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ian said |
| 2 years 95 days ago |
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What is Money?
Excerpts from The Coming Collapse of the Dollar and How to Profit from It, ©2004, Chapter 6, "WHAT IS MONEY?"
Pick up any introductory economics text, and you’ll see money defined as something that performs three functions:
• A standard of value—that is, a generally agreed-upon measurement used to express the price of goods and services.
• A store of value, which holds its purchasing power over long periods of time, to allow people to save and thereby defer their spending until some future date.
• A medium of exchange, which is easily transferred from one person to another in return for goods and services.
This is an acceptable definition, as far as it goes. But a deeper understanding of money is possible when you think of it as a communications medium. Just as spoken language enables us to convey ideas, money is the mental tool each of us uses to communicate our own subjective view of value in an exchange. Say, for instance, that a seller offers something at a given price, which represents his (perhaps hopeful) view of its value. You counter with a lower price, and you meet somewhere in the middle, at a price you can each accept. Money is both the conceptual framework in which this conversation takes place and the tool that allows you to translate each other’s idea of value into understandable terms. Money thus makes economic calculation, and by extension our market-based economy, possible.
Just as a given word means the same thing over years and centuries, allowing language to convey ideas from one generation to the next, money communicates the measurement of wealth. A gram of gold is an unchanging unit of account, like an inch or a meter. It conveys meaningful knowledge by how much it has purchased over time. A gram of gold has bought roughly the same amount of wheat since the Middle Ages, for instance. And as you can see from the chart below, the relationship between gold and oil in our industrialized economy has been remarkably stable.
When a unit of account is unchanging (again, think of inches or meters, which refer to the same lengths from one year to the next), the money based on it is “sound.” That is, it effectively communicates wealth over time. As you’ll see in the next couple of chapters, for 200 years the British pound was sound because each unit of currency was, throughout this period, defined as 0.2354 troy ounces of gold. And the U.S. dollar was sound from 1900 to 1933 when it was defined as 23.22 grains of fine gold. These currencies were simply names for given weights of gold. Today’s dollar, on the other hand, is emphatically not sound, because it isn’t defined in any unchanging way. A dollar isn’t a weight of gold, silver, or anything else. It’s simply a bookkeeping entry, an IOU of the banks that are permitted by the U.S. government to create dollars. Compare the following chart to the one on the preceding page for an idea of the difference between sound and unsound money.
But sound money is not the same thing as stable purchasing power. As the gold/oil chart illustrates, over the years an ounce of gold has bought very different amounts of oil. Why? Because supply and demand for both goods and money are always in flux, causing prices to bounce around. The difference is that with sound money the fluctuations tend to even out over time, bringing the price back into line with historical norms. The purchasing power of unsound money, as you’ll recall from Chapter 2, tends to move in only one direction: down. Currency, meanwhile, is the physical representation of money, the item that passes from hand to hand in return for goods and services. When it takes the form of society’s standard of value, as with gold and silver coins (or, as you’ll learn shortly, older forms of money like goats and slaves), currency is also money. When it takes the form of, say, paper notes, currency is not money but a “money substitute.” And if a currency is not defined in terms of money, but is created and controlled by a national government, it is a “fiat” currency, so called because it exists by government fiat, or decree.
In accounting terms, money is a tangible asset, while a money substitute is a liability of a bank, the assets of which may or may not be money. In practical terms, only money can extinguish an exchange for some good or service. That is, an exchange is extinguished when assets are exchanged for assets. If you accept a money substitute (for instance, dollars) when you sell a product, the exchange is not extinguished until you use those money substitutes (those dollars) to purchase some other good or service.
We trust sound money because it exists in limited supply and is, by definition, not subject to government manipulation. Fiat currencies, in contrast, are controlled by governments, which are, as you now know, fundamentally incapable of managing their monetary affairs.
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ian said |
| 2 years 95 days ago |
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