What is money, Part 2

In Part 1, I came to the conclusion that the value of something is determined by what someone is willing trade for it, and that includes the value of cash/paper money/currency.

Our money has absolutely no intrinsic value (to have intrinsic value means that it can serve a purpose in and of itself, ie, you can eat it, build something with it, perform a service with it, etc.) Intrinsically, a dollar bill is actually worth less than the paper it’s printed on, because in order to use it for writing on effectively, you’d have to recycle it and bleach it to get all the green crap off of it first. A dollar only has value as long as someone else wants it, and its only worth what someone will give you for it. (Note, it didn’t used to be that way, but it’s the way it is now.)

Here’s what gives dollars value:

1. The government says it has value. As strange as it sounds, that’s about the best answer I can find. From the United States Coinage Act of 1965, "United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes and dues. Foreign gold or silver coins are not legal tender for debts." In other words, in order to pay your taxes, debts and dues, you have to pay in dollars. The government will not accept your sack of potatoes or your pair of shoes as payment for your taxes. Since everyone has to pay taxes, and the government only accepts dollars, people have to acquire dollars, and therefore find value in them. It’s arbitrary and phony value, but it’s value. (Oh, and it’s illegal for a business to refuse payment in US currency, but that’s more of a supply thing than a demand thing. It’s interesting to note, though, that people are forced by law to accept something as payment that has no intrinsic value.)

Another factor that affects the dollar’s value is that, since around the time of World War 2, when the United States emerged as the ultimate victor, economic colossus, and western military superpower, the dollar has been, in effect, the world’s reserve currency. This means that international commodity prices are quoted and traded in US dollars. Why US dollars? Because a) early on, the US dollar was backed by gold, b) the United States was the most economically and politically stable country on earth, and c) we had a massive trade surplus that meant people needed our dollars to buy our stuff. People wanted dollars, which meant dollars had more value. Countries stockpile dollars by trading their own currency for them, or by buying US government debt. Either way, with everybody wanting dollars, the value of the dollar increased. Supply and demand at work.

In the 1970s, the United States abandoned the gold standard. Before this point, people could trade currency to the government for a set amount of gold. This meant that in order to issue money, the government had to have a certain amount of gold reserves available to exchange for currency. This gave paper money real value. It wasn’t intrinsic value, and the government still set the amount of gold you could exchange it for, but it was still backed by a valuable asset. But by abandoning the gold standard, the dollar was suddenly backed by nothing more than the promise that the US government (and its proxy, the Federal Reserve) would act responsibly with the money supply (and/or kill anybody who threatened the dollar-based, centrally-managed global economic regime, but let’s save that for another time).

The point is that since the dollar doesn’t really mean anything, it can mean…anything. It’s ripe for manipulation by politicians, central bankers, financial cartels and other miscreants.

OK, so now that we know that a dollar has value, how do you really know what the value of a dollar is at any given time? Well, that’s super-complicated, but I’ll start trying to explain it using another massively oversimplified potato sack analogy!

Let’s say that there are only $100 dollars available in the world. You and your neighbor each have $1 to spend each week. The local grocer is sells 2 sacks of potatoes every week for $1 each, and you and your neighbor each buy a sack of potatoes every week. This situation has been going on for quite some time.

Now let’s say the government that issues dollars increases the amount of money available to everybody, and now you and your neigbor each have $2 to spend each week. The first week, you show up, flush with cash, and buy both sacks of potatoes for a total of $2. Your neighbor shows up later, but can’t buy potatoes, and so goes home hungry and pissed. The next week, your neighbor shows up first, hungry as hell and afraid to go hungry ever again. The potato merchant, knowing that the demand went up last week, raised his price to $2 per sack, which he learned is now the price that the “market” will accept. Your neighbor buys both sacks ($2 from this week plus his $2 from last week = 2 sacks of potatoes). You stay home, since you’ve still got enough potatoes from your double-purchase last week. The following week, you show up, but now your $2, which seemed like a windfall a couple weeks ago, will now only get you one sack of potatoes, just like before you got your raise. Your neighbor blows his extra money for the week on some shit he didn’t need before, artificially driving up demand (and prices) for whatever he bought. The grocer thinks he’s a business genius until he realizes that all the crap he usually buys has inflated in price, too, since everybody has twice as much money to spend. It’s a friggin cluster-eff for everybody involved.

Meanwhile, there’s a third neighbor who, with his $1 per week, decided to scrimp and save and get by on half a dollar worth of apples each week and save the rest of the money. Over time, he had $20 saved up, almost enough to buy a fine new mule! Then the government came along and inflated the currency, everybody spent it willy-nilly, prices increased, and now his $20 would only pay for half a mule, and it’ll take another 20 weeks of scraping by on crappy apples just to get back to the point where he was before inflation. All of this through absolutely no fault of his own.

And that’s inflation. Inflation is increased prices caused by the increase in the supply of currency relative to the amount of goods available. This is important to understand, because a lot of people think that inflation is any increase in prices. For example, they think that when oil prices go up, it’s because of inflation, or that inflation can be caused by high oil prices, but that’s not really true. Inflation is a very specific kind of price increase that’s caused by an increase in the amount of currency available. So there.

Now obviously, we don’t generally see 100% inflation rates in this country very often (although we have in the past). The mechanic works the same though. If inflation is steady at 3%, any money that you’re hiding in your mattress loses that much of its value every year. You have to earn at least that amount in interest in order to stay even. It’s sickening and stupid, unfortunately.

Anyhow, next up, I’ll try to explain to myself how exchange rates work, and why currency manipulation is an important tool for all the pointy-headed bastards who run the financial system in the country. Cheers!