What is money?
Money is an integral part of our lives and every economy in the modern world. For this reason it is vital to understand the history of money and how the monetary system works. Upon scrutiny it is clear that our current monetary policy is only hurting the people and the government.
Before the creation of currency, people bartered, or traded things. For example, a corn farmer may trade his excess corn to a wheat farmer for some of his excess wheat. This way both farmers would have wheat and corn. It was simple enough, but the system posed problems for several reasons. First of all, it was very difficult to trade large quantities of product because everything would have to be physically moved. Also, if someone wanted something that they didn’t own, they would have to find someone else that did have that product. If the corn farmer wanted soy, but knew no soy farmers, he probably wouldn’t be able to get soy.
The solution to this problem was using a commodity that everyone wanted and would trade for their products. Different civilizations used different things from conch shells to precious metals (such as gold, which eventually became the most popular form of money), as long as it was something that everyone wanted. Since everyone wanted it, everyone accepted it as payment for whatever products they wanted to trade. This was the invention of money.
Pretty soon the banks started issuing receipts to depositors, so that they could claim their gold when they needed it. People soon realized that the receipts were “as good as gold” because they could be turned in for the gold any day. Since it was easier exchanging the paper receipts than the heavier gold coins, the system stuck and paved the way for paper money. Eventually, governments would just print official paper currency that was backed by gold. Each bill of paper money had a set amount of gold behind it, that the government held in reserves. Originally, most countries (including the United States) allowed its citizens to turn in the paper money in exchange for gold (since it was the same thing in theory.)
As money evolved, a new type of currency was created: the fiat currency. A fiat currency is not backed by any commodity (and hence can’t be turned in for anything,) but is accepted around a nation because of the government’s order. The United States currently uses a fiat currency, as do most major world currencies. This wasn’t always the case though.
The United States has flipped between commodity-backed and fiat currencies a few times in its history. Governments have historically changed to fiat currencies in times when more money is needed such as wartime because fiat currencies have no backing, so there is no restraint to how much can be printed. The United States did this during the Civil War, but changed back to a commodity-backed currency after the war. In 1971, President Nixon signed a bill that made the USD a fiat currency (theoretically it was to stay that way forever.) At that time, many world currencies were pegged to the USD (essentially they were backed by the USD, which was backed by gold,) so when the USD became a fiat currency, so did the currencies that were pegged to it. This is why most of the major currencies today are fiat.
Fiat currency is fine as long as the people accept it and as long as it isn’t printed at a rate higher than the economic growth of the area it serves. When the rate of printing does exceed the economic growth of the area, the value of each existing bill decreases and we see inflation. This is exactly what our government is currently doing.
We don’t have money, but big government insists on spending more, so a lot of what is needed is simply printed. Every time a new bill is printed after the rate of printing exceeds the rate of economic growth, we experience inflation. This is because when that bill is printed, all existing bills take a hit in value. One dollar printed above this balance may not be so detrimental to an economy as big as ours, but when the government starts printing billions (as it currently is,) the buying power of the dollar goes down and everything seems more expensive.
When this overprinting of money gets to a certain point, it gets ugly, and fast. We start to see hyperinflation, which is exactly what it suggests: massive inflation. The currency has lost a lot of its value and if the government doesn’t stop printing it, it risks becoming worthless; even to the point where the bill is worth less than the paper on which it is printed. This is not a theoretical situation because it actually has happened. There are several historical examples of such collapses, most notably the Weimar Republic (in more recent news, Zimbabwe is headed down a similar path as the government just announced the issuance of the $10 billion note- which is worth less than $20 USD.) In situations such as these, the part that hurts the most is hearing about those who had savings.
Say you saved $100,000 over your lifetime. If we experience hyperinflation and everything costs huge numbers of dollars, that 100,000 will be worth almost nothing. When you saved it the dollar would’ve been worth a lot more and it certainly would’ve taken a long time to save all that money up, but in a state of hyperinflation all the hard work turns into a waste. That money is worthless. People can lose their life savings because of this.
This is why it is no joke when the government prints money at a rate higher than economic growth. Even though it hasn’t been done enough to cause hyperinflation in the United States yet, it certainly has caused inflation. The government essentially steals the money from you in order to give value to its newly printed bills, which it needs to support big government. Many like to call this the inflation tax because the government is essentially taxing all the dollars you have by reducing the value of them.
So next time you see a new proposal to increase spending think twice before supporting it because if we continue to support and spend as much as we currently are, our money will quickly become worthless.
2 Comments »
Jan 05 2009 at 4:08 pm
[...] plan only tries to make Obama look good in front of those who don’t understand or care about how the monetary system works. In reality, it is a [...]
Jan 10 2009 at 9:13 pm
[...] important in order to get a firm grasp of how the economy of any nation works. In my post, “What is money?,” I briefly explained how the government printing large supplies of money can be disastrous. [...]