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Understanding what money is

June 7, 2010

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Throughout the recent financial crisis, it has become increasingly apparent to the average person that money can be and has been created out of thin air. Although the complexity of the Federal Reserve and central banks around the world is beyond the scope of this article, it is important to obtain an introductory snapshot of what money is.

Our money is debt

In a speech in the Senate in 1833, Daniel Webster stated, “We are in danger of being overwhelmed with irredeemable paper, mere paper, representing not gold nor silver; no sir, representing nothing but broken promises, bad faith, bankrupt corporations, cheated creditors and a ruined people.”

All forms of paper currency are pieces of debt. They are obligations of each issuing entity to “make good” on a promise to repay. For example, the Federal Reserve, which is a private entity, prints money or issues electronic currency that it then loans to the U.S. government. This must be repaid with interest. Not many people realize this relationship between the Federal Reserve and the government. Saying “the government is printing more money” is a misinformed statement. As each new stimulus or bailout is signed into existence, the debt level related to money creation becomes an exponentially increasing issue.

Good money

Legal tender legislation has been created to give value to our currency as a medium of exchange. Good money, however, needs no legislation. Coins and forms of bullion made of precious metals have value based on their metal content. For thousands of years, silver and gold have been used as money. Although their value may have short-term fluctuations in relation to dollars, the purchasing power of precious metals remains fairly constant over the long term. Purchasing power is the ability to buy the same goods in the future as you can today. We have been trained to think that inflation is a natural thing, but essentially the increase in prices we see is the purchasing power of our dollars being eroded away.

In the 1950s, all dimes, quarters and half-dollars were made of 90 percent silver. Three dimes would buy a gallon of gas at that time. Did you know those same three 1950s dimes (based on their metal value) would buy a gallon of gas today? That is how good money maintains purchasing power. Even though it is cleverly disguised, our money today contains no silver at all.

Bad money

Even though ancient Rome used silver as money, it still found a way to inflate its money supply. Dishonest money began to circulate because small pieces of silver were clipped off the edges of coins, melted down and used to create new ones. How similar is this to what is occurring today? Since 1933, the dollar has lost over 97 percent of its value, because as more and more is created, value is virtually “clipped” from it. This has accelerated in the past 100 years because there is no connection between the dollar and any kind of valuable commodity.

Gresham’s Law

Under legal tender laws, bad money drives out good money. This means that most of the pre-1964 coins that are 90 percent silver have slowly been hoarded and removed from circulation. It is a rare occurrence to receive change back that contains any silver. If you do, don’t put it in the parking meter downtown!

As the gap continues to widen between good money and bad money, it is important to become aware of the fact that our monetary system affects every one of us every day. Since money affects all of our lives, it would be wise to follow the advice of long-standing federal judge Robert Hemphill, who said, “Money is the most important subject intellectual persons can investigate and reflect upon.” I encourage you to investigate.

Comments

Khublai_Juan 5 years, 1 month ago

Great article. This explains many of the aspects of our money system that people don't know. They have a hard time believing that we really have a currency system based on fiat money with no real substance. The belief that inflation is just a natural part of the economy is another idea that drives me nuts. One of the foundations of economics is that any amount of currency will do, there is no need to print off more because the amount we have now will naturally regulate and value itself. When more is printed it negatively affects this naturally regulating system. It gives me a sick feeling when I see them printing off millions in new "money" to stimulate the economy.

just_another_bozo_on_this_bus 5 years, 1 month ago

"The belief that inflation is just a natural part of the economy is another idea that drives me nuts."

Human economy ceased being "natural" about the time we started settling in villages and developed agriculture.

And once currency replaced straight bartering, inflation and boom-and-bust cycles have been with us ever since.

coldandhot 5 years, 1 month ago

In times of loss of confidence in monetary systems...one must own hard assets. Land (that can produce something), gold, silver, oil etc...are ways to protect yourself. One local company, www.silversaver.com is helping people protect their purchasing power.

trollpatrol 5 years, 1 month ago

Readers need to be aware that these "gold bug" views are not part of any standard economics theories (whether Keynesian, monetarist, new classical, or whatever), and it was bad journalism to leave a contrary impression.

Here are just a few of the problems.

  1. The gold standard does not lead to stable prices. The Spanish empire and then Europe as a whole once suffered from persistent inflation and economic stagnation due to imports of American gold. On the other hand, the gold standard leads to deflation and recession or even depression whenever the world aggregate GDP grows faster than the gold supply.

  2. The gold standard is nonunique. There are many precious metals and substances. Choice of a standard is itself a matter of fiat. Silver has often been the standard, for example.

  3. Long term stable prices are not necessarily a very good goal. Low levels of inflation may encourage growth by allowing wage cuts without renegotiation. The ideal inflation rate is an unsettled question in economics.

  4. Almost all economists are agreed that short term stable prices can be achieved under either fiat money or a gold standard by using monetary and/or fiscal policy, PROVIDED that is what the authorities really want more than any other goal. Most people however would prefer having a growing economy and low unemployment with a certain amount of inflation over having stable prices and high unemployment, and sometimes that's the choice we face. The gold standard has almost nothing it do with it.

  5. Long term stable prices cannot be guaranteed under a gold standard without limiting growth in GDP to the growth in gold supply. Since the economy can grow exponentially, that means you need exponential growth in the gold supply to maintain desirable growth rates. Since the total gold in the earth is finite, exponential growth in gold cannot be maintained permanently. Worse yet, as cheap gold gets mined out, mining for gold gets more and more more expensive, which means that eventually the real price of gold has to keep rising if you want the gold supply to increase at all. Conversely, that means you have to live in a deflationary environment to maintain a permanent gold standard. And that probably means permanent depression.

Chris Golledge 5 years, 1 month ago

Paper money has some value only because we all agree it has some value; true enough. But then, I have to ask, what is the intrinsic value of pretty minerals?

coldandhot 5 years, 1 month ago

Troll patrol says...

"Readers need to be aware that these "gold bug" views are not part of any standard economics theories (whether Keynesian, monetarist, new classical, or whatever), and it was bad journalism to leave a contrary impression."

And where has standard Keynesian policies gotten us...INTO THIS MESS!

People are tired of it. Its time to wake up. Standard economic theories have failed us! Call people gold bugs or whatever...but they are right. I was not a believer at first, but Keynesian policies have failed us.

Folks, if you listen to troll patrol...you will be broke!

headdoctor 5 years, 1 month ago

We are not operating under a pure bred version of Keynesian economics. It is more of a bastardization of Keynesian, Babylonian system, barter, and commodity money systems. The true root of our system is Babylonian. The Keynesian system is just the influence of a Governments involvement.

KansasPerson 5 years, 1 month ago

"I don't know anything about the gold standard, I'm afraid. But I do like kittens. They're so soft and furry." http://www.youtube.com/watch?v=LS37SN...

monkey_c 5 years, 1 month ago

Butterflies don't care about money, mountains don't care about time. Everything is cool if you think it's funny. Nothing matters, if you don't mind.

headdoctor 5 years, 1 month ago

Now for another kink or two thrown into the mix. The banks loan you money in the form of ones and zeros. What you have to pay them back in is more based in the form of actual currency. Seems like a great racket. The Banks get something of recognized value for nothing.

Also silver, gold, and platinum isn't really a sure thing. Silver and platinum prices are based more on demand from manufacturing and gold prices are based more on political issues.

05121784 5 years, 1 month ago

Watch on youtube: Zeitgeist - Federal Reserve

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