What Money is Not
With the possible exception of international trade, no topic in economics contains more myths than monetary theory. Here I address four popular opinions concerning money that suffer from either ambiguity or outright falsehood, among which that the purchasing power of money equals the supply of real output divided by the supply of money, that deflation is undesirable, and that money represents a claim on goods and services. FULL ARTICLE
Comments (54)
RPM
I didn't mention this in the article, but actually even the "Austrian" part of that Wikipedia entry is wrong, I think. It assumes that the price of a widget is simply Money Supply / Supply of Widgets, which is not merely inaccurate but totally the wrong approach.
Published: February 28, 2006 8:50 AM
Don Beezley
I read the article quickly, but I think under the third section, Deflation..., that equating a fall in prices with deflation is in error. I would equate deflation with a contraction of the money supply, which is potentially problematic (as is an undue increase in it ala inflation), and may likely be expected to give rise to a somewhat correlative fall in prices (an increase of purchasing power per unit of money in circulation) depending on the magnitude of the deflation. Whereas a fall in prices due to an increase in productivitity is beneficial (perhaps the essential "magic" of capitalism in terms of quality of life). Naturally a price can change due to many other factors (supply problems, miscalculations by entrepreneurs, increases in the relative popularity of a product, etc.), but within the context of this section, one might assume it is an increase in productivity, or certain subjective market factors, (good marketing for example, or perception in the change in the quality of the wine in a given year). Though one could still have some of the same factors within a true deflation, therefore not necessarily underminging the example, the distortions economically make the example more problematic if one is equating deflation with a price change, and, in the example, definitionally, a simple price change appears to be equated with deflation versus defined as a derivativtive symptom.
Published: February 28, 2006 9:48 AM
Paul Edwards
Don,
You wrote
“I would equate deflation with a contraction of the money supply,� and I would agree. But you continued with the statement “which is potentially problematic� which I interpret to mean potentially not so good. Can you elaborate?
The reason I ask is because my take on deflation, in your terms, is that since it always moves the economy towards (in the final analysis) beneficent corrections and to the liquidation of malinvestments it is always a good thing and therefore the more and faster these corrections takes place, the better.
Published: February 28, 2006 10:50 AM
billwald
Agree with what money is not. Then what is it in 2006? A universally accepted accounting mechanism for keeping score in the game of life.
Published: February 28, 2006 11:10 AM
Steven Kane
"Although (as a libertarian, Austrian economist) I fully condemn the monetary history of the United States, and deplore the means by which the public was forcibly weaned from the gold standard, nonetheless it is simply misleading and inaccurate to deny that the green pieces of paper in our wallets and purses are genuine money."
Robert, it appears that you are unaware of the etymological roots of the word money. The word 'money' had little to do with pieces of paper. The technical definition of 'money' was strictly gold or silver coin. That is why on the old Federal Reserve Notes it said "This note...is redeemable in lawful money..."
Clearly the note was not money itself for then the statement above would be completely absurd.
So who was misleading who when that phrase was removed from the FRNs?
Published: February 28, 2006 11:41 AM
RPM
Steve,
I think you're missing my point. I'm not denying that it was fraudulent for the government to get the public to hold green pieces of paper because of the redemption, and then to renege. Nonetheless the pieces of paper in my wallet are money, when we define money as a universally accepted medium of exchange.
Published: February 28, 2006 11:58 AM
Eric Taylor
While money today is not a claim on goods and services, like a warehouse receipt, paper money once was such a claim, on specific goods, in particular silver and gold.
While I doubt the claim will be honored today, you can purchase these certificates; for example, google on silver certificate and you will find:
1935 and 1957 $1.00 Silver Certificate Pair, PMG Certified 66 Gem Uncirculated
"One dollar in silver payable to the bearer on demand." These two bills are a throwback to a time when U.S. money was backed by silver.
And before the FED, we had bank notes, which I believe were considered claims on gold.
Published: February 28, 2006 12:02 PM
Steven Kane
"Nonetheless the pieces of paper in my wallet are money, when we define money as a universally accepted medium of exchange."
But that is precisely the attitude that allowed the government to renege on its promise to redeem in the first place. Hence, I still do not see why you are turning the charge of being 'misleading' onto those who believe in the original definition of money.
As for the charge of inaccuracy, that should lie squarely on the shoulders of those who started to loosely call the piece of paper itself 'money' rather than the actual gold and silver that it could be redeemed for.
Published: February 28, 2006 12:47 PM
Person
The other "problem" (again, "problem") people claim relates to deflation is that it will lead an increasing portion of the economy to be directed into producing money privately. That is, when each unit of money buys more, more goes into making money. In a fiat system, that could mean resources being directed in couterfeiting or gold hunting, while on a gold standard it would mainly lead to gold hunting. This supposedly hurts economic growth because it's not productiong of "real" wealth.
As for money "not being a claim to goods and services", that is correct in a sense, but it depends on the level of abstraction through which you're describing the world. In the same way, it's wrong to say that "markets work through competition, socialism through cooperation". What actually happens in markets is that people try to satisfy their own desires by satisfying the desires of others. In some instances, people will choose not to buy from a supplier, but from a different one. In the sense that this decision benefited one supplier at the expense of another, then you can view the suppliers as "competing", but again, only as an abstraction. So it's true that money isn't literally a claim on goods and services, but in some purposes it is helpful to think of it in those terms.
Published: February 28, 2006 12:48 PM
Paul Edwards
Steven,
RPM is really just stating an objective fact. Today, the dollar is money. Whatever his attitude toward this fact is, it isn’t going to change the fact. So, while many of us recognize that gold would be better for us as money, and that it was state coercion that removed gold as money, and put in place this fraudulent fiat dollar, the fact remains, in the end, that the paper dollar is money.
Published: February 28, 2006 12:59 PM
Brad Dexter
I think the debate on the value of paper money is that people are fooled into thinking it is money, so it is, just as they are fooled into to thinking they have both equity AND a slate of benefits coming from the State, just for the asking.
The public operates under all forms of illusions, and it works as long as the illusion can be maintained. But when the time comes when dollar manipulations and interest manipulations and cooked books comes to a head, then we'll see how valuable the unbacked pieces of paper are. They're money for now because the going is good. What happens when Europe doesn't want our dollars anymore?
Also, how are things going to change when paper money disappears and everything is electronic 0's and 1's?
Published: February 28, 2006 2:08 PM
Sasha Radeta
Person said: "The other "problem" (again, "problem") people claim relates to deflation is that it will lead an increasing portion of the economy to be directed into producing money privately.... on a gold standard it would mainly lead to gold hunting. This supposedly hurts economic growth because it's not production of "real" wealth."
-------------------------------------------------
OK, but examine that scenario more closely. If you go for more “gold hunting�, you are incurring high costs of mining (spending gold to extract more gold), plus you have limited supplies of gold to begin with - so the effects would never be so severe as in production of paper money (a century of gold extraction would correlate with one year's inflation in a fiat system). If we discover alchemy and gold becomes easily available – it would stop being the money and market would switch to something else… but that’s not my major point.
When we have an increase of gold stock in a society, certain people who invested their capital and labor in gold mining acquire a generally desirable and exchangeable good (gold) and it brings them more purchasing power. If they increase their consumption – the market prices will go up. Market simply adjusts the units in which market exchanges are made and those people who invested their resources to produce gold will temporarily gain the wealth in a market exchange. Likewise, an increased production of any desirable good or service would temporarily increase the wealth of sellers from the market exchange (before prices adjust to increased supply).
If I was able to produce a dozen highly demanded art paintings, holding money supply constant, that production would actually create more wealth for me. Investing in art or gold mining is not like investing in a revolutionary production process that would increase the aggregate amount of goods and services – increase real wealth and decrease prices, but as long as art and gold is demanded, people will invest to produce it. It is the free will of people that directs resources to their production – not the will of some government’s despot. THERE IS NO MALINVESTMENT HERE – only a temporary increase of gold-holders purchasing power. Notice the contrast between this difficult market money creation process (based on production efforts to create a desirable good) and fiat money that is created out of thin air – to benefit those who are close to the government’s power… but this is still not my major point.
My point is this:
When supply of gold goes up for some “gold hunters�, those people’s savings will also tend to go up (due to a lower rate of diminishing marginal utility of money and the fact that people’s increase in wealth reduces the cost of saving, i.e.). This decrease in time preference (postponement of consumption) translates into lower interest rates. THIS DECREASE IN INTEREST RATES IS A GENUINE MARKET SIGNAL that conveys the message that people’s willingness ability to purchase goods and services tomorrow will be larger – because real savings have gone up. This will correctly induce an increase in capital-intensive, long term projects that aim to meet tomorrow’s increasing demand. In contrast, when government artificially lowers interest rates by credit expansion and inflation, willingness to save will go down and spending on capital-intensive long term projects will go up. This tragic combination of drop in real savings (future consumption) and increase in a production of future inventories brings a recession after a temporary boom. We call this “malinvestments,� because investments were not induced by market signals (expressions of free people’s will), but based on a central planners’ idea.
Published: February 28, 2006 2:55 PM
Paul Edwards
Brad,
The interesting thing about the money regression theorem is that it holds that a money commodity can maintain its utility as a medium of exchange even if this commodity eventually lost all of its non-monetary utility and value. As long as it was established as money before this occurred, it would continue to happily function purely as a medium of exchange.
This also explains how paper once based on and then removed from a money commodity can function in that manner as well. But of course the government will inflate and devalue it as well. With all that, it remains a fact that for a new or revived commodity money to immerge, it must do so out of the barter market. This makes this fiat dollar irreplaceable or un-displaceable by commodity money because we have not been and are unlikely to be reduced to barter.
In respect to your last point, electronic accounts really don’t change things. We could have electronic accounts in a gold coin standard and our money substitutes could be paper, checks, plastic or anything imaginable. And yet it would all be on the up and up as long as we prosecuted banking fraud such as FR banking. The problem isn’t electronics; it’s purely that someone has been given the coercive monopoly on the issuing of fiat money and the expansion of bank credit.
Published: February 28, 2006 3:07 PM
Sasha Radeta
I assumed that a significant increase in gold will induce the higher savings rate, only to illustrate the importance of interest rates as the market signal that indicates the inter-temporal mood of consumers. Regardless of reasons for this change in preference, the important part is to remember that in 100 % gold standard any drop in interest rates (for whatever reason) indicates the lower time preference (the increase in real saving and future consumption) that correctly guides investors by communicating the will of consumers. On the other hand, when a central bank artificially reduces the interest rates without an increase in real savings, there is a problem of miscommunication between buyers and sellers (widespread forecasting errors regarding the sellers’ future levels of consumption).
Published: February 28, 2006 3:35 PM
Sasha Radeta
Lapse...
regarding the buyers' future level of consumption...
My next post will be a response to Don's argument about deflation.
Published: February 28, 2006 3:40 PM
Sasha Radeta
Don said:
“I think under the third section, Deflation..., that equating a fall in prices with deflation is in error. I would equate deflation with a contraction of the money supply, which is potentially problematic (as is an undue increase in it ala inflation), and may likely be expected to give rise to a somewhat correlative fall in prices (an increase of purchasing power per unit of money in circulation) depending on the magnitude of the deflation.�
________________________________________________________________________
It is absolutely correct that equating a fall in prices with deflation is incorrect. A fall in prices (expressed in money), due to an increase in supply or a drop in demand for regular goods and services, should not be confused with a fall in prices due to a decrease in supply of money (due to an overall trade deficit or some other reason for money/gold departure) or an increase in demand for money holding (due to an increase in saving for future consumption).
On the other hand, we should not confuse a market process of reduction in a supply of generally exchangeable commodity called gold - with a government created deflation by confiscation. In cases when market reduces a supply of gold, there are following scenarios (none of which results in confiscation of people’s wealth or any malinvestments).
Joseph Salerno summarized all scenarios for market deflation and contrasted them with the examples of government caused deflation:
http://mises.org/journals/scholar/salerno.pdf
Published: February 28, 2006 5:04 PM
Chris
The United States dollar has a recursive definition: US dollars are backed by US Treasury bonds, which are denominated in dollars. (When the Federal Reserve creates new money it goes on the open market and buys US Treasury bonds with the new money. This is why inflation is driven by government spending, not the Federal Reserve's "expansion of the money supply". The Federal Reserve determines the mix of government liabilities held by the public, not the amount. Inflation can occur regardless of whether the government liabilities held by the public pay interest.)
The US dollar, like all fiat currencies, is backed by real goods. Specifically, taxes are assessed in dollars and payable only in dollars. Dollars held by the public are a claim on property to be seized from taxpayers and given to dollar holders. Please understand that due to the dollar's recursive defintion, one cannot walk into the Federal Reserve with a dollar and demand anything (other than a new dollar). If dollars had no value, taxes would have no consequences, and the state could not "buy" anything. Dollars allow the government to seize a portion of every haircut, automobile, and telephone call and buy fighter jets, beef-awareness advertisements, and pension-benefits.
Published: February 28, 2006 5:19 PM
RPM
Eric wrote:
While money today is not a claim on goods and services, like a warehouse receipt, paper money once was such a claim, on specific goods, in particular silver and gold.
Well, I dealt with this in my article--as you yourself note with the title of the things you ask us to google, I wouldn't classify these paper tickets as money, but rather as money certificates.
You may object that the distinction is unhelpful, but I for one think it is quite useful to distinguish between things that are (a) actual legal claims on other items versus (b) things that are not. Under a pure gold standard with no paper at all, the gold bars in your safe aren't legal claims on anything, yet they're still money.
So my point is, right now a $20 bill isn't a legal claim on anything, so it's not like a bond or a stock. Yet it is genuine money because it is a universally accepted medium of exchange.
Published: February 28, 2006 5:50 PM
Sasha Radeta
Chris, you're right on the money!
What you said in essence is this (allow me to paraphrase):
The confiscatory power of the US government provides a certain amount of "dollar-backing" in goods and services - but that value is variable and depends of the will of a central planner. Using this power of inflation, the government can confiscate the purchasing of working class and give it to our politicians and their lobbyist - without even messing with an unpopular open taxation. This kind of monetary system also destroys the market mechanism of the "interest rates" that guides our production process by signaling people's real preferences. That's how artificial booms and consequential busts (recessions) are created.
You pretty much got it.
Published: February 28, 2006 5:50 PM
RPM
Steve wrote:
But that is precisely the attitude [i.e. that we should define money as a universally accepted medium of exchange--RPM] that allowed the government to renege on its promise to redeem in the first place. Hence, I still do not see why you are turning the charge of being 'misleading' onto those who believe in the original definition of money.
As for the charge of inaccuracy, that should lie squarely on the shoulders of those who started to loosely call the piece of paper itself 'money' rather than the actual gold and silver that it could be redeemed for.
Let me try it this way: I think you're contradicting yourself, and it proves my whole point. From your post above, you want to deny the term "money" to pieces of paper that were claims on gold. I totally agree--in the article I say such claims aren't money but "money certificates."
But you want to say more. You want to say that the "original" definition of "money" is "the actual gold and silver that the paper could be redeemed for." OK, great, I agree with you.
Now what was it that made that gold and silver money? It certainly wasn't that it could be redeemed for something--there was no one who was printing promises on a gold bar saying, "Turn this in to my cashier and you get 100 lbs. of steak."
I submit that the reason gold and silver were money is that they were universally accepted media of exchange.
If you still disagree with me or my definition, please tell me what your definition of money is.
Published: February 28, 2006 5:55 PM
RPM
Whoops--in the post above the 2nd paragraph ("As for the charge of inaccuracy...") was also a quotation from Steve, but the italics didn't carry through.
Also, I meant to clarify that "deflation" can be defined as either a drop in prices or in the money stock. Since most people think of it as the latter, that's why it was in the "myth" that I quoted and tried to refute. But you are all right, I should have clarified.
Published: February 28, 2006 5:59 PM
RPM
Gee whiz--I meant most people think of deflation as the former, i.e. a drop in prices. I have an angry 15-month-old demanding my attention...
Published: February 28, 2006 6:01 PM
Dave
Egads, this became rather technical.
I just wanted to restate the obvious: money is a collective state of mind. Today I can exchange my $20 for a nice dinner. Twenty years ago it took about half that much money. Today I can't walk into a chain restaurant and buy a dinner with a Maple Leaf unless I find someone willing to do a dollar-for-gold exchange. In ten years that situation may be the same and may be different, who knows?
Regarding deflation, isn't it a "radical" deflation that is worrisome? For decades people have feared "inflation" while in reality it drastically eroded their purchasing power while driving up their real taxes. Little of the world's economy is cash...most of it runs on credit. It seems that the inflation has mostly been credit growth, and an unanticipated large contraction of this credit would temporarily increase the value of outstanding cash (atleast until printers both official and unofficial sought to fill the credit shortfall with paper currency) vis-a-vis most "things." This would really cream the millions of Americans up to their necks in debt who unconsciously pursue a strategy that worked during the uninterrupted inflation of past decades.
Published: February 28, 2006 9:47 PM
Steven Kane
"If you still disagree with me or my definition, please tell me what your definition of money is."
My definition of money is precisely gold or silver coin. This was the definition the government officially recognized within the Federal Reserve System as well. That was my whole point regarding the fact that they printed on each FRN the statement saying that you could redeem the note for lawful money. Lawful money meant gold or silver coin.
People of course would inaccurately call the FRN(the note itself), money. Hence, that is why I believe you have it backwards. The real inaccuracy was people casually (in coversation) referring to the FRNs as money, when in fact money was technically defined as the coinage that the note could be redeemed for.
Another inacurracy that was closely related was that people would also call the notes themselves dollars. But the precise definition of a dollar was a specific weight of gold or silver. The FRNs also said that they would "Pay to the Bearer on Demand" X dollars. This meant that if someone went to a bank they could get a precise amount of gold or silver (contained in the coins) for their notes. The notes themselves were not dollars. Quarters were called quarter-dollars at the time because they were 90% silver and had exactly 1/4 of a dollar (a precise amount of silver) in them.
I would like to clarify something as well. And I think this will clear up what Edwards was talking about.
I do not want to come down hard on people who call Federal Reserve Tokens (those green things in your wallet) money or dollars. I fully recognize the fact that people now define money to be simply a media of exchange. My qualm is with the fact that you said that people who wish to stick to the old definition of money are misleading or inaccurate. It is my contention that it is the exact opposite. The people who started to define pieces of paper as money were the initiators of the inaccuracies.
I have another objection to your piece as well. This objection is more along the lines of philosophy since it has to do with epistemology. My question is can we call our currency today anything, money or otherwise? I claim that we cannot.
And my claim begins with another question. What is a dollar? In your piece you referred to it as 'green pieces of paper.' But this day and age 'dollars' are taking many other forms. They are in the form of electronic blips in computers and clad metals as well. The fact that dollars are taking such a wide and varying physical form alone is evidence that the concept of a dollar appears to be epistemologically bankrupt.
Suppose I spoke of a new object called a zork. And suppose I claimed zorks were the most wonderful objects in the universe. Everywhere I went I said that zorks were so great until at some point someone asked me what a zork was. And suppose I told them that zorks were fuzzy animals that existed on the planet Xenon. At this point the person I am talking to knows I am full of it and that zorks are nothing but an imaginary construct in my own mind. That being the case we cannot know anything at all about zorks since they are purely the product of my own imagination. Scientists cannot gather data on zorks, we can/never will know what color zorks are or exactly what they do.
My claim is that zorks and dollars are in the same boat. In the case of zorks, those exist purely in my own imagination. In the case of dollars, those exist purely in the imaginations of millions of people. We think we are exchanging dollars and perhaps earning dollars but in reality we are all just playing pretend based on what the 'officials' in government tells us is currently a dollar. When does an object cease being just a piece of metal or a piece of paper and take on the role of being a dollar? When do electronic blips do the same? As soon as the agents in the Treasury Department say so. They are merely signaling the general population that it is time to play pretend with those objects. An imaginary construct that exists in one persons mind is no more epistemologically valid than an imaginary construct that exists in the minds of a billion people.
Gold and silver of course are real. These are elements that exist in space. We know many things about these and whether or not something is gold or silver can be objectively determined with scientific tests.
Another interesting fact is that Black's Law dictionary has no legal definition of the word 'dollar.' The reason why is clear. Any attempt at a definition of 'dollar' would be silly.
As a side note I am referring to 'dollars' here as being the new 'dollars,' not the 'dollars' that were once defined to be a specific weight of silver or gold.
Published: February 28, 2006 9:58 PM
Steven Kane
BTW, RPM, I was the one who added the entry on the Austrian view of deflation in the Wikipedia article. If you look at the history of edits you will see that section was added with an edit from 'Dissipate.' That's me. :)
Published: February 28, 2006 10:10 PM
Don Beezley
RPM: Your take on my use of the term "problematic" is correct. In your example, assuming a prior inflation, the corrective cleanse of a (presumably) inevitable deflation is indeed a good thing. Assuming an ideal world of a reliable gold standard in which such things don't happen, an undue deflation would, I think, be just as distortive in its own way as inflation.
Published: February 28, 2006 11:12 PM
Don Beezley
To those dogmatically committed to the notion that gold is the only true money:
Gold is not money. Gold is a rock. Money is a concept.
(ok, yes, i know, gold is a mineral/metal, not a rock).
Gold, incidentally, happens to have some key attributes that have caused it historically to be valued as a medium of exchange. It is valued by human beings, primarily because of aesthetics and relative scarcity (along with increasing industrial uses), all of which increase confidence that someone will accept it in exchange down the road for something of use that you might want (which relates to the mild mis-label of money as a "store of value"); it not counterfeitable; it is durable but malleable; it is relatively portable; it exists in a relatively limited quantity that cannot be dramatically increased, except for short localized periods, and requires significant investment of time and resources to do so. But it is still just a rock.
We attach the concept "money" to gold because the above attributes make it widely accepted for the purpose that the concept of money serves as a medium of exchange, a kind of "virtual, portable, instantaneous, accounting system". But it's still just a rock. And it's not perfect money. It can and does fall prey to inflation (ongoing mining and new finds), is less easily divisible than paper as value increases due to rapid increases in productivity (increasing the purchasing power of a given amount); though modern electonic systems nullify the last issue by allowing infinite divisibility.
Paper currency is money too, because money is a concept, not a rock. It (paper money) just isn't as good in its inherent attributes in one key area as it relates to its usefulness as money--it is easily counterfeited, as the USG/FR proves daily. In at least one way it (paper) functions better as money--it is lighter and easier to carry. To move from one "dollar" of gold to $1 million requires an increase in physical bulk, it only requires a little ink on currency. Which, of course, brings us back to its primary weakness of fraudulent production.
For anyone who thinks only gold is money and FRN's are not, email me, and I'll send you my address and you can send me all of your non-money reserve notes--small bills only please.
Published: February 28, 2006 11:44 PM
Cyanoacrylate
A sophisticated critic could answer that the true problem with deflation is not that it would completely eliminate all investment, but rather that investment would stop at the point at which the marginal real return equaled the real return from holding cash.
This is always the case. An investor will always consider the expected return of various investments, which include simply holding 'money' whether in a gold standard or fiat system, and select the 'best' one.
In the inflationary scenario, investment will stop when the real return of the investment equals the real return from interest plus a risk premium.
I'll note that the real problems occur when there is an unexpected change in the value of money, from either inflation or deflation. Neither one, in and of itself, occuring in a predictable fashion, is particularly harmful. Note that this does not change the fact that the net effect of the 'slow, steady expansion of the money supply' is taxation.
Published: March 1, 2006 2:11 AM
Alex
RPM:
A 400% return is a pretty hefty return. Let's try 20%. If prices of grapes and wine stay constant during the year, the return from holding money (at least from price changes) is zero. Investment in grapes and wine production wins. But, say prices of grapes and wine fall by 50% as you suggest in your example. The return from wine production is, as you say, unaffected (20% in my example). But the return from holding money for the year is, as you say, 100%. Holding money wins.
Published: March 1, 2006 10:58 AM
Sasha
Don,
You got lost in your attempt to misinterpret the proponents of gold standard. We are not "dogmatically" arguing that gold is the only true money. We say that gold possesses all important characteristics that make it a nice medium of exchange and that for those reasons it historically served as money. Some other generally demanded goods served as money throughout history.
So we all agree that money as a concept is nothing but some real goods and services we exchange in the market. Money can truly represent some generally desirable good (such as units in gold) - or it can be variable and subject to political manipulation (fiat currency), in which case market suffers from falsification of important market signals and we suffer from malinvestments (booms and busts).
Published: March 1, 2006 4:36 PM
Sasha Radeta
There can be no historical record about a ruler which issued an executive order that formed money as a concept, but there is rich archeological evidence that confirms that generally accepted goods started to be exchanged as money and that this process is only an extension of barter. But I don’t have to bother you with archeology – we have examples of money formation in this day and age.
Those of you who did some time in prison know what happens when you find yourselves in an environment in which paper money no longer serves as a medium of exchange. You start trading with cigarettes, like Jews did in the Warsaw ghetto, during the WW2. Imagine if the strongest prisoners (rulers) ordered all the prisoners to use some pieces of paper as money – and that they could manipulate with the amount of those paper notes… that would be ridiculous. The only reason why the federal government got away with that is that paper note once were redeemable in some real units of gold – on demand.
Published: March 1, 2006 4:56 PM
Paul Edwards
I think Don’s reference, is specific to Steven’s comment that “My definition of money is precisely gold or silver coin.�
Published: March 1, 2006 5:02 PM
Steven Kane
"For anyone who thinks only gold is money and FRN's are not, email me, and I'll send you my address and you can send me all of your non-money reserve notes--small bills only please."
There are no more FRN's in circulation. Look up the legal definition of a note.
Published: March 1, 2006 5:25 PM
billwald
When money was 100% gold and silver the working class didn't have any. It was a convenience for the rich people. The working stiff got his one coin a day if he had a job.
Published: March 1, 2006 7:46 PM
Sasha Radeta
billwald,
Besides historical inaccuracy of your funny statement, can't you see your logical error? If printing more paper money made people richer (regardless of production of real goods and services), why were workers in Yugoslavia so poor in 1992-93? Not only they had the recorded hyperinflation, but they actually had 100 billion Dinars bills. It didn't seem to help them.
Just like in a barter exchange, you can get more money (goods that are generally acceptable) - if you offer some good or service (labor) of your own. Capitalism made people achieve more, hence labor more valuable, but that's a totally different topic.
Published: March 1, 2006 9:46 PM
RPM
OK a quick answer to a bunch of different things:
* Steve, I don't think it's very useful to *define* money as "gold and silver coin." And I mean what is the definition as far as economic theory is. For example, I'm sure you're aware that in different societies throughout history all sorts of things served as money (livestock, rubies, cigarettes, etc.). Even in a purely free market, it's possible that hundreds of years from now gold and silver would become too plentiful and some other commdodity (perhaps platinum) would be adopted (completely voluntarily!) as a superior medium of exchange.
Several people (not so much on this list but in email) have demanded, "WHICH textbooks define money as a universally accepted medium of exchange?? Keynesian ones??" Well, no, even Rothbard and Mises define money that way. Menger's whole theory of the origin of money builds up from things that are more highly saleable (i.e. liquid) and then become media of exchange, and then once just about everybody in a community accepts it, it's money. If people still doubt this I can try to give you an exact quotation from Mises or Rothbard.
Steve, if I understood you you were saying you were the author of the thing in Wikipedia about widgets. I think that's the wrong approach, to simply divide supply of money by supply of the real good. Two major problems that spring to mind: How do you apply this approach when there is more than one consumer good (because then it would imply if there are twice as many TVs as apples, that apples should have a gold-price twice as high), and how do you deal with the "velocity of circulation" idea? I.e. if people spend a given stock of money twice as quickly, prices can be twice as high; there doesn't need to be more money and/or lower volume of real goods in order for prices to rise.
Finally, Cyanoacrylate and Alex, that's a very good question you raise, but if you go look at the critiques of (price) deflation in the Wikipedia entry and the Haberler piece, I think you'll see that that's NOT what those writers are saying. E.g. in the Wikipedia, the author (the first one, not Steve Kane) talks about "negative profits" in a (price) delationary environment. So it seems as if he's thinking, "You buy real goods today at base price of 100, and then you sell your inventory next year at 90, so you're down. Why invest?"
Published: March 2, 2006 6:33 AM
RPM
Oh one last thing (for now), just to clarify my semantic point that is upsetting so many people: I am merely pointing out that it is inconsistent with Austrian economic theory to say, "We don't currently use real money." This doesn't somehow ENDORSE the Federal Reserve. You can still say, "The government used coercion to get us into the practice of using this very bad money, and it uses coercion to prevent the switch to a superior system."
By the same token (for a silly analogy), if libertarians were in the practice of always saying, "Man! The Fed really rapes us during the boom-bust cycle!" and then I were anal retentive and said, "Well actually guys, the Fed's not really _raping_ us..." that wouldn't make me a Fed-worshipper.
Published: March 2, 2006 6:40 AM
Alex
RPM:
I take your point about the error in Wikipdia. But we mustn't go overboard in correcting that error by making another.
"Once we allow for the prices of capital goods and raw materials to adjust to expectations of deflation, there is no reason for falling prices to hamper investment whatsoever."
This statement is not correct. In fact, as I pointed out, falling prices does hamper investment, since in that scenario it is sometimes (not always, but sometimes) more profitable to hold money than real investment.
Published: March 2, 2006 9:03 AM
Paul Edwards
Alex,
"falling prices does hamper investment"
I think you have a point. However, i'm not sure what your view is of the degree of the deleterious effect this fact has. In a deflation with higher expectations of future lower prices, people, including investors will tend to abstain from buying, which will tend to provide a positive feedback to the lowering of prices process. That is, in combination with a reducing money supply there will also be an increased demand for money.
This will serve to speed up the process of price deflation. The point where people are no longer willing to hold money and will begin again buying will obtain quicker because of this; because it will be more obvious when the price floors have been reached. A more dramatic fall in prices makes for a more dramatic reaching of a price floor.
Hence, i would argue that even if all investment were entirely halted for a time, it would be a short time and then investment would resume at the new price levels with an economy well corrected and more healthy than could have otherwise been achieved.
Published: March 2, 2006 9:35 AM
Frank Z
I think a word has been missed here and the word is currency.
The definition for money supplied by Mr. Murphy is actually the definition of currency.
It is true that money does not have a contractual obligation and todays "money" does not, but strictly speaking money is a commodity be it gold or silver or cigarettes. They also do not have a contractual obligation.
Paper currency when backed by gold did have a contractual obligation. It was deceitful of bankers to remove that obligation of a claim on an actual commodity or the actual "money". It, blatantly, was theft.
Money offers some protection against future loss. Currency does not. If I hold currency and the dollar fails I have nothing. If I hold money and the currency fails the possibility is more likely I still hold some wealth.
That protection is lost with FRNs.
Money needs no contractual obligation, a currency should, but when it doesn't it is merely a token. We do accept tokens and think of them as money due to a bastardization of the language and poor economic education.
Published: March 2, 2006 10:21 AM
Frank Z
Just an add-on. Money can be used as currency, currency used as money offers me a neurotic concern for my future.
Published: March 2, 2006 10:25 AM
Mike Sproul
RPM:
Did you ever wonder if maybe there is no such thing as fiat money? I wondered about it for 14 years as I taught it to undergraduates. I don't expect that a guy with an angry 15-month-old has time to read a 20-page paper on the subject, but here's the link:
www.geocities.com/sproulmike/nofiatmoney.doc
Published: March 2, 2006 11:00 AM
Eric Taylor
Robert:
Ok, paper money backed by gold/silver would be a money certificate. But gold and silver are goods themselves. So, in the past, these pieces of paper serving as a medium of exchange were a claim on a particular good, gold or silver. We are splitting hairs and if I were taking one of your exams, and had points deducted over this, I'd be complaining it was a trick question.
I agree, there is no denying that our fiat money is money. One could always burn them for heat, so they are a commodity as well: fuel. And that jives with what I thought was the Austrian definition of money "the most marketable commodity". I thought I read that in a Rothbard book, or maybe Mises.
Published: March 2, 2006 1:21 PM
Don Beezley
Good point, Eric T. Paper IS a tangible commodity. And we may all be using it (paper money) as fuel sometime in the next few years.
Published: March 2, 2006 5:09 PM
Paul Edwards
"One could always burn them for heat, so they are a commodity as well: fuel."
That’s funny. But the dollar, today, does not posses its value as money because it is also or was once a fuel commodity, nor even due to its legal tender status, although that is how it was disconnected from gold. The dollar has purchasing power today simply because it had purchasing power yesterday. The money regression shows that the ultimate reason why the dollar has purchasing power is because it was once a gold certificate. But further, gold ultimately obtained its purchasing power by having emerged from barter markets as the most marketable commodity.
The dollar today, is a purely monetary commodity and this is so purely because of its historic connection with gold; not because it has or ever had any other commodity value independent of gold. So today, the dollar is a commodity because it is money; its solitary use: medium of exchange.
The point of confusion, I believe, is that while only a useful non-monetary commodity that is exchanged in a barter market can emerge from that market as money, it is not necessary once it is money, for a commodity money to remain useful for non-monetary purposes to remain useful as money. There comes a point where historical purchasing power is more important than the commodity’s use for non-monetary purposes in giving it its purchasing power.
This is why the dollar is money and why it is a monetary commodity and absolutely nothing else.
And if my muddled argument isn’t persuasive, there’s always Rothbard:
“On the other hand, it does not follow from this analysis that if an extant money were to lose its direct uses, it could no longer be used as money. Thus, if gold, after being established as money, were suddenly to lose its value in ornaments or industrial uses, it would not necessarily lose its character as a money. Once a medium of exchange has been established as a money, money prices continue to be set...Therefore, while it is absolutely necessary that a money originate as a commodity with direct uses, it is not absolutely necessary that the direct uses continue after the money has been established.�
http://mises.org/rothbard/mes/chap4b.asp
Published: March 2, 2006 6:12 PM
Don Beezley
Paul: undeniably paper money, as it now stands, derived its original status as a result of the unique attributes gold pssessed and the attachment of paper money to that value, then separting from that stabilizing anchor within the culture. It seems unlikely that paper, for all the obvious reasons, would have ever achieved that status on its own (although a particularly rare parchment of a special and difficult to produce and highly valued type could have, I suppose,done so if it had other uses than money that led to that special value). But I think that the point is that an item's status as a commodity doesn't necessarily qualify as uniquely valuable as money. Of course, there are probably commodity futures contracts that relate to paper production (I don't know if there are, but paper is a huge volume commodity with a degree of volatility, though I don't know if it's a enough to justify hedging), with the futures contract functioning, in a way, like a medium of exchange (since they are tradable) backed up by the underlying value of...paper!
Published: March 2, 2006 6:24 PM
Paul Edwards
Hi Don,
“But I think that the point is that an item's status as a commodity doesn't necessarily qualify as uniquely valuable as money.�
I agree wholeheartedly with your statement, but if this is the point of our discussion then I need to lay off acid for a while. I also didn’t follow you on the paper futures contract analogy, which confirms my thinking regarding the acid.
But I will say that i believe we run a little fast and loose if we happen to connect paper money to the paper commodity. I do not think there is any economic connection. The same paper bill that says $1 can say $1000. It isn’t different or more paper or ink, it’s just a different number printed on it.
In contrast, in the days of gold money, an ounce of .90 pure gold was that plain and simple. They didn’t change the stamp to two ounces and change the amount of money.
Published: March 2, 2006 7:07 PM
RPM
Paul,
Fantastic! Thanks for providing that Rothbard quote. I was going to make the same argument (but less eloquently). This is why I think the definition of "universally accepted medium of exchange" is the correct one; to insist (say) that the good also have direct use value would possibly rule out free market money in the unlikely event that gold lost its consumption/production purposes.
Frank Z, you wrote this:
I think a word has been missed here and the word is currency. The definition for money supplied by Mr. Murphy is actually the definition of currency. It is true that money does not have a contractual obligation and todays "money" does not, but strictly speaking money is a commodity be it gold or silver or cigarettes. They also do not have a contractual obligation.
I'm afraid I lost you a bit. You're saying currency (not money) is "a universally accepted medium of exchange," and then say that money is real commodities like gold and cigarettes. But what makes gold money, and not a TV? Isn't it that the gold (at certain times in history) was a universally accepted medium of exchange, while TVs never were?
What of the possibility (described by Rothbard) of gold losing its other functions? Would you say it ceased being a money at that point, and turned into a currency (consisting of yellow blocks)?
Anyway, for what it's worth these are the reasons that I think the textbook definition (at least in Austrian "textbooks" and some other ones as well) is good. I think the thing that really distinguishes something as a money is the fact that its a universally accepted medium of exchange.
Finally, somebody said that he'd be mad if I took off points from his test...Let me clarify, I didn't go out of my way to "trick" the students, they volunteered what I thought was an inconsistent statement.
Let me reiterate what the inconsistency is: If you say (as many on this blog have) that only gold or silver are really money, then how can you say, "Under a gold standard the money is backed up by something"? What you mean is, "Under a gold standard the green pieces of paper are backed up by money."
That's all I'm saying, and I don't think it's improper to take off points from a senior who's getting a major in economics if s/he writes something inconsistent like that.
Published: March 2, 2006 7:25 PM
Paul Edwards
Marking that way seems fair to me too. I think subtle errors can reveal significant holes in one's understanding.
Published: March 2, 2006 11:44 PM
Frank Z
Hello Mr. Murphy,
Here is your full definition from the article.
"They are a medium of exchange accepted almost universally in a given region."
As I said money can be used as a currency and that definition sounds to me like a currency.
If money and currency are the same we need only one term.
What makes gold money and not a TV? One convenience, two -universality of acceptance. TVs wouldn't even make good currency.
Someone jokingly (I hope) suggested a fiat currency was a commodity - that of fuel. In order for it to be a fuel of any value you would have to burn a few million every night in a Canadian winter. The actual commodity would be wood not paper if it was used as a fuel and if it were of any value for any other purpose a blank piece of paper would be more useful and more valuable.
Part of the Rothbard quote is this:
"Therefore, while it is absolutely necessary that a money originate as a commodity with direct uses, it is not absolutely necessary that the direct uses continue after the money has been established."
I believe this is true. He doesn't say that the currency that subtituted for the money
continues after the money has been established. Although it has proven to be the case.
I accept the "textbook" definition under common usage only. I am fully aware that most people would be happy with that definition today and i am arguing for the retention of an original intent of the word. Precisely money is: Coins or other mechanical devices manufactured in a mint from gold, silver or other precious or semi-precious metals to be media of exchange.
Gold is not money either if you want to get really technical, not until it is "monetized" in a mint. Before that it is the commodity "gold". The reason it is monetized is so that people can be guaranteed of its honest weight.
Formally, money is usually the first definition in any large dictionary - although I haven't checked the latest editions. They may start defining money as an entry in an electronic ledger. Will we accept that? It will still make me a bit neurotic about my savings.
Published: March 3, 2006 12:50 AM
Frank Z
And while I am here.....
A "dollar" is also not a piece of paper except under common usage. Technically it is a specified weight of gold or silver.
The removal of the contractual obligation on the US currency making it irredeemable effectively took gold deposits out of the hands of the citizen and placed it directly into the hands of bankers.
Previous to that money was offered "as" a legal tender it was decreed by "fiat" to "be" a legal tender. Refusal to accept it being a legal tender would result in forfeiture of payment.
I would call that being forced to use it.
The debate rages because some economists have entered the informal defintion and I might add partial definition of money into their textbooks.
There is no debate in the public's mind. "Money" is what is in their wallet. Dollars are those pieces of paper. Nevertheless, they are formally a "fiat currency".
Published: March 3, 2006 8:39 AM
Don Beezley
Paul, perhaps it's that sweet but thin Rocky Mountain air I breathe all day.
Published: March 3, 2006 12:29 PM
Paul Edwards
Don,
That sounds truly awesome. I took a trip through the Rockies once and the views were far more amazing that i ever could have imagined. It would be cool to live around them.
Published: March 3, 2006 1:02 PM
Wes Bertrand
Since epistemological clarity seems to be the crux of this debate about the meaning of money, I offer the following definitions, which may or may not be "textbook," commonly accepted or understood, or for that matter earn me points on the professor's test. Refine as you like, but I believe they express the necessary distinctions:
MONEY: A commodity, such as gold or silver, generally recognized and accepted in the marketplace as a universal medium of exchange (typically shaped or organized for accurate assessment and ease of transfer, e.g., minted). Monetary properties such as being scarce (relatively difficult to increase supply), portable, durable, equally divisible, non-counterfeitable, and esthetically or culturally appealing contribute to it being widely accepted. Money that also has non-monetary, e.g., industrial uses (thus providing additional value in the marketplace), may contribute to its favorability over other types of money—though non-monetary uses are not necessary for its continued use as strictly money.
CURRENCY: A note or coin (or digital representation thereof) that may or may not be redeemable for money, but is nonetheless recognized and accepted as a universal medium of exchange for use in non-barter transactions. Money backed currency, such as paper receipts or certificates, facilitates transactions in which physical transfer of the money they represent (historically, gold and silver stored in banks) proves burdensome.
FIAT CURRENCY: Governmentally controlled currency that is issued monopolistically and prohibited from being redeemable for money. Because of its coercive character, fiat currency exposes two facts: It has not been recognized and accepted voluntarily by the marketplace; and, any voluntarily chosen market money and/or redeemable currency would otherwise drive it out of existence. Thus, fiat currency requires a legalized monopoly in order to prevent its own demise as well as to promote its recognition and acceptance as a universal medium of exchange. Unfortunately, for numerous reasons, fiat currency tends to be seen by the citizenry as synonymous with money. "Money," after all, can be an all-inclusive conceptual category for any media of exchange, but it is unwise—vis a vis statism—to overlook its important subcategories. Over time, few people understand the voluntary roots of money and its natural selection by the marketplace, and few acknowledge the various negative economic consequences of fiat currency.
AMERICAN DOLLAR: The basic unit of fiat currency in the United States of America. Originally, it was a governmentally regulated money coin that designated a specific quantity (typically silver) or a currency note redeemable for a set quantity of either silver or gold (under governmentally controlled bimetallism).
Published: March 3, 2006 6:49 PM