no2 &he other candidate is an umbrella factory2 0eestimate that the stoc(s of these to companies promise the highest yield relative to theirris(s2 .n order to ma(e the decision, e need to (no hat the eather ill be li(e in thecoming years2

.f it ill rain a lot ne)t year, Beachson$s ship ill be less popular, hile the products of theumbrella factory ill sell ell2 =et$s assume the umbrella factory ill yield a A!Y profit,hile the holiday ship ill produce a 1!Y loss2 .f, hoever, it ill be nice, sunny year, thesituation is reversed, and the holiday ship ill yield the A!Y profit, and the umbrella factory

ill produce the 1!Y loss2 =et$s disregard intermediate possibilities no2.f the chances of nice and bad eather are e*ual, then both investments ill produce a A!Y

profit or a 1!Y lost ith a probability of @!Y2 9o matter hat e chose, our e)pected gainill be 1@Y :the average of A! and %1!;2 0e ould be happy ith this moderate 1@Y profit,

but the problem is that neither the umbrella factory, nor the holiday ship can guarantee this2Both of them can only promise that it may be much better or much orse, but on the average,on the long run, the gain ill be this much2

&he famous British economist, Sir Hohn 'aynard 3eynes used to say referring to similarpromises, that on the long run, e are all dead2 &his 1@Y yield on the long run is nice, butill e live to see it 9o matter hich investment e choose, after a fe unluc(y years e

become penniless, and e ill not be consoled by the fact that people investing in the samestoc( at that time ill become ealthy2 Both stoc(s are ris(y, this is hy their profit is 1@Y2


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#ichson$s ban( pays only @Y interest, and even that is somehat ris(y, for a ban( can also goban(rupt2

0ell, in this special situation e can reach a 1@Y profit ithout any ris(2 +ll e have to do isbuy stoc(s of the holiday ship for half of our money, and buy stoc(s of the umbrella factoryfor the other half2 &his ay, no matter hat the eather is li(e, half of our money brings aA!Y profit, the other half a 1!Y loss, and as a sum, e gain 1@Y for sure2 &his ay e haveapplied the method of diversification, i2e2, e invested our money in a mi) of investments, sothat the desired return is produced at the loest possible :here 8ero; level of ris(2

>nce you come across an investment-constellation li(e the holiday ship and the umbrellafactory, do not ait ith the investment even a second2 Hust imagine, that on your ay to thestoc( e)change you go to #ichson$s ban( to ithdra the money for buying the stoc(s2 ou

pee( in to #ichson$s room to boast ith your discovery< you$d li(e to see his long facehearing that you can achieve 1@Y yield ithout ris(, and that you ill not leave your moneyin his ban( for a trifle @Y interest2 #ichson responds you$d better hurry to the stoc( e)change,

because if he (eeps you hile ansering, you may suffer a great loss2

Even so, as you arrive at the stoc( e)change, you can see that the current price of the stoc( ofboth the holiday ship and the umbrella factory has tripled2 &hus, the joint fi)ed profit of thediversified investment decreased threefold, e)actly to @Y2 >thers have also noticed hat youdid, and the suddenly increased demand drove the prices up in the case of both the holidayship and the umbrella factory2 Hust as much as the lo value of joint ris( justified it2

#ichson did not ant to ta(e it to his heart that you miss the great opportunity, so he did notstart e)plaining the economics of the situation2 5e ould have said, by and large, thatnaturally, even this constellation is not ithout ris(s2 or e)ample, in case of a stormyeather, not only the holiday ship ould produce a loss, but a lightning may stri(e theumbrella factory as ell2 &he mar(et seems to have evaluated such ris(s about the same as

#ichson$s ban( going ban(rupt2 &his is hy the profit of both investment possibilities:diversified stoc(-buying and ban( deposit; leveled off at @Y2

&he value of the stoc(s of the holiday ship and those of the umbrella factory ere raised notbecause their economic situation suddenly improved, but because they complement each otherso luc(ily2 'aybe this is hat Beachson sensed ith an e)cellent intuition in economics henthe idea of the holiday ship occurred to him2 .f so, he fully deserved that the value of hisstoc(s suddenly got tripled2 +nd if so, Beachson probably bought4in time4as many stoc(sof the umbrella factory as he could ithout his very buying driving the prices up2

.f it happened so, then4as e$ll see later4the money as a replicator found its ay toreplication through Beachson this time, and produced a holiday ship for this purpose2 But letus not run ahead this much2 .t may not have happened so2 Beachson may have just gottenluc(y4things li(e that happen2 +nd for the umbrella factory, the appearance of the holidayship, and thus, the rise of their stoc(s may have been an une)pected gift from ortuna2

T$e beta

.n reality, the luc(y constellation as e sa in the case of the holiday ship and the umbrellafactory rarely happens2 But diversification can be very productive even if the relationshipamong the stoc(s is not so strong2 .t is not even necessary that the relationship beteen toinvestments be inverse it is enough if e find investments that are affected by e)ternal

factors very differently2


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&he more investments e can find that are affected differently by the e)ternal circumstances,the more e can eliminate the ris( of diversified investment2 .f e can collect about tentysuch investments, the ris( drops to practically 8ero4let$s say to the level of a ban( going

ban(rupt2 &his means that a diversified investment of tenty different (inds of stoc(s :intechnical terms it is calledportfolio; has almost no ris( at all2 But this is true only if the effect

of the e)ternal circumstances on one of the stoc(s in the portfolio is not at all related to thevery same effect on another stoc( in the portfolio2 9aturally, it is much better if therelationship is definitely negative, but no e are happy if the stoc(s in the portfolio areunrelated2

Unfortunately, hoever, it is almost impossible to find tenty, or even less such investments2&he reason is that it is true for almost every investment that on the long run they move moreor less together ith the hole economy2 &his means that hen the hole economy has agood year, the specific investment also closes a better year than usual, and hen the holeeconomy is stagnant, the same investment does not produce the usual profit, or even has aloss2 .n every year there are e)ceptions to this rule, but not many on the long term2 +nd if an

investment canbe an e)ception on the long run, its price ill go up so much that, eventually,its yield ill not be higher than the ban( interest2

&his means that the success of most investments more or less moves together ith that of theothers :and ith that of the hole economy;2 &herefore, the effect of the sum of e)ternalcircumstances is similar, or at least partially similar for all investments2 +nd this is hy it isimpossible to eliminate completely that part of the ris( that springs from the unevenfunctioning of the economy2 .t is possible only in the luc(y case of a portfolio li(e the holidayship and the umbrella factory2

&hose parts of the ris( of an investment that can be guarded off by diversification, are notjustified to be really considered a ris(2 .t is called the non-systematic ris, hich is not

ac(noledged by the mar(et as real ris(, and is not honored by e)tra profit2 &o be moreprecise< e cannot say that the mar(et DhonorsF or Ddoes not honorF, it only enforces the laof demand and supply for investments as ell2 &he economists DSiss (nifeF, the analysis ofthe demand and supply curves can ell be applied here, too2 .f an investor can guard off one(ind of ris( :e2g2, by diversification;, this ill push the supply curve donard, since thisay the investor can be satisfied ith a loer yield2 .f demand does not change in themeantime, prices :in our case< yield e)pected of the investment; ill decrease2 +fter sometime, an e*uilibrium develops here the non-systematic ris( has no longer an effect on theyield-e)pectation2

&hus, it doesn$t ma(e any difference ho sensitive an investment is to the good or badconditions of the environment, the important thing is only that its sensitivity be of different(ind from that of the others2 &his seems to be unfair, because if an investment is moresensitive, its ris( is higher, thus e should e)pect a higher yield2 #ichson in the first chapteractually did ta(e #obinson$s physical condition into consideration, because he thought if#obinson is strong, the ris( of not getting his loan and its interest bac( is less2 .n case of aloan, he is right, but if #ichson is thin(ing in terms of investment, the situation is different2 +#obinson ho is e)pected to become ill often, ill probably produce less income, becausehen he is ill, he does not produce anything2 &herefore, the value of investing in him is less2&he ris( arising from ea(ness is orsened only if this #obinson tends to get ill at the sametime as the others2 &he part of the ris( hen various #obinsons fall ill independently of eachother can be arded off by diversification2

#is( that cannot be arded off even by diversification is called systematic ris2 &his is thepart of the ris( that comes from the fact that the success of a specific investment more or less


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moves together ith the success of the hole economy2 .n the case of the #obinsons, ris(arising from physical ea(ness also has such a component2 0ea(er #obinsons probably fallvictim to epidemics and hard inters more than the stronger ones2 9o then, in times ofepidemic and hard inter, the hole economy struggles ith difficulties2 &he ea(er a#obinson, the more his performance ill move together ith these difficulties2 .nvesting in

such #obinsons is said to have a high beta value2 >n the other hand, the stronger a #obinson,the more li(ely he ill not fall ill along ith the majority in times of epidemics and hardinters2 .nvestment in these #obinsons has lo beta value2 &he higher the beta value of aninvestment, the higher the profit that is e)pected of it2

Beta is scaled so that its value is 1 if the profit of the investment fluctuates as a result of thechanges in the circumstances, similarly to the average profit of the hole mar(et2 Beta is lessthan 1 hen the given investment generally reflects the general state of the mar(et so as tolevel it off, hile beta is greater than 1 hen the given investment generally amplifies thecurrent fluctuations of the mar(et2 .f, for e)ample, betaR, than fluctuation is tofold thus, ifthe average yield on the mar(et is 1!Y, this investment brings !Y, hile if the loss is

typical, this investment ill produce double the average loss2 .f betaR!, the profit of theinvestment varies independently of the average, i2e2, sometimes they move together,sometimes in opposite directions2 &heoretically, beta can be negative, but in practice, it veryrarely happens2

+ctually, it is the beta value in hich investors compress all the information they have aboutthe ris( of the studied investment2 0hen #ichson analy8ed the ris( of the fishing company inthe previous chapter, he did not pay much attention to the dangers the ship has to face on thesea2 9ot because these dangers are not ris(y, but because they are not systematic ris(s2#ichson too( this (ind of ris( into consideration by mentally devaluating the e)pected profitslightly, for the hole ship may get destroyed, even if the chances of it are lo2 &his,hoever, does not affect beta, because the probability of such an accident is independent ofthe hole economy$s booming or stagnating2

Beta is affected, hoever, by the fact that the company produces basic food :although it mustbe admitted, that no other food e)ists in these islands;2 #ichson too( this fact as a betareducing factor, for people must eat even hen the economy is stagnating2 &hus, the demandfor the products of the fishing company is affected by a general economic recession only alittle2 >n the other hand, hen the economy is in the upard phase, people ill not eatsignificantly more2 or this enterprise, then, beta has a lo value in this respect2 >n the otherhand, the estimated income depended very much on the small changes in the fish production2.t did matter hether the number of fish caught as M! or ?!!2 +nd this does affect beta, forthis can change together ith the general state of the economy2 .n good eather everything

flos more smoothly, and the fishing ship has a greater output2 0hen the eather is bad,everything goes a bit orse, but the fishing business feels this in a particularly amplifiede)tent, because its outcome is greatly influenced by as little as ten missed fish2

0e have seen a component that reduces the beta of the fishing ship enterprise, and anotherone that raises it2 #ichson summari8ed these to :and many other; things hen he evaluatedthat the systematic ris( of the fishing ship enterprise is relatively high, say, betaR?2"

67;M: t$e 6a/ital 7sset ;ri!ing M*el

.n the previous chapter, e generously s(ipped the step of ho #ichson arrived from

estimating the ris( :i2e2, determining that betaR?2"; to e)pecting A!Y yield from thisinvestment2 0ell, the so called Capital +sset Pricing 'odel, or C+P', may have been of


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great help to #ichson2 >ne of the conse*uences of the C+P' is perhaps the most fre*uentlyused mathematical formula in the monetary orld2 &his formula is also called the e*uation ofthesecurity maret line it shos the re*uired yield as a function of beta :or ris(;2

&he mathematical deduction of the e*uation of the security mar(et line is rather complicated2&he basic idea of the deduction is similar to ho Beachson as thin(ing :provided he

proceeded very consciously, and he did not just get luc(y;2 .n C+P', an optimal portfoliothat includes the investment to be studied is imagined around the given enterprise2 &here*uired yield of this optimal portfolio gives the value the investor can e)pect of the givenspecific investment2 &his is ho the C+P' includes that the diversifiable part of the ris( doesnot justify increasing the re*uired yield2

+lthough the deduction is complicated, the arising e*uation is pleasantly simple2 .t can beseen in the figure that there is a linear relationship beteen beta and re*uired yield2 &o fi)ed

points determine a line4in our case, e get these to points by (noing the ris(-free return:or rather the return of minimal ris(;, and the average mar(et return2 &he former has a betavalue of !, the latter is betaR12 &hus, once e succeed in determining the beta value of a

specific investment, the re*uired return can easily be read from the figure2 +nd from here one can calculate the value of the investment just as #ichson did in the previous chapter2

&he linear e*uation of the security mar(et line is only a side effect of C+P', although a greatproportion of the practical application of the model is ta(en by the use of this e*uation2 &hetheoretical significance of C+P' lies mainly in proving that a (ind of e*uilibrium in themar(et can develop on cases of investments as ell2 &he functioning principle of thise*uilibrium is very similar to hat e shoed about the mar(et e*uilibrium of demand andsupply in Chapter G2 'ar(et e*uilibrium frees economy of the unpleasantly huge, hysteric

fluctuations in the mar(et4at least in theory2


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Similarly to all models, C+P' does not describe reality perfectly2 &he validity of C+P' canbe e)amined easily, for e can place ourselves into any moment in the past and can chec(hat investment recommendations C+P' ould have given at that moment2 &hen, (noingthe subse*uent turn of events, e can see ho successful the decision based on C+P' ouldhave been2 +lthough these studies have shon that the e)actness of C+P' is far from being

perfect, it has proved to be very difficult to improve the model so as to surpass the success ofC+P' by the improved model2

&he basic principles of C+P' had an enormous effect on the thin(ing of economists2 .n the1M"!s, an actual beta-cult prevailed on 0all Street2 +s every sharply rising trend in fashion, itlater leveled off, but the concept of beta is still e)tensively used by investors, and in a moregeneral sense than folloing from C+P' only2 &heoretically, beta can be used only forcompanies that have a long standing history and the relationship beteen their performanceand the development of economic activity in the mar(et can ell be seen2 .n practice, beta:and C+P'; is used to evaluate all (inds of investment possibilities, even beginningenterprises, just as #ichson did2 .n these cases the ine)actness of the C+P' is due to the fact

that beta cannot be determined accurately enough29o onder that many attempts have been made by many people in many ays to improveC+P' and to ma(e it more e)act2 5oever, the purely mathematical or economic approacheshave lead to very modest results2 &he most promising road lead through the application of

psychological research4for the first time in the history of economics2

2is" see"ing: ris" a'i*an!e

Perhaps it is not an e)aggeration if e say that in a certain sense, beta is the memory of thecapital, because investors condense all the ris( factors ta(en from past e)perience in thissingle number2 0e sa in Chapter @ :p2 OOO;, hoever, that human memory isfundamentally reconstructive in nature2 rom this e)perimentally thoroughly grounded

psychological phenomenon an important characteristic of information society resulted, i2e2,the stability of facts2 0hat is relevant from our perspective no, is, that upon the influence ofe)ternal information, memories can greatly change2

+ video record on hich to cars had an accident as shon to e)perimental subjects2 9e)t,the subjects performed various other tas(s, then they ere as(ed to recall the video< half ofthe subjects ere as(ed about the video Don hich the to cars hit each otherF, and the otherhalf ere reminded as Don hich the to cars smashed each otherF2 &he to groups recalledthe accident completely differently2 &hose ho ere as(ed to recall the to cars hittingeachother, remembered the speed of the cars to be much loer than those ho had to estimate ho

fast the to cars smashing each other ent2 urthermore, the majority of the first groupresponded ith a DnoF to the *uestion hether they sa any bro(en glass, hile the majorityof the second group said DyesF :although there as no bro(en glass in the film;2

9ot only our memories, but our preferences are also easily manipulated by changing thepoints of reference2 .n one study, for instance, people ere as(ed to choose beteen toemployment policies2 >ne of them as characteri8ed by high employment and a highinflation rate, the other by loer employment and a loer inflation rate2 0hen it as as(edhether unemployment should be 1!Y or @Y, the majority accepted a higher inflation rate forthe sa(e of decreasing unemployment2 0hen it as as(ed hether employment should beM!Y or M@Y, the majority of the respondents considered (eeping inflation lo more

important2


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.n one of their studies, 3ahneman and &vers(y had subjects ma(e an unpleasant decision2

.magine that a rare lethal disease brea(s out in a village, and all G!! of the inhabitants areinfected2 &hey can try to drugs, but, unfortunately, the to drugs preclude each other2 &hesituation as described to half of the e)perimental subjects as follosnly the surroundings, hatever is aroundhappiness, that cost you money, the stupid, boring accessories2 .t does not cost you money

that you are in .taly, but it does cost you money to travel there and sleep under a shelter2 .tdoes not cost you any money that the oman is your lover, but it does that she has to eat anddrin( in the meanhile, and that she has to dress in order to undress2F &he great majority of

people thin( similarly, even if they cannot e)press it so poetically2

+s research has shon, it is true only in certain cases and only to a certain e)tent that themore money is paid to someone, the better he ill perform2 or most people, there is a pointafter hich this curve does not rise, but, in fact, begins to fall2 &his point generally comesmuch before performance cannot be increased due to biological or intellectual limits2 =et megive you a typical e)ample< in 9e or( City, there are much feer cabs in the streets in theafternoon on rainy days than on dry days in fact, it is almost impossible to catch a cab on

rainy afternoons2 >ne ould thin( cab drivers are happy to or(, for there are manypassengers, and the cabdrivers can ma(e a lot of money2 &his is not ho the majority of thecabdrivers thin(, hoever2 Because of the heavy demand, they can ma(e sufficient money forthe day in the morning, then they go home and enjoy a free afternoon2

+ll this is rarely true of businessmen and invertors2 .t remains to be ansered hy ouldanyone having a fe hundred millions ant to have further hundreds of millions, hen hecould live on that sum till the end of his life, and beyond, up to his great grandchildren2 +ndstill, it is not uncommon to see that above a fe hundred millions, every cent counts2

=et me mention a parallel story, hose gist ill really become clear only in Chapter 1A2 .n1M!@, at the age of @, +lbert Einstein published four papers in physics in hich he solved a

fe of the most important problems of physics of the time2 &he *uestion for the 9obelcommittee as not hether the young scientist deserved the pri8e or not, but they haddifficulty in deciding hich of his papers should be aarded2 9evertheless, Einstein devotedhimself deeply to studying the *uestions of physics, and nobody as(ed him hy, havingachieved so much and having received such a high pri8e2 Could the situation be similar iththe hundred millions of businessmen

By the time e reach Chapter 1A, it ill become clear that this parallel is not just an analogy,but an e)act logical identity2 0hile the scientist is motivated by the scientific problem itself,the businessman is motivated by money itself2 But only a fe businessmen admit this tothemselves2 9elson Bun(er 5unt, a &e)as oil-billionaire said D'oney never meant anythingto us2 .t as just a sort of ho e (ept the score2F &he majority of successful businessmenand investors develop more comple) e)planations for themselves than that2 &hey tal( aboutinnovation, creating jobs, running the economy, or about the heritage of their children2 .norder to understand the motivation behind these statements, e have to get ac*uainted ith afe fundamental psychological mechanisms2

9e#ense &e!$anis&s

Successful businessmen also (no that the orth of living does not lie in having moremoney2 +s e sa under the section+ichsons dog at the end of the previous chapter, eventhey do not pay anything that is orth living for from their capital, but from their salary or the

yield of their capital2 >n the other hand, it is the essence of their profession that the money in


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their possession should multiply as much as possible2 Unavoidably, it causes cognitivedissonance in them2

+s e sa in Chapter A, one cannot go on living ith cognitive dissonances for a long period,so e try to resolve them as much as e can2 >ne of the most fre*uent methods is to changethe facts in ourselves for ourselves2 .f this encounters difficulties, the ne)t ea(est lin( in thechain is our opinions, and if that cannot change, our feelings and attitudes fall victim to thereduction of cognitive dissonance2 Sometimes even that does not help4changing our feelingsand attitudes may encounter severe obstacles e cannot ta(e upon ourselves2 &hen e employmeans psychologists call defense mechanisms2

&hese mechanisms first appeared in Sigmund reud$s psychoanalytic theory2 .n reud$stheory, the role of the defense mechanisms is to prevent the recognition of those personallyrelevant moments that threaten our self esteem or lead to an)iety2 /efense mechanisms areunconscious and are usually manifested in some (ind of action :or the avoidance of action;2

reud developed his theory more than half a century before the theory of cognitive dissonanceas developed2 .n vie of the concept of cognitive dissonance, a great proportion of reud$sideas got ne light, and in addition to the ones he described, a fe ne defense mechanismshave been also discovered2 =et$s have a loo( at the most important defense mechanismshose e)istence have been supported not only by theoretical considerations, but empiricalstudies as ell2

+ccording to reud, the most important defense mechanism is repression2 .t means the personunconsciously e)cludes thoughts, images, and memories related to instinctual impulses fromthe conscious mind that are too fearful or painful for him2 &hey ould usually causeembarrassment, bad conscience, decrease in self esteem, or other feelings of suffering2

.t is a typical repression hen a rich person forgets, represses the memory of once having

been very poor2 +s a result, he can sho no empathy toard the poor, definitely avoids, oreven hates them2 5e does not ant to, therefore, he does not notice poverty2 5e may evenemploy self-deceptive thoughts li(e they surely have money, they just thre it aaymindlessly or dran( it aay2 &hus he successfully represses his intensive fear of poverty2

&here is one positive outcome of this defense mechanism for the businessman< he does notfeel an)ious of the possibility of becoming poor again2 5e unconsciously represses the feelinghe (nos and he used to suffer from2 .t can be seen that despite the frightening name,repression should not be considered a negative thing only2 #epression, hoever, is rarely

perfect2 #epressed contents bombard consciousness, and may cause an)iety and even bodilydisease if they come to the surface only partially2 &hus, further mechanisms are also needed2

+eaction formation is another fre*uent defense mechanism2 .n this case, one conceals theunacceptable repressed desires and impulses from oneself by developing just the oppositemotivation2 or e)ample, he may too vehemently scourge lo morality, alcohol, or gambling2.n cases li(e this it often turns out that the person himself have had very similar problems, andith the fervid attac( he mainly ants to defend himself from relapse2

&his may be the mechanism in the bac(ground hen a rich businessman begins to have fits ofe)cessive generosity, shoing that he is not miserly or greedy2 .n reality, he ants to havemore money, but he turns his greediness to its opposite< he employs the defense mechanism ofreaction formation in the service of his on mental health2

&he mechanism ofproectiondefends us from admitting our on unpleasant traits or desires

by attributing them to others2 + typical e)ample is hen the husband begins to be jealous ofhis ife and unjustly accuses her of infidelity2 &his behavior often conceals the fact that he is


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the one ho ould li(e to cheat on her, but represses his desire, because it ould causeunpleasantly bad conscience for him2 #epression, hoever, is not *uite successful, and thedesire stubbornly comes to the surface2 &hen, the ne)t defense mechanism comes to play, thistime, projection2 +s a result, he is becoming increasingly certain that his ife is cheating onhim, and cannot get it out of his mind, for infidelity is in his very head4but is projected to his

ife2.t is a typical e)ample hen a rich man complains that everybody ants only his money, andhe is loved only for his money2 +lbeit he is the one ho ma(es friends only ith those fromhom he hopes to gain something2 But he conceals this from himself, and attributes his on,repressed and rejected desires to others2

istancingis another defense mechanism2 .n this case, e do not project the material to berepressed onto others, but insert another object beteen ourselves and the object of our desire,or compartmentali8e our feelings and cognitions2 &his ay, e escape the pain of theunbearable closeness of the object of our on desire2 +lthough the insertion itself can beconscious, it remains hidden from ourselves hy e do that2 or e)ample, hen a girl in love

is pic(ing petals murmuring Dloves meI loves me notF, pic(ing petals is a ay of distancing2.t is a typical distancing behavior hen a businessman deals ith his business affairs veryefficiently and does not mi) them ith his everyday life at all2 5e pays himself a salary hedetermines via negotiations ith his partners or4if he has none4ith himself2 5e covers thecosts of his lifestyle from this, but ma(es his capital completely independent of it2 &his ayhe defends himself from his ealth seducing him into e)penses that he feels are inappropriateand unise2 Perhaps it as this defense mechanism that paved the ay to the emergence ofthe capital2

+ationali(ation is a very common defense mechanism2 .t is used already in +esop$s fableabout the fo), ho cannot reach the grapes, but convinces himself that he does not ant to,

because they are too sour2 &hus, rationali8ation does not mean e act rationally, but that etry to present our actions as if they ere rational2 0e loo( for a good e)cuse for our action inorder to be able to hide the real cause from ourselves2

&here as a typical instance of rationali8ation on both sides, hen 'r2 Boo(ish and 'r2itness e)changed goods in Chapter G2 +fter the conversation they could already rationali8ehy they got rid of the gift of a dear relative2 &his is hy e said that actually, in addition toto objects getting e)changed, to stories also got e)changed2 0e also sa that theconversation beteen 'r2 Boo(ish and 'r2 itness brought about real value in economics,

because it created a psychological change that made the mutually advantageous e)changepossible2 /efense mechanisms often bring about real economic values, because they create

the psychological conditions for reali8ing that value2.t is also a typical rationali8ation hen a businessman says he is striving at collecting as muchealth as possible, in order to pass it over to his children as a legacy2 &his is ho he ma(eshis desire to ma(e as much money as possible more acceptable for himself2 &his ay it is notmoney, but biology that motivates his actions%hich is more acceptable for him2

Intellectuali(ationis related to rationali8ation2 .n this case, one guards off painful contents ofconsciousness by treating them in an abstract, intellectual form2 + doctor, for e)ample, couldnot bear the burden of identifying psychologically ith the suffering of each of his patients2

9o matter ho empathic he is, he must dra a line beteen his and his patients$ problems2

0hen a businessman tal(s about opening ne job opportunities, about running the economy,and similar things e)ceedingly emphatically, he probably uses the defense mechanism ofintellectuali8ation2 &his is ho he hides from himself that in reality he is motivated by money2


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isplacement, or in reud$s original e)pression,sublimation, is the most acceptable ay ofsatisfying certain aggressive or se)ual motives2 .n this case, the drive itself is not changed,only its object2 +ctually, e do satisfy it, but in another, socially acceptable form, li(e inmartial arts, or in some creative form, li(e arts, poetry, music4or perhaps business, hich isfight and a creative activity at the same time2

N N N

.f the defense mechanisms do not or( appropriately or are too strong, they can lead to bothpsychological and bodily diseases2 Still, they are essential for all of us, and e all use them2reud and his folloers thought that the condition for mental health is to get to (no thetotality of our conscious and unconscious mind ith all their contents2 .t has become clearsince then, hoever, that defense mechanisms play a basically positive role in fact,

psychologists today often aim not at uncovering the repressed, rationali8ed or sublimatedcontents of consciousness, but to repair the malfunctioning defense mechanism2 .f somethingis ell cemented in the unconscious, it is usually better to leave it there undisturbed, and oftenthe psychologist can help the most if he helps the client in this2

/efense mechanisms help us maintain our psychic balance, thus, in (eeping our bodily andmental health2 But they do not ma(e us happy2 &he secret of happiness could be found, or atleast successfully studied, by entirely different methods and in entirely different areas2

T$e #l

5ungarian-born professor of psychology of the University of Chicago,'ihTly CsV(s8entmihTlyi :pronounced me-5.75 chee(-sent-me-5.75-ee; intervieedhundreds of successful people :artists, athletes, musicians, chess players, surgeons; abouttheir pea( e)periences and about hat it feels li(e doing hat they are doing2 >n the basis of

these reports he developed his theory about the psychology of optimal e)perience :or moreloftily< of happiness;2 +s he put it, optimal e)perience is based on Dflo4the state in hich

people are so involved in an activity that nothing else seems to matter the e)perience itself isso enjoyable that people ill do it even at great cost, for the sheer sa(e of doing it2F .n case ofthe respondents of CsV(s8entmihTlyi, the most important common characteristic as thefeeling of effortlessness, even hen the athlete$s muscles ere very sore and could hardlygasp for air2 :=et me note that the e)pressionflowis used in the psychological sense here2 .neconomics, the ord is used in an entirely different meaning2;

Subse*uently, CsV(s8entmihTlyi and his colleagues intervieed tens of thousands of peopleall over the orld2 +s it turned out, optimal e)perience is described ith almost identical

ords by men and omen of various age, nationality, culture, or educational level2 >ptimale)perience as virtually alays coupled ith the presence of flo2

+s a ne)t step, CsV(s8entmihTlyi and his colleagues came forard ith an ingenious research-methodological invention2 &he subjects of the investigation ere e*uipped ith a pager for aee(2 &he pager beeped randomly, J times a day on the average2 0hen the beeper sounded,the respondents had to fill out a brief *uestionnaire about hat they ere doing at themoment, hat they ere thin(ing, and ho happy they ere feeling2 .n the course of todecades, several hundred thousand *uestionnaires ere collected2

#elying on the responses, the researchers tried to determine the best ay to describe thosemoments hen people reported ma)imal happiness2 +s it turned out, they can be identified

the most e)actly by eight characteristics2 .f they included either more, or less characteristicsinto the analysis, it made the identification of the moments of ma)imal happiness less e)act2


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>n the basis of this, it can be (non that flo is determined by the folloing eightcharacteristicsne of the most often cited characteristic of theflo e)perience is that one forgets all other aspects of life2 +ll troubles in life stope)isting, all information unrelated to the tas( at hand is pushed out of aarenesstemporarily2

G2 # sense of control2 .n the state of flo one does not orry about controlling the situationor activity2 5e concentrates only on the present, on the flalessness of the given moment2'any signs indicate that in order to achieve flo, one has to give up wanting to be incontrol2 .n Hade 0arrior, a movie based on the innish national epic, 3alevala, the iseold mon( tells the young heartbro(en hero D5ad you not anted her, you ould havegotten herF2

"2 + loss of the feeling of self-consciousness.+s an e)ample, this is ho an roc( climberdescribed his e)perience< D.tKs a \en feeling, li(e meditation or concentration2 >ne thingyou are after is the one-pointedness of mind2 ou can get your ego mi)ed up ithclimbing in all sorts of ays and it isn$t necessarily enlightening2 But hen things becomeautomatic, it$s li(e an egoless thing in a ay2 Someho the right thing is done ithoutyou ever thin(ing about it or doing anything at all2 I.t just happens2 +nd yet, you aremore concentrated2F &his e)cerpt as cited, because several other characteristics also

appear in it clearly2


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J2 $emporarily distorted time senseis a typical characteristic of flo e)periences2 0e do not(no yet if this is only an accidental by-product of intensive concentration, or somethingthat contributes to the development of flo on its on2 .t is easily conceivable thatescaping the bondage of time in itself increases, or even produces the enjoyment of fullinvolvement2

inally, let$s mention a characteristic of flo that could not be directly identified in the*uestionnaires, but all the bac(ground studies pointed in this direction2 'ost flo e)perienceshappened during activities that ere inherently rearding, because the person enjoyed doingit2 +ctivities that can bring about flo are great motivators in themselves4the specificactivity that can bring a given person into the flo state, hich may, of course, vary from

person to person2 Contemplation ith understanding, li(e profound enjoyment of the beautyof 9ature may also lead to flo2 +nd in the psychology of homo informaticus, it is animportant feature to enjoy involved contemplation of not only the physical orld, but theorld of information as ell2

Mne an* $a//iness

=et$s bring the truism Dmoney does not ma(e you happyF under scrutiny in vie of theaforementioned psychological research2 0ell, if happiness can really be identified ith flo,then it has nothing to do ith money2 But let$s recap the ords of +ntal S8erb< D>nly thesurroundings, hatever is around happiness, that cost you money, the stupid, boringaccessories2F 0ell, even if money does not ma(e you happy, prolonged and severe lac( ofmoney definitely ma(es you unhappy2

'oney is generally used as an e)trinsic motivator2 0e or( for money, so that afterards ecan do hat e enjoy2 But or( can also be a source for flo, and as research has revealed, itoften is2 &his is possible only if4in ourselves4or( is completely separated from the factthat e get a salary for it2 =et me tell you a personal story, instead of cumbersomee)planations2

ears ago, . participated in a television game sho)eopardy2 .f somebody could in in tenconsecutive rounds, he could in a car2 &he contest itself as a rather fast, rapidly rolling*ui8 game, here one had to ma(e very fast decisions hether or not one (ne the anser,and press the button2 >therise, the other played pressed the button sooner and earned theright to anser2 Under these circumstances, one unavoidably tal(s a lot of rubbish as ell,including the inner2

&his game suited me very much, but . did not *uite understand hy2 &hey say, the

shoema(er$s ife is alays the orst-shod< . reali8ed only much later that hat . (no frompsychology, applies to my functioning also2 &his game suited me, because it could bring meinto the state of flo2 or e)ample< during the game, . had no idea ho long e had been

playing2 . as happy if my anser as correct, but fran(ly, . did not care much if hat . saidas correct or not2 'y state of mind as D>3, let$s see the ne)t *uestionF . performed much

better toard the end of the game, hen the *uestions came ith lightning speed, than in theprevious, thematic rounds2 .t came to me only very sloly, hy2

&he anser lies in the Gthcharacteristic of flo as described above2 or after ansering thethematic *uestions, the player alays had to name the topic from hich he anted to get thene)t *uestion2 0ell, overta(ing control, even if only this much and for that short a time, gotme out of the state of flo, undermining my performance2 &his part of the game favored thoseho ere pulling out all the stops, instead of playing in the state of flo2 Some of them haddefinitely greater (noledge than . did, but . on the game nevertheless4than(s to the flo2


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&he most shoc(ing e)perience struc( me in the seventh round2 .n this round, . side-glanced atthe car, on the road to hose inning . as already more than half ay2 &his had a verystrange effect2 . sloed don, . could not remember anything, and if . did, it as not correct2=uc(ily for me, . had the ea(est rivals in that round2 .f . had played li(e that in any of theother rounds, . ould have plainly lost2 E)trinsic motivation stopped flo, and hat as left

as just endeavor2 . ent to play for the car, but . could in, because . completely forgotabout it4e)cept for this single instant2 &he game itself became an intrinsic motivation2 .enjoyed playing2

'oney as an e)trinsic motivator or(s against flo, and thus, happiness2 et at the sametime, it is also an essential condition for it2 &his parado) can be resolved only if e forgetduring or( that e are actually or(ing for money2 .f e succeed, e can e)perience floduring or(, too2

. have heard from many e)cellent authors and other creators that receiving an order is theirmain source of inspiration, and deadline is their best 'use2 &hey may be right, but it does notcontradict hat has been said above2 'any authors, once they start, can merge ith the tas( at

hand, but in order to start, they need an e)trinsic impetus2

Mne &ti'ates t &a"e &ne

.n the case of entrepreneurs, businessmen, and investors, ma(ing money itself is or(25oever, money can really become an intrinsic motivation for many people2 .f . as as(ed togive an e)ample of something that carries all eight characteristics of flo in the most simplemanner, . ould say money ma(ing, not in the sense of ma(ing money to spend it, but tomultiply it2 =et$s run through the eight characteristics of flo ith respect to ma(ing moneyto ma(e money2

.t is easy to identify ith this activity2 .t challenges one$s s(ills to the utmost2 7oals are clear,feedbac( is unambiguous and immediate2 =arry +dler, one of the orld$s most s(illedharmonica players once said in an intervie D'oney is the only applause a businessman getsfor his performanceF2 'erging ith the tas( is very easy4although in order to do that,sometimes the employment of a defense mechanism or to may be necessary2 +nd notorrying about the control is sometimes unavoidable< people ho can never trust others, illnever ma(e money multiply2 >nce e have found hom to trust and e have created theframeor( of the activity, e must let things happen2 =oss of the feeling of self-consciousness ta(es place almost by itself< money is an ideal medium to concentratee)clusively on it2 +nd any businessman can give plenty of e)amples of distorted time sensee2g2, cases of missed planesI Perhaps this is hy they thin( it is orth buying the terribly

e)pensive airplane tic(ets ith hich the time of travel can be modified even in the lastminute2

or the majority of people, the most realistic ays for achieving a flo state are arts, se), andsports2 But as e have seen, money is also a suitable activity to enter flo2 0hen #obinsonand #ichson had a discussion in Chapter ", #ichson as more in a state of flo than#obinson2 5e as doing something in hich he can get immersed the most easily2 #obinsoncould do this only after the agreement, hile building, and then hile running the ship2 +sith everything else, e are not ali(e in the ays e reach happiness2

.t follos from the functioning of the human psyche that money can very easily turn frombeing an e)trinsic motivator into being an intrinsic motivator2 9either man, nor money isresponsible for this4it is just in the nature of flo, and in the nature of money2

The Evolution of Money Chapters for Cluj

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