Philosophy of Money and Finance (Stanford Encyclopedia of Philosophy)

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Gambling definition platonic theory

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Finance and philosophy may seem to be worlds apart. But they share at least one common ancestor: Thales of Miletus. Thales is typically regarded as the first philosopher, but he was also a financial innovator. He appears to have been what we would now call an option trader. When the harvest turned out to be as good as predicted, Thales earned a sizable amount of money by renting out the presses Aristotle, Politics , a.

Coins have largely been replaced by either paper or electronic money, and we have built a large infrastructure to facilitate transactions of money and other financial assets—with elements including commercial banks, central banks, insurance companies, stock exchanges, and investment funds. This institutional multiplicity is due to concerted efforts of both private and public agents, as well as innovations in financial economics and in the financial industry Shiller Our ethical and political sensitivities have also changed in several respects.

It seems fair to say that most traditional ethicists held a very negative attitude towards financial activities. Attitudes in this regard seem to have softened over time. However, the moral debate continues to recur, especially in connection with large scandals and crises within finance, the largest such crisis in recent memory of course being the global financial crisis of This article describes what philosophical analysis can say about money and finance.

It is divided into five parts that respectively concern 1 what money and finance really are metaphysics , 2 how knowledge about financial matters is or should be formed epistemology , 3 the merits and challenges of financial economics philosophy of science , 4 the many ethical issues related to money and finance ethics , and 5 the relationship between finance and politics political philosophy.

Money is so ever-present in modern life that we tend to take its existence and nature for granted. But do we know what money actually is? Two competing theories present fundamentally different ontologies of money. The commodity theory of money: A classic theory, which goes back all the way to Aristotle Politics , b—b , holds that money is a kind of commodity that fulfills three functions: it serves as i a medium of exchange, ii a unit of account, and iii a store of value.

Imagine a society that lacks money, and in which people have to barter goods with each other. Barter only works when there is a double coincidence of wants ; that is, when A wants what B has and B wants what A has. But since such coincidences are likely to be uncommon, a barter economy seems both cumbersome and inefficient Smith , Menger At some point, people will realize that they can trade more easily if they use some intermediate good—money.

This intermediate good should ideally be easy to handle, store and transport function i. It should be easy to measure and divide to facilitate calculations function ii. And it should be difficult to destroy so that it lasts over time function iii. Monetary history may be viewed as a process of improvement with regard to these functions of money Ferguson , Weatherford For example, some early societies used certain basic necessities as money, such as cattle or grain.

Other societies settled on commodities that were easier to handle and to tally but with more indirect value, such as clamshells and precious metals. The archetypical form of money throughout history are gold or silver coins—therefore the commodity theory is sometimes called metallism Knapp , Schumpeter Coinage is an improvement on bullion in that both quantity and purity are guaranteed by some third party, typically the government.

Finally, paper money can be viewed as a simplification of the trade in coins. The commodity theory of money was defended by many classical economists and can still be found in most economics textbooks Mankiw , Parkin This latter fact is curious since it has provoked serious and sustained critique.

An obvious flaw is that it has difficulties in explaining inflation, the decreasing value of money over time Innes , Keynes It has also been challenged on the grounds that it is historically inaccurate. For example, recent anthropological studies question the idea that early societies went from a barter economy to money; instead money seems to have arisen to keep track of pre-existing credit relationships Graeber , Martin , Douglas , Part III.

The credit theory of money: According to the main rival theory, coins and notes are merely tokens of something more abstract: money is a social construction rather than a physical commodity.

The abstract entity in question is a credit relationship; that is, a promise from someone to grant or repay a favor product or service to the holder of the token Macleod , Innes , Ingham It is commonly thought that the most creditworthy issuer of money is the state. This thought provides an alternative explanation of the predominance of coins and notes whose value is guaranteed by states.

But note that this theory also can explain so-called fiat money, which is money that is underwritten by the state but not redeemable in any commodity like gold or silver. Fiat money has been the dominant kind of money globally since , when the United States terminated the convertibility of dollars to gold. The view that only states can issue money is called chartalism , or the state theory of money Knapp Most credit money in modern economies is actually issued by commercial banks through their lending operations, and the role of the state is only to guarantee the convertibility of bank deposits into cash Pettifor These are sometimes seen as arguments for a return to the gold standard Rothbard , Schlichter However, others argue that the realization that money is socially constructed is the best starting point for developing a more sustainable and equitable monetary regime Graeber , Pettifor We will return to this political debate below section 5.

This question invokes the more general philosophical issue of social ontology, with regard to which money is often used as a prime example.

When other people recognize or accept the declaration it becomes a standing social rule. Thus, money is said to depend on our subjective attitudes but is not located solely in our minds for a discussion see also the entries on social ontology and social institutions. In an early philosophical-sociological account, Georg Simmel had described money as an institution that is a crucial precondition for modernity because it allows putting a value on things and simplifies transactions; he also criticizes the way in which money thereby replaces other forms of valuation see also section 4.

It is typically said that the financial sector has two main functions: 1 to maintain an effective payments system; and 2 to facilitate an efficient use of money. The latter function can be broken down further into two parts. First, to bring together those with excess money savers, investors and those without it borrowers, enterprises , which is typically done through financial intermediation the inner workings of banks or financial markets such as stock or bond markets.

The modern financial system can thus be seen as an infrastructure built to facilitate transactions of money and other financial assets, as noted at the outset. It is important to note that it contains both private elements such as commercial banks, insurance companies, and investment funds and public elements such as central banks and regulatory authorities.

What are the defining characteristics of financial assets? Just like money, they can be viewed as a social construction. However, financial transactions are different from ordinary market trades in that the underlying assets seldom change hands, instead one exchanges abstract contracts or promises of future transactions.

More distinctly, financial assets are defined as promises of future money payments Mishkin , Pilbeam If the credit theory of money is correct, they can be regarded as meta-promises: promises on promises. The function of a synthetic CDO is mainly to spread financial risks more thinly between different speculators. Intrinsic value: Perhaps the most important characteristic of financial assets is that their price can vary enormously with the attitudes of investors.

Put simply, there are two main factors that determine the price of a financial asset: i the credibility or strength of the underlying promise which will depend on the future cash flows generated by the asset ; and ii its transferability or popularity within the market, that is, how many other investors are interested in buying the asset.

But what is the intrinsic value of an asset? The rational answer seems to be that this depends only on the discounted value of the underlying future cash flow—in other words, on i and not ii above.

However, someone still has to assess these factors to compute a price, and this assessment inevitably includes subjective elements. As just noted, it is assumed that different investors have different valuations of financial assets, which is why they can engage in trades on the market in the first place.

A further complication here is that i may actually be influenced by ii. For example, a company whose shares are popular among investors will often find it easier to borrow more money and thereby to expand its cash flow, in turn making it even more popular among investors. This phenomenon amplifies the risks posed by financial bubbles Keynes Given the abstractness and complexity of financial assets and relations, as outlined above, it is easy to see the epistemic challenges they raise.

For example, what is a proper basis for forming justified beliefs about matters of money and finance? A central concept here is that of risk. Since financial assets are essentially promises of future money payments, a main challenge for financial agents is to develop rational expectations or hypotheses about relevant future outcomes.

The two main factors in this regard are 1 expected return on the asset, which is typically calculated as the value of all possible outcomes weighted by their probability of occurrence, and 2 financial risk, which is typically calculated as the level of variation in these returns. It is often argued that the financial system is designed exactly to address or minimize financial risks—for example, financial intermediation and markets allow investors to spread their money over several assets with differing risk profiles Pilbeam , Shiller This point leads us further to questions about the normativity of belief and knowledge.

Research on such topics as the ethics of belief and virtue epistemology considers questions about the responsibilities that subjects have in epistemic matters. These include epistemic duties concerning the acquisition, storage, and transmission of information; the evaluation of evidence; and the revision or rejection of belief see also ethics of belief. In line with a reappraisal of virtue theory in business ethics, it is in particular virtue epistemology that has attracted attention from scholars working on finance.

For example, while most commentators have focused on the moral failings that led to the financial crisis of , a growing literature examines epistemic failures. Epistemic failings in finance can be detected both at the level of individuals and collectives de Bruin Organizations may develop corporate epistemic virtue along three dimensions: through matching epistemic virtues to particular functions e.

Epistemic virtue is not only relevant for financial agents themselves, but also for other institutions in the financial system. An important example concerns accounting auditing firms. Accounting firms investigate businesses in order to make sure that their accounts annual reports offer an accurate reflection of the financial situation. While the primary intended beneficiaries of these auditing services are shareholders and the public at large , accountants are paid by the firms they audit.

This remuneration system is often said to lead to conflicts of interest. While accounting ethics is primarily concerned with codes of ethics and other management tools to minimize these conflicts of interests, an epistemological perspective may help to show that the business-auditor relationship should be seen as involving a joint epistemic agent in which the business provides evidence, and the auditor epistemic justification de Bruin We will return to issues concerning conflicts of interest below in section 4.

Epistemic virtue is also important for an effective governance or regulation of financial activities. For example, a salient epistemic failing that contributed to the financial crisis seems to be the way that Credit Rating Agencies rated mortgage-backed securities and other structured finance instruments, and with related failures of financial due diligence, and faulty risk management Warenski Credit Rating Agencies provide estimates of credit risk of bonds that institutional investors are legally bound to use in their investment decisions.

This may, however, effectively amount to an institutional setup in which investors are forced by law partly to outsource their risk management, which fails to foster epistemic virtue de Bruin Beyond this, epistemic failures can also occur among regulators themselves, as well as among relevant policy makers see further in section 5.

Compared to financial practitioners, one could think that financial economists should be at an epistemic advantage in matters of money and finance. Financial economics is a fairly young but well established discipline in the social sciences that seeks to understand, explain, and predict activities within financial markets.

However, a few months after the crash in , Queen Elizabeth II famously asked a room full of financial economists in London why they had not predicted the crisis Egidi Yet only a few philosophers of science have considered finance specifically.

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