Today I want to begin a multi-part discussion of money–what it is and what it isn’t.
Imagine yourself on a remote island with tropical fruit growing all around you and more fish swimming along your shores than you could eat in a lifetime. The weather is warm all year-round and there are no mosquitoes. What a life!
Imagine also there is one other person on this island. You both have the same needs for food and shelter but your friend is better at fishing and climbing orange trees; you are better at building sturdy huts and implements to make them. Naturally, then, using your competitive advantages to improve your lives, your friend will gather food and you will build shelter, and each will share the fruits of his production. Isn’t life grand?!
In exchange for fish and fruit, you agree to build your friend a hut. You get to eat; your friend doesn’t have to sleep in the rain. As long as all needs are taken care of with this simple arrangement, there is no need for money.
Money is, and is only, a means of tracking the value of production. If we expand our example to include a hundred people on the island, each with abilities and talents that give him or her a competitive advantage in the production of some good, whatever one person produces in excess of his or her needs can be traded for something that someone else has produced in excess of their needs. Initially, twelve bananas might be traded for three fish. The exchange rate, at least for those specific people is 4 bananas to 1 fish. I’m sure I don’t have to outline the problems with this barter economy in a complex society. Suffice to say that at some point, something of value to everyone, something that is not readily duplicated, something that holds its value, something that is easy to transport, and something that does not rot away with the passage of time will come to be used as a standard unit of trade.
The important thing to note, as far as we’re concerned today, is that this thing, money, is only a representation of the value of production, production of goods that are desirable by the people in the economy. One person could dig holes and fill them in all day, working incredibly hard, sweat profusely, but if no one desires that holes be dug and filled in, nothing is being produced and there is no value to it. The person digging holes cannot, at the end of the day, tell the person who has been fishing all day that he is owed three fish for his labor. In the same way, if the economy has developed pieces of copper as the medium of exchange, or money, the hole-digger cannot claim any amount of copper coins for his work, as he has produced nothing of value.
Money is only a measure of production.
The other important thing to note is that if all the people within the economy of our desert island circulate 1,000 copper coins to trade goods among themselves, increasing that number to 2,000 copper coins results in only one thing: the doubling of prices of everything being traded. If anyone was hungry before the increase, he will still be hungry after. If anyone had to sleep in the rain before the increase, she will have to sleep in the rain after. Pumping more currency into the economy does absolutely nothing to increase the production of goods. No one is any better off.
Only more production can increase the wealth of the people within our little island economy.
The U.S. economy has grown since 1913 when the Federal Reserve was created. But consider this: our standard of measurement, an ounce of gold, in 1913 could purchase a tailor-made men’s suit. Today, an ounce of gold will purchase a tailor-made men’s suit. But our current unit of measure, the dollar, has been devalued so that what $35 purchased in 1913 (e.g., a men’s tailor-made suit) today costs $2,000. The wool for the suit is now easier to acquire and less expensive. The machinery available to make the suit enables the tailor today to make a suit in half a day rather than a week. By rights, the suit should be less expensive, not more. But the effects of dumping money into the economy only serves to increase prices. The government and those with first access to the increase (government and the well-connected) are able to benefit from the increase while diminishing its value to everyone else.
We’ll talk more about that in future newsletters.
But, however, with that said (any way you want to introduce a different direction to the essay), don’t fall for the non-sequitur, “The American dollar is a worthless piece of paper.” If you really think that I’ll let you know where to send all your useless paper. I’ll even pay for shipping.
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