Friday, August 01, 2008

What is Money?

Category: Issue 11

A friend of mine asked me if I understood money.  Here’s my answer:

Imagine you own an apple orchard.  You get apples every fall.  But you want bacon and it’s Winter.  So you write an IOU for 50 apples and bring it to the market and trade it for some bacon.  You just printed money and gave it to the pig farmer.  This only works if the pig farmer trusts you.

If the baker trusts you and recognizes your signature on the IOU, then the pig farmer can trade the IOU to him for bread.  This is what makes money useful.

Once you’ve done this for a few years, there may be a lot of apple IOUs out there with your signature on them.  When someone brings you one and you are out of apples, they may wait for you to grow more, or they might get mad and tell people you’re no good.  At least you have apple trees and you will be able to redeem them next year.  You might appease the holder of the IOU by making the IOU for 60 instead of 50.  If you’re smart and sneaky, you might prepare for this beforehand by making the IOUs for “One BOX of apples”.  Then when you have too many IOUs in circulation, you put 30 apples in a box instead of 50.  This is inflation.

This is “hard currency”.  It is redeemable for something useful, and inflation makes it redeemable for less and less.  If you do this well, you will eventually be able to “close the apple window,” meaning that you no longer provide apples in return for the IOUs.  This is, in fact, what Nixon did to the US dollar in the early 70s.  He said dollars are no longer worth the gold that had previously backed them (and which had been shrinking in weight as the US Government grew more parasitic).

BUT WAIT! You must be thinking.  How can they do that?  The IOUs would then be useless!  Not so.  People are habitual creatures, and so they are used to using the IOUs to trade and they don’t bother checking that they are redeemable.  Some people are allergic to apples anyway, right?  So the IOUs you create are no longer redeemable and they are called “fiat currency”.  This is what most countries use now.  Fiat currency is based on getting parents to place a value on pieces of paper printed by the government to represent value and teaching this value to their children.  Obviously, this provides the government with a great deal of power.  Its essential function is to forestall the death of the government through hyperinflation.

You don’t have to start with apples.  You only need to start with credibility.  You could give people IOUs for their gold and then keep their gold safe while they trade with the IOUs.  A house’s worth of gold weighs a lot, but a piece of paper is very light.  This is the original essence of the banking system - “we keep your stuff safe” - and they provide you with a tradeable note (the IOU, or banknote).  Governments could not do this because people didn’t trust them, so instead they made laws to protect against BANKruptcy, which led people to believe they didn’t have to determine the credibility of their bank.  But banks still failed, and so the government made a central bank.  The failure of a central bank is called “hyperinflation”.  Basically, the government does what governments always do, which is to use laws to push all the bad stuff out toward the future where it piles up and eventually destroys the general welfare of a country.

Families can last forever.  That’s why we’re all here today, with an unbroken chain of ancestors.  Countries, however, fail eventually because of this behavior of governments.  The solution is to expect and protect yourself from behaviors that exploit you, the chief one of which is the enforcement of tax laws.

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Old Comments

  • I like this.  Economics lesson. More or less right on.  Dave and his tax laws, though—I’ve yet to see a workable alternative.  (yark, but seriously)

    Posted by julianyway  on  09/17  at  05:34 AM
  • In this book: http://www.mises.org/Books/mysteryofbanking.pdf, Rothbard explains something I missed.  Money used to mean something better than an IOU.  It used to mean the substance or material that was useful.  It used to mean the actual apples. But collectively, socially, and historically, we have forgotten what benefit THAT meaning of the term “money” provides, and so now we use the term just to mean the IOUs themselves. What is that benefit?  Stability.  Inflation only happens when the effort required to get more of it (apples, salt, gold, etc.) falls faster than the effort required to get the stuff we buy with it.

    Posted by .(JavaScript must be enabled to view this email address)  on  09/17  at  05:05 PM
  • I don’t even have to read the book to agree with it.

    Posted by julianyway  on  09/18  at  12:11 AM
  • Um, nice summary.

    Posted by julianyway  on  09/18  at  12:12 AM
  • Very interesting!

    Posted by .(JavaScript must be enabled to view this email address)  on  10/04  at  10:32 PM
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