From Commodity Money to Representative Money to Fiat Money

Posted by PITHOCRATES - April 8th, 2014

History 101

(Originally published November 8th, 2011)

The Drawbacks to Using Pigs as Money Include they’re not Portable, Divisible, Durable or Uniform

They say we use every part of the pig but the oink.  So pigs are pretty valuable animals.  And we have used them as money.  Because they’re valuable.  People were willing to accept a pig in trade for something of value of theirs.  Because they knew they could always trade that pig to someone else later.  Because we use every part of the pig but the oink.  Which makes them pretty valuable.

Of course, there are drawbacks to using pigs as money.  For one they’re not that portable.  They’re not that easy to take to the market.  And they’re big.  Hold a lot of value.  So what do you do when something is worth more than one pig but not quite worth two?  Well, pigs aren’t readily divisible.  Unless you slaughter them.  But then you’d have to hurry up and trade the parts before they spoil because they’re not going to stay fresh long.  For pig parts aren’t very durable.

Suppose you have two pigs.  And someone has something you want and they will trade two pigs for it.  But there’s only one problem.  One pig is big and healthy.  The other is old and sickly.  And half the weight of the healthy one.  This trader was willing to take two pigs in trade.  But clearly the two pigs you have are unequal in value.  They’re not uniform.  And not quite what this trader had in mind when he said he’d take two pigs in trade.

Our Paper Currency Evolved from the Certificates we Carried for our Gold and Silver we Kept Locked Up

Rats are more uniform.  They’re more portable.  And they’re smaller.  It would be easier to price things in units of rats rather than pigs.  They would solve all the problems of using pigs as money.  Except one.  Rats are germ-infested parasites that no one wants.  And they breed like rabbits.  You never have only one rat.  Man has spent most of history trying to get rid of these vile disease carriers.  So no one would trade anything of value for rats.  Because these little plague generators were overrunning cities everywhere.  So rats were many things.  But one thing they weren’t was scarce.

Eventually we settled on a commodity that addresses all the shortcomings of pigs and rats.  As well as other commodities.  Gold and silver.  These precious metals were portable.  Durable.  They didn’t spoil and held their value for a long time.  You could make coins in different denominations.  So they were easily divisible.  Unlike a pig.  They were uniform.  Unlike pigs.  Finally, you had to dig gold and silver out of the ground.  After digging a lot of holes trying to find gold and silver deposits.  Which made it costly to bring new gold and silver to market.  Keeping gold and silver scarce.  And valuable.  Unlike rats.

But gold and silver were heavy metals.  Carrying large amounts was exhausting.  And dangerous.  A chest of gold and silver was tempting to thieves.  As you couldn’t hide it easily.  Soon we left our gold and silver locked up somewhere.  And carried certificates instead that were exchangeable for that gold and silver.  And these became our paper currency.

Governments Everywhere left the Gold Standard in the 20th Century so they could Print Fiat Money

The use of certificates like this is typically what people mean by gold standard.  Money in circulation represents the value of the underlying gold or silver.  And can be exchanged for that gold or silver.  Which meant that governments couldn’t just print money.  Like they do today.  Because the value was in the gold and silver.  Not the paper that represented the gold and silver.  And the only way to create money was to dig it out of the ground, process it and bring it to market.  Which is a lot harder to do than printing paper money.  So governments everywhere left the gold standard in the 20th century in favor of fiat money.  So they could print money.  Create it out of nothing.  And spend it.  With no restraints of responsible governing whatsoever.

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Hard Money versus Paper Money

Posted by PITHOCRATES - March 17th, 2014

Economics 101

(Originally published April 1st, 2013)

Money would have No Value if People with Talent didn’t Create things of Value

Money is a temporary storage of wealth.  We created it because of the high search costs of the barter system.  It took a lot of time for two people to find each other who each had what the other wanted.  And we started trading things to have things we couldn’t make efficiently for ourselves.  Someone may have been a superb potter but was a horrible farmer.  So, instead, the potter did what he did best.  And traded the pottery he made for the things he wanted that he was not good at making.  Or growing.  Before that we were self-sufficient.  Whatever you wanted you had to provide it yourself.

As we go back in time we learn why money is a temporary storage of wealth.  For it was the final piece in a growing and prosperous economy.  And at the beginning it was people with talent, each creating something of value.  Something of value that they could trade for something else of value.  It’s the creative talent of people that has value.  And we see that value in the goods and/or services they make or provide.  Money temporarily held that value.  So we could carry it with us easier to go to market to trade with other talented and creative people.  Who may not have wanted what we made or did.  But would gladly take our money.

So we took our goods to market.  People that wanted them traded for them.  They traded money for our goods.  Then we took that money and traded for what we wanted elsewhere in the market.  Trade grew.  With some people becoming professional traders.  By trading money for goods from distant lands.  Then trading these goods for money at the local market.  People who didn’t spend time creating anything.  But bought and sold the creative talent of others.  Who were able to do that because of money.  The creative talent came first.  Then the goods.  And then the money.  For money is a temporary storage of wealth.  Which has no value if no one is making anything of value.  Because if you can’t buy anything what good is having money?

There were no more Gold Certificates in Circulation than there was Gold in the Vault to Exchange them For

These early traders used a variety of things for money.  Pigs, tobacco, grain, oil, etc.  What we call commodity money.  Which was valuable by itself.  As people consumed these commodities.  Which is what gave them the ability to store value.  But because we could consume these they did not make the best money.  Also, they weren’t that portable.  And not easy to make change with.  Which is why we turned to specie.  Such as gold and silver.  Hard money.  It was durable.  Portable.  Divisible.  Fungible.  For example, all Spanish dollars were the same while all pigs weren’t.  One pig could weigh 30 pounds more than another.  So pigs weren’t fungible.  Or durable.  Portable.  And, though divisible, making change wasn’t easy.

So in time traders big and small turned to specie as the medium of exchange.  For all the reasons noted above.  If you worked hard to produce fine pottery you trusted in specie.  You would accept specie for your pottery goods.  Because you knew this hard money would hold its value.  And you could use it in the future to buy what you wanted.  No matter how long that may be.  Why?  Because the money supply remained relatively constant.  As it took a lot of work and great expense to mine and refine ore to make specie out of it.  So there was little inflation when using hard money.  Which meant if you saved for a rainy day that hard money would be there for you.

Gold and silver could be heavy to carry around.  Anyone struggling under the weight of their specie were targets for thieves.  Who wanted that money.  Without creating anything of value to bring to market.  So we found a way to improve a little on using gold and silver.  By locking our gold and silver in a vault.  And carrying around receipts for our gold and silver to use as money.  These gold certificates were promises to pay in gold.  People could continue to use them as money.  Or they could take these receipts back to the vault and exchange them for the gold inside.  These gold certificates were as good as gold.  And there were no more gold certificates in circulation than there was gold in the vault to exchange them for.

Governments Today use nothing but Paper Money because it gives them Privilege, Wealth and Power

Some saw advantages of expanding the money supply with paper currency.  Money that isn’t backed by gold or any other asset.  Money easy to print.  And easy to borrow.  Allowing rich people to borrow large sums of money to buy more assets.  And get richer.  Giving them more power.  And if you were the one printing and loaning that money it gave you great wealth and power.  So having a bank charter was a way to wealth and power.  You could make it easy for those who can help you to borrow money.  While making it difficult for those who oppose you to borrow money.  So there were those in business and in government that liked un-backed paper money.  Because a select few could borrow it cheaply and get rich and powerful.

While some liked these banks and that paper money there were others who bitterly opposed them.  Some who didn’t like to see so much power in so few hands.  And the hard money people.  Who wanted a money that held its value.  The common people.  People who couldn’t borrow large sums of cheap money.  But people who had to get by on less as the inflation from printing all those paper dollars raised prices.  Leaving them with less purchasing power.  Making it harder for them to get by.  Often having to turn to the hated banks to borrow money.  Again and again.  Such that the interest on their loans consumed even more of their limited funds.  Making life more tenuous.  And more bitter between the classes.  The rich who benefited from the cheap paper money.  And the common people who paid the price of all that inflation.

Rich people, on the other hand, loved that inflation.  It helped them make money.  When they bought something at a lower price and sold it at a higher price they made a lot of money.  The greater the inflation the greater the selling price.  And the more profit.  Also, the money they owed was easier to pay off with money that was worth less than when they borrowed it.  Allowing rich people to get even richer.  While the common people saw only higher prices.  And the value of their meager savings lose value.  So this cheap paper money fostered great class warfare.  The hard money people hated the paper money people.  Debtors hated creditors.  The middling classes hated the large landowners, merchants, manufacturers and, of course, the bankers.  And those who had talent to create things hated those who just made money with money.  The greater the inflation the greater the divide between the people.  And the greater wealth and power that select few acquired.  This is what paper money gave you.  Privilege.  Which is why most governments today use nothing but paper money.

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Hard Money versus Paper Money

Posted by PITHOCRATES - April 1st, 2013

Economics 101

Money would have No Value if People with Talent didn’t Create things of Value

Money is a temporary storage of wealth.  We created it because of the high search costs of the barter system.  It took a lot of time for two people to find each other who each had what the other wanted.  And we started trading things to have things we couldn’t make efficiently for ourselves.  Someone may have been a superb potter but was a horrible farmer.  So, instead, the potter did what he did best.  And traded the pottery he made for the things he wanted that he was not good at making.  Or growing.  Before that we were self-sufficient.  Whatever you wanted you had to provide it yourself.

As we go back in time we learn why money is a temporary storage of wealth.  For it was the final piece in a growing and prosperous economy.  And at the beginning it was people with talent, each creating something of value.  Something of value that they could trade for something else of value.  It’s the creative talent of people that has value.  And we see that value in the goods and/or services they make or provide.  Money temporarily held that value.  So we could carry it with us easier to go to market to trade with other talented and creative people.  Who may not have wanted what we made or did.  But would gladly take our money.

So we took our goods to market.  People that wanted them traded for them.  They traded money for our goods.  Then we took that money and traded for what we wanted elsewhere in the market.  Trade grew.  With some people becoming professional traders.  By trading money for goods from distant lands.  Then trading these goods for money at the local market.  People who didn’t spend time creating anything.  But bought and sold the creative talent of others.  Who were able to do that because of money.  The creative talent came first.  Then the goods.  And then the money.  For money is a temporary storage of wealth.  Which has no value if no one is making anything of value.  Because if you can’t buy anything what good is having money?

There were no more Gold Certificates in Circulation than there was Gold in the Vault to Exchange them For

These early traders used a variety of things for money.  Pigs, tobacco, grain, oil, etc.  What we call commodity money.  Which was valuable by itself.  As people consumed these commodities.  Which is what gave them the ability to store value.  But because we could consume these they did not make the best money.  Also, they weren’t that portable.  And not easy to make change with.  Which is why we turned to specie.  Such as gold and silver.  Hard money.  It was durable.  Portable.  Divisible.  Fungible.  For example, all Spanish dollars were the same while all pigs weren’t.  One pig could weigh 30 pounds more than another.  So pigs weren’t fungible.  Or durable.  Portable.  And, though divisible, making change wasn’t easy.

So in time traders big and small turned to specie as the medium of exchange.  For all the reasons noted above.  If you worked hard to produce fine pottery you trusted in specie.  You would accept specie for your pottery goods.  Because you knew this hard money would hold its value.  And you could use it in the future to buy what you wanted.  No matter how long that may be.  Why?  Because the money supply remained relatively constant.  As it took a lot of work and great expense to mine and refine ore to make specie out of it.  So there was little inflation when using hard money.  Which meant if you saved for a rainy day that hard money would be there for you.

Gold and silver could be heavy to carry around.  Anyone struggling under the weight of their specie were targets for thieves.  Who wanted that money.  Without creating anything of value to bring to market.  So we found a way to improve a little on using gold and silver.  By locking our gold and silver in a vault.  And carrying around receipts for our gold and silver to use as money.  These gold certificates were promises to pay in gold.  People could continue to use them as money.  Or they could take these receipts back to the vault and exchange them for the gold inside.  These gold certificates were as good as gold.  And there were no more gold certificates in circulation than there was gold in the vault to exchange them for.

Governments Today use nothing but Paper Money because it gives them Privilege, Wealth and Power

Some saw advantages of expanding the money supply with paper currency.  Money that isn’t backed by gold or any other asset.  Money easy to print.  And easy to borrow.  Allowing rich people to borrow large sums of money to buy more assets.  And get richer.  Giving them more power.  And if you were the one printing and loaning that money it gave you great wealth and power.  So having a bank charter was a way to wealth and power.  You could make it easy for those who can help you to borrow money.  While making it difficult for those who oppose you to borrow money.  So there were those in business and in government that liked un-backed paper money.  Because a select few could borrow it cheaply and get rich and powerful.

While some liked these banks and that paper money there were others who bitterly opposed them.  Some who didn’t like to see so much power in so few hands.  And the hard money people.  Who wanted a money that held its value.  The common people.  People who couldn’t borrow large sums of cheap money.  But people who had to get by on less as the inflation from printing all those paper dollars raised prices.  Leaving them with less purchasing power.  Making it harder for them to get by.  Often having to turn to the hated banks to borrow money.  Again and again.  Such that the interest on their loans consumed even more of their limited funds.  Making life more tenuous.  And more bitter between the classes.  The rich who benefited from the cheap paper money.  And the common people who paid the price of all that inflation.

Rich people, on the other hand, loved that inflation.  It helped them make money.  When they bought something at a lower price and sold it at a higher price they made a lot of money.  The greater the inflation the greater the selling price.  And the more profit.  Also, the money they owed was easier to pay off with money that was worth less than when they borrowed it.  Allowing rich people to get even richer.  While the common people saw only higher prices.  And the value of their meager savings lose value.  So this cheap paper money fostered great class warfare.  The hard money people hated the paper money people.  Debtors hated creditors.  The middling classes hated the large landowners, merchants, manufacturers and, of course, the bankers.  And those who had talent to create things hated those who just made money with money.  The greater the inflation the greater the divide between the people.  And the greater wealth and power that select few acquired.  This is what paper money gave you.  Privilege.  Which is why most governments today use nothing but paper money.

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Inflation and the Erosion of Savings

Posted by PITHOCRATES - February 4th, 2013

Economics 101

Some of the First Banknotes were Gold Receipts Redeemable for Gold on Deposit in a Goldsmith’s Safe

Money has a few important attributes.  It has to be portable so we can carry it to the store.  It has to be durable so we can use it and carry it without it wearing out.  It has to be divisible so we can buy things at a variety of prices and make change.  It has to be fungible so one $20 bill is the same as any other $20 bill.  And it has to be scarce.  Because above all else money has to store value.  For money is a temporary storage of value.  Which is why we don’t use garbage for money.  Because garbage isn’t scarce.  Nor is it portable, durable or fungible.  And it smells bad.  No one wants it.  And no one will take it in payment for anything.

Precious metals make good money.  They have all of the necessary attributes money should have.  Especially gold.  Which will last forever.  And it will never rust or lose its sheen.  And above all it is scarce.  No one can make gold.  It takes enormous costs to find it, mine it and process it.  So it’s not easy to make it NOT scarce.  Which means it will hold its value.  The only drawback to gold is that it’s not that portable.  It’s pretty heavy to carry around.  And a little dangerous.  As you can’t hide a large and heavy pouch full of gold very well.

So some people started thinking.  Who else has a lot of gold?  And needs to put it in a safe place where others can’t help themselves to it?  A goldsmith.  Who has a large safe they lock their gold in.  So, for a fee, the goldsmith would lock up other people’s gold in his safe.  And give them a paper receipt for the gold on deposit.  And the banknote was born.  People left their gold in the safe.  And used their gold receipts as money.  Paper currency.  Which were fully redeemable for the gold on deposit in the goldsmith’s safe.

The more we Increase the Money Supply the more we Depreciate the Currency and reduce Purchasing Power

Issuing banknotes for gold on deposit evolved into the gold standard.  Where we used paper currency that represented the gold on deposit.  And it was just as good as that gold.  Sharing all the same attributes.  Portable, durable and fungible.  As well as scarce.  If, that is, the amount of paper in circulation equals the amount of gold on deposit.  If so then the paper is as scarce as gold.  And as valuable.  So people will be willing to hold onto it.  Just as they are willing to hold onto the gold.  Because the paper currency is redeemable for the gold on deposit.

But as governments spent money they started to think.  They could spend more money if they just printed more.  And increase the amount of money in circulation beyond the amount of gold on deposit.  Allowing governments to spend more.  And they did.  But it made paper money less scarce.  And less valuable.  We can see how with the following table.  We start with $100 of gold on deposit.  And $100 of paper banknotes in circulation.  Then each year we increase the number of banknotes in circulation (the money supply) by 3% while the amount of gold on deposit remains the same.  Representing a 3% annual inflation rate.  ‘MSB’ stands for Money Supply at the Beginning of the year.  ‘New’ stands for the New money added to the money supply that year.  ‘MSE’ stands for Money Supply at the End of the year.  ‘100/MSE’ is the result of dividing the $100 of gold on deposit by the money supply at the end of the year.  And ‘Savings’ stands for the purchasing power of $750,000 in retirement savings after being adjusted for inflation ($750,000 X 100/MSE).

Inflation on Savings 3 Percent

When 100/MSE equals 1 the amount of banknotes in circulation equals the amount of gold on deposit.  Which means those banknotes are as good as gold.  For you can redeem every last one of them for that gold on deposit.  But when they start printing more banknotes the money supply grows greater than the gold on deposit that backs it.  Making each dollar worth less.  Depreciating the currency.  For the total amount of currency in circulation still equals the $100 of gold on deposit.  The more we increase the money supply the more we depreciate the currency.  Reducing the purchasing power of the currency in circulation.  Which erodes away the value of retirement savings over time.

High Inflation Rates greatly Discourage Savings and Encouraging Consumption

This was at a 3% annual inflation rate.  Which is something you may find in the United States or Britain.  Some countries, though, really inflate their currency.  Especially nations that have abandoned the gold standard.  Which removed all restraint from printing money.  The following table shows what happens to that retirement savings at a 25% annual inflation rate.

Inflation on Savings 25 Percent

Even though there is no longer an exchange mechanism between gold and dollars to keep the monetary authorities responsible they are still supposed to exercise restraint.  As if there was still a gold standard.  Because whether there is gold or not a massive inflation of the money supply still depreciates the currency.  And the greater the inflation the greater it erodes that retirement savings.  At this rate a person’s retirement savings loses over half of its value in 4 years.  It loses 74% of its value in 6 years.  And loses 89% in 10 years.  Greatly discouraging savings.  And encouraging consumption.  Graphing these results we get savings curves for these different inflation rates.

How Inflation Erodes Savings

Note that the higher the inflation rate the steeper the curve.  And the steeper the curve the faster your retirement savings lose their purchasing power.  Here you can see why people living in countries with high inflation rates don’t want to hold onto their currency.  They try to spend it as soon as they get it.  Buying things that hold their value.  Or exchanging it for a stronger currency.  Like U.S. dollars.  British pounds.  Or Eurozone euros.  Anything to avoid their wealth eroding inflation.

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The Chicago School of Economics

Posted by PITHOCRATES - March 5th, 2012

Economics 101

Monetarists believe in Laissez-Faire Capitalism and Fiat Money

Keynesian economics supports hands-on government management of the economy.  Using fiscal and monetary policy to move the aggregate demand curve at will to end business cycles.  The boom bust cycles between inflation and recession.  Leaving only the inflationary boom times.   Using tax and spend fiscal policies.  Or simply printing money for government expenditures.  For in Keynesian economics consumption is key.  The more of it the better.  And when people stop buying things the government should step in and pick up the consumption slack.

The Austrian school is a more hands-off approach.  The markets should be free.  Laissez-faire capitalism.  And the business cycle should remain.  For it is a necessary part of the economy.  Part of the automatic pricing mechanism that adjusts supply to meet demand.  When people demand more prices go up.  Encouraging businesses to expand production to sell at these higher prices (inflationary expansion).  Then when supply exceeds demand businesses have excessive inventory that they can’t sell anymore at those higher prices.  So they cut their prices to sell off this excessive supply (deflationary recession).  Also, that hands-off approach means no playing with monetary policy.  Austrians prefer a gold standard to prevent central bank mischief that results in inflation.

The Chicago school of economics takes a little from each of these schools.  Like the Austrians they believe that government should take a hands-off approach in the economy.  Markets should be free with minimum government intervention.  But unlike Austrians, they hate gold.  And blame the gold standard for causing the Great Depression.  Instead, they believe in the flexibility of fiat money.  As do the Keynesians.  But with a strict monetary policy to minimize inflation (which is why proponents of this school were also called monetarists).  Unlike the Keynesians.  For monetarists believe only a government’s monetary policy can cause runaway inflation.

(This is a gross simplification of these three schools.  A more detailed and comprehensive study would be a bit overwhelming as well as extremely boring.  But you get the gist.  At least, for the point of this discussion.)

We used Gold and Silver for Money because it was Durable, Portable, Divisible, Fungible, Scarce, Etc.

At the heart of the difference between these schools is money.  So a refresher course on money is in order.  Money stores wealth temporarily.  When we create something of value (a good or a service) we can use that value to trade for something we want.  We used to barter with other creative people who made value of their own.  But as the economy got more complex it took more and more time to find people to trade with.  You had to find someone who had what you wanted who also wanted what you had.  If you baked bread and wanted shoes you had to find a shoemaker who wanted bread.  Not impossible.  But it took a lot of time to find these people to trade with.

Then someone had a brilliant idea.  They figured they could trade their good or service NOT for something THEY wanted but something OTHER people would want.  Such as tobacco.  Whiskey.  Or grain.  These things were valuable.  Other people would want them.  So they could easily trade their good or service for one of these things.  And then later trade it for what they wanted.  And money was born.  For various reasons (durable, portable, divisible, fungible, scarce, etc.) we chose gold and silver as our money of choice.  Due to the inconvenience and danger of carrying these precious metals around, though, we stored our precious metals in a vault and used ‘receipts’ of that deposit as currency.  And the gold standard was born.

To understand the gold standard think of a balance scale.  The kind where you put weights on one side to balance the load on the other.  When the scale balances the weight of the load equals the sum of the weights needed to make the scale balance.  Now imagine a scale like this where the VALUE of all goods and services (created by talented people) are on one side.  And all the precious metal in the gold standard are on the other.  These must be in balance.  And the sum of our currency must equal the amount of precious metal.  (Because they are ‘receipts’ for all that gold and silver we have locked up someplace.)  This prevents the government from creating inflation.  If you want to issue more money you have to put more precious metal onto the scale.  You just can’t print money.  For when you do and you don’t increase the amount of precious metal on the scale you depreciate the currency.  Because more of it equals the same amount of precious metal.  For more currency to equal the same amount of precious metal then each unit of currency has to be worth less.  And when each unit is worth less it takes more of them to buy the same things they bought before.  Thus raising prices.  If a government prints more currency without adding more precious metals on the scale they increase the value of that precious metal when MEASURED in that currency.  It becomes worth more.  In other words, you can trade that precious metal for more of that depreciated currency than before they depreciated it.  You do this too much and eventually people will prefer the precious metal over the currency.  They’ll lose faith in the currency.  And when that happens the economy collapses.  As people move back towards a barter system.

Milton Friedman wanted the Responsibility of the Gold Standard without Gold’s Constraint on increasing the Money Supply

A healthy economy needs a stable currency.  One that people don’t lose faith in.  Imagine trying to shop without money.  Instead, taking things to trade for the groceries you need.  Not very efficient.  So we need a stable currency.  And the gold standard gives us that.  However, the thing that makes gold or silver a stable currency, its scarcity, creates a liability.  Let’s go back to that balance scale.  To the side that contains the value of all goods and services.  Let’s say it increases.  But the precious metal on the other side doesn’t.  Which means the value of that precious metal increases.  The currency must equal the value of that precious metal.  So the value of the currency increases.  And prices fall.  It takes less of it to buy the same things it bought before.  Not a bad thing for consumers.  But it plays havoc with those who borrowed money before this appreciation.  Because they now have to repay money that is worth more than when what is was worth when they borrowed it.  Which hurt farmers during the 1920s.  Who borrowed a lot of money to mechanize their farms.  Which helped to greatly increase farm yields.  And increased food supplies while demand remained unchanged.  Which, of course, lowered farm prices.  The supply increased on the scale.  But the amount of gold didn’t.  Thus increasing the value of the gold.  And the currency.  Making prices fall.  Kicking off the deflationary spiral of the Great Depression.  Or so say the monetarists.

Now the monetarists wanted to get rid of the gold supply.  The Keynesians did, too.  But they wanted to do it so they could print and spend money.  Which they did during the Seventies.  Creating both a high unemployment rate and a high inflation rate.  Something that wasn’t supposed to happen in Keynesian economics.  For their solution to fix unemployment was to use inflation to stimulate aggregate demand in the economy.  Thus reducing unemployment.  But when they did this during the Seventies it didn’t work.  The Keynesians were befuddled.  But not the monetarists.  Who understood that the expansion of the money supply (printing money to spend) was responsible for that inflation.  People understood this, too.  And had rational expectations of how that Keynesian policy was going to end.  Higher prices.  So they raised prices before the stimulus could impact unemployment.  To stay ahead of the coming inflation.  So the Keynesian stimulus did nothing to reduce unemployment.  It just caused runaway inflation.  And raised consumer prices.  Which, in turn, decreased economic activity.  And further increased unemployment.

Perhaps the most well known economist in the Chicago school was Milton Friedman.  Who wanted the responsibility of the gold standard.  But without gold’s constraint on increasing the money supply to meet demand.  The key to monetarism.  To increase the money supply to match the growth in the economy.  To keep that scale balanced.  But without gold.  Instead, putting the money supply directly on the scale.  Printing fiat money as needed.  Great power.  But with great power comes great responsibility.  And if you abuse that power (as in printing money irresponsibly) the consequences of that abuse will be swift.  Thanks to the rational expectations of the people.  Another tenet of the Chicago school.

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From Commodity Money to Representative Money to Fiat Money

Posted by PITHOCRATES - November 8th, 2011

History 101

The Drawbacks to Using Pigs as Money Include they’re not Portable, Divisible, Durable or Uniform

They say we use every part of the pig but the oink.  So pigs are pretty valuable animals.  And we have used them as money.  Because they’re valuable.  People were willing to accept a pig in trade for something of value of theirs.  Because they knew they could always trade that pig to someone else later.  Because we use every part of the pig but the oink.  Which makes them pretty valuable.

Of course, there are drawbacks to using pigs as money.  For one they’re not that portable.  They’re not that easy to take to the market.  And they’re big.  Hold a lot of value.  So what do you do when something is worth more than one pig but not quite worth two?  Well, pigs aren’t readily divisible.  Unless you slaughter them.  But then you’d have to hurry up and trade the parts before they spoil because they’re not going to stay fresh long.  For pig parts aren’t very durable.

Suppose you have two pigs.  And someone has something you want and they will trade two pigs for it.  But there’s only one problem.  One pig is big and healthy.  The other is old and sickly.  And half the weight of the healthy one.  This trader was willing to take two pigs in trade.  But clearly the two pigs you have are unequal in value.  They’re not uniform.  And not quite what this trader had in mind when he said he’d take two pigs in trade.

Our Paper Currency Evolved from the Certificates we Carried for our Gold and Silver we Kept Locked Up

Rats are more uniform.  They’re more portable.  And they’re smaller.  It would be easier to price things in units of rats rather than pigs.  They would solve all the problems of using pigs as money.  Except one.  Rats are germ-infested parasites that no one wants.  And they breed like rabbits.  You never have only one rat.  Man has spent most of history trying to get rid of these vile disease carriers.  So no one would trade anything of value for rats.  Because these little plague generators were overrunning cities everywhere.  So rats were many things.  But one thing they weren’t was scarce.

Eventually we settled on a commodity that addresses all the shortcomings of pigs and rats.  As well as other commodities.  Gold and silver.  These precious metals were portable.  Durable.  They didn’t spoil and held their value for a long time.  You could make coins in different denominations.  So they were easily divisible.  Unlike a pig.  They were uniform.  Unlike pigs.  Finally, you had to dig gold and silver out of the ground.  After digging a lot of holes trying to find gold and silver deposits.  Which made it costly to bring new gold and silver to market.  Keeping gold and silver scarce.  And valuable.  Unlike rats.

But gold and silver were heavy metals.  Carrying large amounts was exhausting.  And dangerous.  A chest of gold and silver was tempting to thieves.  As you couldn’t hide it easily.  Soon we left our gold and silver locked up somewhere.  And carried certificates instead that were exchangeable for that gold and silver.  And these became our paper currency.

Governments Everywhere left the Gold Standard in the 20th Century so they could Print Fiat Money

The use of certificates like this is typically what people mean by gold standard.  Money in circulation represents the value of the underlying gold or silver.  And can be exchanged for that gold or silver.  Which meant that governments couldn’t just print money.  Like they do today.  Because the value was in the gold and silver.  Not the paper that represented the gold and silver.  And the only way to create money was to dig it out of the ground, process it and bring it to market.  Which is a lot harder to do than printing paper money.  So governments everywhere left the gold standard in the 20th century in favor of fiat money.  So they could print money.  Create it out of nothing.  And spend it.  With no restraints of responsible governing whatsoever.

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