About Money

gldstndrdAnyone who attends a quality class in basic economics will know the following book definition of money: A measure of value, a store of value, and a standard of deferred payment. They may also know the practical definition: Money is whatever the government says is money.

This second definition is valid, only to the extent that the people have confidence in whatever the government has mandated. If no one is willing to accept government issued money then they will move on to something else in short order. This was a common practice at the time of the American Revolution when the public lost confidence in paper issued by the Continental Congress and demanded specie instead. In societies where “real” money is not available, money substitutes come into effect. An excellent example occurred in POW camps during World War II where cigarettes became the accepted medium of exchange. Another happened on the early American frontier where whisky became an accepted form of payment, indirectly resulting in what became known as the Whisky Rebellion, when the federal government began taxing alcoholic beverages.

There is really only one thing necessary for something to act as money, and that is essentially universal acceptance within the society using it. This is possible because the use of money is really only an extension of the barter economy using what might be called a “universal intermediate good.” In this way money makes an economy more efficient by allowing people to use intermediate goods instead of having to trade exactly what they have for exactly what they want. But in the end, it all amounts to the same thing: simply an extension of barter.

Today we are seeing renewed calls for a return to a gold standard for American currency. Part of this is fueled by fears of inflation, and part by the budget deficits requested by the current administration primarily due to the war and related expenses in Iraq. Having some hard standard in place is desirable, and is certainly better for all concerned than a paper standard, which relies on the “full faith and credit of the United States Government,” whatever that may be. Still, in the end, a gold standard is not a panacea. Inflation has happened in specie-based economies before. In Europe, when large amounts of gold and silver were brought back from the New World, inflation was a major problem. Even more illustrative is the experience of the California gold camps, where prices rose to absorb the increased amount of gold available in the local economies. Of course, the effect was strictly local. Outside of the area prices were essentially unchanged.

In a government-controlled system where certificates are issued with purported specie backing, it is always possible for the government to print paper in excess of the amount of available gold. When private banks use fractional reserve banking it multiplies the problem by increasing the amount in circulation further. Recall that money is an economic commodity, and its value reflects supply and demand. Its value rises and falls as its relationship to other commodities in the economy changes. That is why we occasionally hear that counterfeiting destroys the value of currency. If the value of money was not tied to the amount is circulation this would not be true.

So what is the real answer? In the end the most important factors are whether or not government can control its ability to spend and its concurrent desire to grow. During the Middle Ages in Europe the Catholic Church was the dominant entity. It controlled virtually all aspects of society and exercised a strong hand in the political activity of the time. As human nature and normal political behavior came into play the Church spent more and more money and needed to raise ever greater amounts of revenue. The same effects have shown up in the democratically governed nations of today. As demands for government services have increased, as legislators seek ever-greater power, and government regulation spreads its web over virtually everything, the combination begins to have a destructive effect. Inflation may occur, or may not, depending on how government chooses to fund its activities. Deficits may be a problem, but they are not the only problem.

What most, if not all governments never come to understand is that if they want a free market then they must allow the market to be free. Strong economies and strong governments don’t mix well because influential people use the system to gain personal advantages. Only a limited government will be unable to provide those advantages and it is in the best interests of all citizens to prevent others from using government for personal advantage.

The “gold bugs” may be right and the price of gold may rise to some unheard of level in the next few months or years. However, even if it does happen, it may not be due to inflation and it may not have profound effects on everyone. Keeping a lid on government spending is more important than worrying about the price of gold. Unless, of course, you happen to be a professional metals speculator.

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