AUSTRIAN ECONOMICS ADDICT

Monopoly Money (Photo credit: John-Morgan)

QUESTIONS CONCERNING MONEY.

I’ve had some questions recently that have to be addressed. 1) If production increases without a corresponding increase of money, would that not cause deflation? 2) If the currency is to be increased to correspond with the increase in production, how is it increased without theft? The simple answers to these two questions are yes to the first one, and, it can’t, to the second one, but that doesn’t help us understand the why’s and how’s.

UNDERSTANDING MONEY.

I wrote a post titled, “We’re All Born In The Middle Of The Story”, in which I quote Thomas Sowell who said, “results observed at a given point in time may be part of a process that stretches far back in time“. Understanding this quote should be our default position for everything we observe and analyze. When it comes to money we are all born in the middle of the story. What do I mean by that? There are very few people alive today who didn’t grow up in a paper money system. In order to understand what money is, and how it came into existence, we can’t base our knowledge about money on the short time we have spent inside the paper money system that we were born into. Being born in the middle of the story automatically makes us ignorant, sometimes blissfully ignorant, about the beginning of the story. Until I read about the beginning of the story concerning money, I was ignorant about what money is and how it came into existence. Lets start at the beginning.

MONEY EVOLVED OUT OF EXCHANGE IN A BARTER SYSTEM.

Nobody came up with the concept of money and then everybody started using it. It evolved spontaneously as people started to exchange goods in a barter system. Money was used long before Governments existed. Governments gave themselves monopoly power to create money, long after money was being used by people in the exchange process. In a barter economy people exchanged goods because they valued the good for its direct use. Because of the difficulty of finding a person who produced what you wanted, and then hoping that person wanted what you produced, people started to exchange for a good they didn’t necessarily need for its direct use, but one they knew could easily be exchanged for what they wanted. They accepted the good for it’s value in exchange not in use. As this process evolved over time, gold and silver became the commodities people accepted for their value in exchange.

In a barter economy exchange ratios developed between goods.  For example, if you can find a shoe producer who wants candy bars, and a candy bar producer who wants shoes, the exchange ratio might be, a pair of shoes for 50 candy bars. But this is a one way trade in a barter system because you can’t exchange 1/50th of a pair of shoes for 1 candy bar. These exchange ratios between goods evolved over time. As gold and silver started to be used for their exchange value, the ratios between goods exchanged in a barter, were now transferred, and calculated, as ratios between a good, and ounces of gold or silver. So now if a pair of shoes would exchange for, say, 2 ozs of gold, a candy bar would exchange for 1/25th of an oz of gold.

QUALITIES OF MONEY.

The qualities that a commodity has to have in order to be used as the medium of exchange [money] are. 1) It has to be highly demanded by the public. 2) It has to be divisible into smaller units without loss of value. 3) It has to be homogeneous [identical when divided or added together]. 4) It has to be durable over time [it can’t rot, rust, or decay]. 5) It has to be transportable. 6) It has to be inelastic or not easily produced, so as to hold a stable value. Gold fits all of these requirements, or I should say, as gold evolved into the medium of exchange, people observed these qualities as being important. Money facilitates exchange much easier than barter, and it is the use of the medium of exchange that allowed for the expansion or trade, which created higher standards of living for everyone. The concept of money couldn’t have come about in any other way than how it evolved through the  market process.

EVOLVING FROM GOLD MONEY TO PAPER MONEY.

Gold was exchanged in nuggets, bags of gold dust, and even jewelry, but eventually gold coins were minted by goldsmiths to assure their weight and purity. People used coins for daily commerce, and bars of gold for larger transactions. People began to store large amounts of gold in gold warehouses, for a fee, and received a warehouse receipt as proof of ownership. The gold could be claimed at anytime by the receipt holder. Instead of going to the warehouse and getting gold every time an exchange was  made, people began to exchange the warehouse receipts instead of the gold. This is how paper money came into existence. These warehouse receipts became commodity money substitutes. These receipts evolved into the paper money we use today. Up until 1933 you could still exchange your Federal Reserve notes for gold; that’s when Roosevelt closed the gold window, mandating that gold must be turned in to the Fed, in exchange for Federal Reserve notes. These notes [dollars] were now legal tender.

Lets remember that money, no matter if it’s a commodity like gold, or just paper, is not wealth. All the goods and services we produce constitutes wealth, and money facilitates its exchange. When we exchange our money for a good, we are actually exchanging a portion of what we have produced, for that particular good. In other words, a good for a good.

DOES MONEY NEED TO INCREASE AS PRODUCTION INCREASES?

Now lets answer our first question: If production increases without a corresponding increase of money, would that not cause deflation? Yes it would be deflationary. The better question would be, do you need a corresponding increase of money, as an economy produces more? Lets look at this from a gold money standard. If there was a fixed amount of gold money; as production of goods increases, the purchasing power of each oz of gold increases. When you have an increasing amount of goods, chasing a fixed amount of gold money, prices will gradually go down [deflate]. It’s simple supply and demand. The exchange ratios [prices in gold ozs] will adjust, as more goods are produced. We have been trained to think that prices going down is a bad thing, when in fact, prices are just signals that send information through the economy about production and consumption. We always complain when gas prices go up but never when they go down [deflate]. When the price of the home we live in goes up we don’t complain, but the person who is trying to purchase a home sure isn’t happy. We as consumers are happy when the price of computers goes down, but the computer companies and their share holders  aren’t happy,and in fact you may be a member of both groups in this case. New money doesn’t need to be created to accommodate expanding production, all that has to happen is for the existing stock of gold to be broken down into 1/25th oz, 1/50th oz, 1/100th oz coins. These smaller increments can purchase what larger increments used to purchase. Gold evolved into money, because it is impossible to counterfeit. The only way new gold can come into existence is if people mine it, which is a very costly process.

In a paper money system, printing money doesn’t cause inflation, printing money is inflation. If the Fed had not been increasing our money supply over the years, you would never walk by a penny lying on the ground without picking it up, because it would have more purchasing power than a penny in today’s inflated world. A penny could conceivably be worth 50 cents in today’s purchasing power. With no increase in the money supply, there would be half a cent, quarter of a cent, and tenth of a cent coins in circulation.

Deflation is the straw man the Federal Reserve  fights a phony war against, in order to fool us into thinking that deflation is bad, and inflation is good. They are trying to keep their monopoly on money printing. The Fed funds Government debt through the printing press. The Federal Government couldn’t have grown to its present size, if we had never gone off the commodity money [gold] standard. Why do you think Government doesn’t want a return to a commodity money standard? Just remember printing is counterfeiting, and counterfeiting is theft. It is an exchange nothing for something. Government counterfeiting results in theft, the only difference is, it’s legal when Government does it. Increasing paper money benefits those who receive it first, at the expense of those who receive it later.

Related article, Counterfeiting By The Federal Reserve, Although Legal Still Results In Theft, by austrianaddict.

Related article, Keynes Was Correct In 1919! by austrianaddict.

Related article, We Can’t Recreate The Garden Of Eden, by austrianaddict.

This entry was posted on April 29, 2013 at 1:44 am and is filed under Econ. 201. You can subscribe via RSS 2.0 feed to this post's comments.

Tags: Banknote, Barter, Counterfeiting, Exchange value, Federal Reserve, Medium of exchange, Money, Printing