Money

 

Money (That's What I Want)

The best things in life are free
But you can keep them for the birds and bees
Now give me money, (That's what I want)
That's what I want

But what is money?

Webster defines money as “something generally accepted as a medium of exchange, a measure of value, or a means of payment.”  To prevent the need to barter, which requires that I have a good that I can exchange for your good, people have historically accepted gold as a medium of exchange.  The problem with gold as  medium of exchange, is that is bulky and heavy.  Paper money began when that gold was stored somewhere and a paper note that represented that gold was used as the medium of exchange.  A problem with this is that it required trust that the paper note was true.  The paper US Dollar might say “In God we trust”, but in fact we trust that the paper dollar is not a counterfeit and does represent something of value.

In addition to trusting that a note is something of value, in order for an economy to grow that medium has to also grow.  Gold can not grow. The frenzy around gold rushes is because the amount of gold on earth is fixed and can not be increased.  This is also true with one of most successful digital currencies, Bitcoin.  There is a limit to the number of Bitcoins that can be created, 21 million, and when all Bitcoins have been created, it can not be grown.

To accommodate growth banks lend the money which is deposited with them.  However, if that money is lent, then it can not be immediately returned to their depositors.  That is why historically there were runs on banks.  The creation of a national bank was a way to spread that problem among the entire nation and not just a few banks.

A popular idea in economics in Modern Monetary Theory, is that the state can create money by increasing the supply of money.  This is hardly modern.  William Jennings Bryan campaigned for silver coinage to increase the supply of money so that “mankind would not be crucified on a cross of gold”. The Weimar republic printed, increased the supply of, money so fast that a loaf of bread in Berlin that cost around 160 Marks at the end of 1922 cost 200,000,000,000 Marks by late 1923.  Increasing the supply of money works only if we can trust those creating money.  They are not really printing money. They are increasing the medium of exchange.  Printing money that exceeds the need for that medium of exchange creates hyperinflation.

The rapid inflation in the 1970s, and the continuous low, but pervasive, inflation of today can arguably be tied to one event, the Nixon Shock of 1971.  Before that event, international trade used the US Dollar backed by gold as its medium of exchange.  When it was no longer backed by gold there was a surplus of international dollars but no comparable increase in the existing supply of goods.  The initial shock resulted in the rapid US inflation in the late 1970s.  The continued growth of the global economy, without increasing the US money supply to consider this growth, has arguably resulted in today’s low but persistent inflation.

When I was a young engineer, I was given advice by an older colleague that a good rule of thumb is that growth should be considered to be 2% per year.  Inflation has been averaging about 2% per year.  A coincidence? I would suggest not.  Should the supply of money be increased, as Modern Monetary Theory suggests? In my opinion yes, but heeding that old advice, it should be limited to about 2% per year.