To understand monetary policy and its effects we first have to understand what money is. by Aaron Emery
Thursday, May 7, 2009
Money, Stability, and Gold
The Principles of Good Money
What is money? Most Americans will say one of two things. Either they'll say "a dollar" or "something you buy stuff with". Ok, true but very short of the real answer. Money is really just a standardized unit of trade, acceptable amongst the people. Whatever that unit is, is dependent upon acceptance of the populace.
The Greek philosopher, Aristotle (384 BC - 322 BC) was arguably one of the greatest minds in history. To this day his teachings on philosophy and money are taught around the world, without many people realizing it. He was a private teacher to Alexander the Great, who consequently was the first leader to unite his empire under a "hard currency". Aristotle was concerned with how fair exchange could be made for different items. Sure under a bartering system a pig can be traded for three chickens, but what if those chickens are all different sizes? Is it the number of chickens or the weight of the chickens that is important? How do you measure the value of items that are not uniform? You can substitute anything else for chickens and a pig, but the basic need for a standardized measurement will remain.
Under this presumption Aristotle searched for a principle that would equalize things that were incomparable or unequal. So he desired a "money" that would become a common measure of everything. He said that in money form, individuals found a unit that can provide measurement upon which fair exchange can take place. Aristotle thought that everything could be expressed in this universal money form. "Good money" meets all the requirements of any item or service that can be exchanged, in a comparable manner. Aristotle defined these as the basic characteristics which money must possess in order to be considered good money:
4. Intrinsic Value
Durability - Money must be able to stand the test of time. It cannot fade, tear, corrode, or change over time. If money is not physically durable, it is liable to lose its worth due to weather, usage, and time. Thus, the owner will lose all of the wealth gained through obtaining that money.
Portability - Money must be easy to carry or move. It must also hold a high amount of value relative to its size and weight. If money is so cumbersome as to disallow the practical carry or transport of it then it will not be valued as highly and will counter the purpose of owning it. Also, if it takes pockets full to carry a very small value it is equally unfitting.
Divisibility - Money must be able to divide easily into smaller units of worth. If the smallest unit of money available is more than that of lesser items or services the user will be forced to overpay. - i.e. If a ten dollar bill were the smallest unit of currency in the United States, buying one pack of gum with it would be grossly overpaying and it would not allow the purchase of "cheap" items and services. Money must be easy to separate and re-combine without changing its basic characteristics. -i.e. Paying for one pack of gum with a ten dollar bill and receiving $8.99 in return. This could be returned in many ways because we have several small denominations of bills and coins.
Intrinsic Value** - This is the most misunderstood aspect of money, in fact many government economists do not fully understand this principle (big surprise, that's why they are government economists and not corporate or institutional). Intrinsic value means that the value of the money is derived from the actual content of it.
Merriam-Webster's Dictionary defines intrinsic as: belonging to the essential nature or constitution of a thing.
Money does not have intrinsic value if it does not contain its own worth. -i.e. A dollar bill or any other paper currency does not have intrinsic value because the worth of the actual paper is not equivalent to the face value of the money. A ten dollar bill is accepted for payment of ten dollars only because people trust that they in turn can pay for an item or service equaling ten dollars. If people suddenly stopped accepting ten dollar bills then it would only be worth the actual value of the paper it's printed on. On the same token (no pun intended) credit and debit cards are not good money. They meet the first three criteria for good money but do not have any intrinsic value, just the value of plastic and a magnetic strip. This is one reason that, for most of the history of civilized society, metal coins have served as the primary form of money.
Metal in and of itself contains value, some metals have more value than others because of their uses and characteristics, but all metal has more value than paper. This is so because metals are much harder and more costly to exhume (mine) from the ground than paper is to grow on trees. Paper is a replenishable source, metal is not. There is only so much metal in the earth's crust and we've been depleting that source for thousands of years. Some metals can be manufactured in a lab, but all the precious metals (gold, silver, platinum, palladium) are single elements, meaning they cannot be manufactured because there are no elements you can combine to make a single element, hence the rarity of these metals.*
These are the four principles of good money as defined by Aristotle, but I think it more appropriate to include a fifth principle because those principles alone have not guaranteed the stability of a currency;
Acceptability - Acceptability is derived from the belief that upon trading an item or service for money, that same money can be used to trade for other items or services. Not all forms of acceptable money have possessed the previous four characteristics of good money, but most money that DOES possess those traits has become acceptable at some point. - i.e. No form of paper currency has much intrinsic value, but it is traded widely within its own country. The high amount of trading lends to its acceptability and it is semi-durable, portable, and somewhat divisible. However, because it does not possess the crucial trait of intrinsic value it cannot be considered good money, and thus you can see why the history of EVERY paper currency has ended in inflation, devaluation, and ultimately the destruction of that currency. Sure, currencies without all the necessary traits can survive and even flourish for awhile in good times, but the test of a currency is whether or not it can survive difficult times and the only currencies that can are stable ones, or good money. It is very telling to note that the average lifetime of paper currencies is 75 years. Whether or not a currency remains strong because of political and social stability or whether that stability is due to a strong currency is up for debate. But certainly a country cannot have stability for long under a bad currency, a citizenry will only accept devaluation and inflation of its currency (lessening of their wealth) for so long before it rebukes it, hence the relatively short (in decades) rise and fall of world powers and similar rise and fall of currencies.
The key to understanding the effects of money and monetary policy is to understand what money is to begin with. These principles provide a solid basis for recognizing and understanding what money truly is. To recap let's again cover the five principles of good money:
You can easily apply these fundamentals to any currency and judge whether or not that currency is considered good or bad money without having to understand the social and political climate of the country. Many people "in the know" love to argue this and counter that money is more complicated, that it is based more off the world political climate and so on, or that "times have changed", but as we've seen the fundamentals of good money have not changed for thousands of years.
The second installment of this article will discuss bad money vs. good money and its effects on a civilization.
*Recent laboratory experiments have been conducted in which gold has reportedly been created in a lab by adding protons to lead, a base metal, resulting in gold. It was previously thought that gold was not able to be manufactured, but changes in processes may allow manufacture a possibility. However, it is such an intensive and expensive process as to be considered inconceivable at this time to manufacture for its purposes. This has not and will not, for the foreseeable future, affect the gold market much.
**It's important to note that there are two types of intrinsic value, economic intrinisic value and monetary intrinsic value. Economic intrinsic value are the useful attributes of something. -i.e. Silver has a great deal of economic intrinsic value (that doesn't mean financial), it is used primarly in industrial capacities, photography, and medicine. Monetary intrinisic value is the "actual price" of something. i.e. Gold has a great deal of monetary intrinsic value (people will pay $920 currently for it). Gold does not have as much economic intrinsic value as silver does, it can't be used for as many purposes as silver but its monetary intrinsic value is extremely high because of its accepted "price" on the market. A dollar bill has monetary intrinsic value, what people will pay for it, as in what they will give to you for it, which is less and less each day, but it has no economic intrinsic value to speak of. The actual paper is worth hardly anything more than fire starter and even then it doesn't do it well. Thanks to Jake Towne for pointing this out.
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Posted By: Jake, the Champion of the Constitution
Date: 2009-05-07 16:53:19
Dear Aaron -
Fantastic article!!¬† I wish every article at the nolan chart was on honest money - well, until people get it, that is :)
I had two comments
1) One is to be very careful when writing about intrinsic value - I did this when I started writing last year but changed my view.¬† Basically, I think its very, very important to make the below distinction.¬† Why?¬† Because value is subjective as Mises explains in Chapter Human Action - try the first page of page 200 , Chapter XI¬†
check out this discussion gene and I had on value recently here if you like http://www.nolanchart.com/article6367.html
A)¬† legal intrinsic value - the mass or weight in precious metal of the coin, or in the modern world its declaration of value by fiat.
B) economic intrinsic value - the utility or uses that can be found for the given mass of metal.
2) We are really in agreement as "Acceptability" tends to cover most of the rest, but I was wondering if you would be willing to take a look at what RP (not really I) define as sound money here
I completely agree with Ron Paul's assessment of money.¬† As far as the intrinsic value goes, yes, you do have to be careful because it scares a lot of people, they simply don't understand.¬† It's actually interesting and not a whole lot of people will see eye to eye on this with me, but as far as economic intrinsic value goes gold does not have a whole lot.¬† It certainly has far more than any paper currency and more than a lot of metals, but that's only because it is accepted as such.¬† People everywhere WILL pay $900 an ounce for it, but the metal itself does not have many uses other then jewelry, some technology, and a little medicine.¬† Silver is much more valuable as a commodity but gold beat it to the punch in being accepted first.¬†
This is what really gives gold its value, the fact that everyone wants it.¬† It became so accepted because of its inherent properties, this led to its value being what it is.¬† I recently read a fantastic book called "Gold: The Once and Future Money" by Nathan Lewis.¬† Very informative and interesting.¬† He points out that although most people assume gold is valuable because it's rare, that is not the case.¬† Silver is more rare and gets used almost immediately in industrial applications (the primary use for silver) yet gold is 70 times more valuable, or shall we say,¬†costs 70 times more.¬† So the intrinsic value (economically speaking) is in silver's favor but that doesn't follow the cost.¬†
On another note I'm very excited about HR 1207, it's doing well and it'll be interesting to see what happens in the next couple years.¬†
Posted By: Jake, the Champion of the Constitution
Date: 2009-05-09 09:29:09
Yes, what's really interesting is the Misesian view - value is completely subjective - ALWAYS.¬† People make trades not because they are trading equivalent "value" for "value" - in this case why would they trade at all?¬†
People trade because they feel - at the moment of the trade - that for some reason they will be better off making the exchange.¬† That's what an economy really is - billions of individual transactions, not some dude from the gov't telling GM to make XX,XXX cars every month
Posted By: Syed Talat Ali
Date: 2010-01-26 07:58:58
Currency must have intrinsic value. Gold and silver coins must be used at place of US $. That will give stability in whole economic system. In paper currency measuring yard is fluctuating that initiate crises for whole world.
It became so accustomed because of its inherent properties 70-528, this led to its amount getting what it is. I afresh apprehend a absurd book alleged "Gold: The Once and Future Money" by Nathan Lewis. Actual advisory and interesting 70-536. He credibility out that although a lot of humans accept gold is admired because it's rare, that is not the case. Argent is added attenuate and gets acclimated about anon in automated applications (the primary use for silver) yet gold is 70 times added valuable, or shall we say, costs 70 times more. So the built-in amount (economically speaking) is in silver's favor but that doesn't chase the cost 70-299.
On addition agenda I'm actual aflame about HR 1207, it's accomplishing able-bodied and it'll be absorbing to see what happens in the next brace years 70-547.