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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Roman Denarius, New World Gold and Silver, American Continental and German Mark

Posted by PITHOCRATES - June 25th, 2013

History 101

Money that is not Scarce is a Poor Temporary Storage of Wealth

They say money doesn’t grow on trees.  And it’s a good thing it doesn’t.  For money is a temporary storage of wealth.  It temporarily stores value.  And one if its attributes is that it has to be scarce.  For example, let’s say you are a highly skilled tomato grower.  And you work in your garden 12 hours each day weeding, fertilizing, watering, tying, pruning, etc., your many fields of tomato plants.  Producing beautiful tomatoes that everyone just loves.  You love your tomatoes so much that you actually gave up your day job to grow them full time.  And support your family with the proceeds from selling your tomatoes.  Which you will exchange with others for money.  Provided that money is scarce.  And will hold the value of your tomatoes.  Until you can exchange that money for something you want.

Now let’s assume money grows on trees.  Anyone can plant one in their backyard.  And it grows like a weed.  That is, you don’t have to fertilize it or water it or do anything else for it.  And anytime you want something you just walk to your money tree and pick the bills you need.  We would never have to work again if we all had money trees in our backyard.  Wouldn’t that be great?  Or would it?  What would happen if everyone quit working because they, too, had a money tree in their backyard?  If no one worked then there would be nothing to buy with the money from your money tree.

But there is another problem.  If everyone had a money tree there would be such much money in circulation that it would no longer be scarce.  And if it’s not scarce it isn’t money.  It isn’t a temporary storage of wealth.  It won’t temporarily store value.  Because someone that has something of value, say delicious tomatoes, won’t want to trade them for something that he or she can just pick off of his own money tree.  Instead, he or she would rather trade those tomatoes for something that does have value.  Like, say, mozzarella cheese.  So a skilled cheese-maker and the skilled tomato-grower can meet to trade things of value with each other.  Tomatoes and mozzarella cheese.  And then each can make a delicious Caprese salad.  Which also has value.  Unlike money that grows on trees that anybody can pick whenever they want to.  Filling the world with people with lots of money but nothing to buy.  Because no one works to grow or make anything.

When Spain brought back New World Gold and Silver it unleashed Inflation in the Old World

For anything to be money it must be scarce.  Just think of the laws of supply and demand.  If there are droughts all summer long farmers have smaller harvests.  Which raises the price of what they bring to market.  Because demand is greater than the supply.  If there was a great growing season they have bumper crops.  Which lowers the price of what they bring to market.  Because supply is greater than demand.  So the scarcer something is the more valuable it is.  And so it is with money.

The main Roman coin was the silver denarius.  As the Roman Empire reached its zenith her borders stopped moving out.  The Roman legions stopped conquering new lands.  And without new conquest there were no spoils to send back to Rome.  So the Romans had to raise taxes to pay for the cost of empire.  The administration of it.  The protection of it.  And a growing welfare state to keep the people content.  To help with these great expenditures they began to debase the denarius.  Mixing more and more lead into the coin.  Reducing the silver content.  So they could make more coins with the available silver.  Thus making these coins less scarce.  And less valuable.  Unleashing an inflation so bad that it devalued the denarius so much that no amount of them could buy anything.   Eventually even the Roman government would refuse to accept it in payment of taxes.  Demanding gold instead.  Or payment in kind.

When Spain arrived in the New World they found a lot of gold and silver.  Which Europeans used as money in the Old World.  The Spanish brought so much gold and silver back to the Old World that it greatly expanded the money supply.  Making gold and silver less scarce.  And less valuable.  Requiring more of it to buy the things it once bought.  So prices rose.  Because of the inflation of the money supply.

The War Reparations the Versailles Treaty imposed on Germany led to their Hyperinflation

During the American Revolution there was little specie (i.e., gold and silver coin) in the colonies.  As wars are expensive this made it difficult to finance the war.  The Continental Congress asked for contributions from the states.  And could only hope the states would give them some money.  For they had no taxing powers.  But they never were able to raise enough money.  So they borrowed what they could.  And then started printing paper money.  The continental.  But they printed so many of them that they were far from scarce.  The massive inflation devalued the continental so much that it created the expression “not worth a continental.”  Which meant something was absolutely worthless.  The people would refuse to accept them as legal tender from the Continental Army because they were worthless pieces of paper.  So the army took what they needed from the people.  And gave them IOUs that Congress would settle at some later date.

The Germans paid for World War I by borrowing money.  The increased debt of the nation during the war devalued the currency.  The German mark.  It took more and more of them to exchange for stronger currencies.  Like the U.S. dollar.  The Versailles Treaty that ended the war saddled Germany with the responsibility for the war.  And made them pay enormous amounts of war reparations.  In gold.  Or foreign currency.  So the Germans turned up the printing presses.  And printed marks like there was no tomorrow.  Making them less scarce.  And worth less.  It took more and more of them to exchange for foreign currency to make their reparation payments.  But they didn’t care what the exchange rate was.  For whatever amount of devalued marks they needed to exchange they just turned to their printing presses.  And printed whatever they needed.  This rapid inflation devalued the mark more.  Requiring them to print more.  Which just fed into the inflation.  Eventually bringing on a hyperinflation where it took enormous amounts of marks to buy anything.  For example, it was cheaper and easier to burn marks than it was to buy firewood to burn.

Anytime you make money less scarce you make it worth less.  The inflation of the money supply devalues the currency.  Which raises prices.  Because it takes more of the devalued currency to buy what it once did before the inflation.  So expanding the money supply leads to price inflation.  Good if you’re a rich investor.  But if you’re someone just trying to buy firewood to keep from freezing to death during the winter?  Not so good.  The Romans, the Europeans, the Americans and the Germans all suffered from bad inflation.  Some worse than others.  If the inflation is so bad, such as in the case of hyperinflation, people may lose all confidence in the currency.  And simply stop using it.  Going to a barter system instead.  Like when a tomato-grower trades his tomatoes for a cheese-maker’s mozzarella cheese.

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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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Prices, Scarcity and Value

Posted by PITHOCRATES - December 12th, 2011

Economics 101

“Economics is the Study of the Use of Scarce Resources which have Alternative Uses”

Agriculture advances gave us food surpluses.  Food surpluses gave us a division of labor.  The division of labor gave us trade.  Money made that trade more efficient.  Religion and the Rule of Law allowed great gatherings of people to live and work together in urban settings.  Free trade let us maximize this economic output and elevated our standard of living.  And free labor sustained economic growth by increasing the number of people making economic exchanges.  Of course, we need something else to facilitate these economic exchanges.  Prices.

British economist Lionel Robbins defined economics as the “study of the use of scarce resources which have alternative uses.”  Resources are the things we buy.  Or they make up the things we buy.  We can use these resources to make many different things.  For example, we can eat corn as a food.  It can be an ingredient in food.  We can make it into a sweetener.  We can use it to make bourbon whiskey.  We can even use it to make fuel to burn in our cars.   So corn has many alternative uses.

Depending on the corn harvest corn can be abundant.  Or scarce.  We can have a lot of it.  Or if there was a drought we may not have so much of it.  For another example of scarcity you can consider a concert.  Whether it is for your favorite band or a Broadway show, ticket prices for that show will vary.  The pair of tickets that are front row center are the most coveted.  And typically end up with a service or a scalper.  Thousands of people may be able to enjoy the show.  But only two can sit front row center.  These two tickets are very scarce.  And if you ever bought a pair of these tickets you know how expensive these tickets can be.

We Agree to Economic Exchanges when both Buyer and Seller Agree on the Value which is Communicated by Price

Those tickets are expensive because they are scarce.  The price of these tickets tells us this.  There are more seats available that are not as good.  And they cost less.  Because there are so many of these ‘cheap’ seats pretty much anyone can buy them.  Unlike the front-row center seats.  The scarcer something is, then, the greater its value.  And the more expensive it is.

Something becomes scarcer when the alternative uses for it grows.  For example, we now use corn to make ethanol to fuel our cars.  Leaving less available for food.  So food prices rise.  Because with this new use for corn the users in the food industry have to compete with each other to buy the smaller amount of remaining corn.  Corn, then, became scarcer when we added another use for it.  And more expensive.

We determine the price we are willing to pay for something based on the value it has to us.  In every economic exchange both buyer and seller assign a value.  Of what the buyer is willing to pay.  And what the seller is willing to accept.  We communicate this information with prices.  And we agree to make the economic exchange when both buyer and seller agree on the value of what they’re exchanging.  By agreeing on a sales price.

‘High’ Prices make sure Scarce Resources that have Alternative Uses are Always Available for those Alternative Uses

In this way prices automatically ration limited resources that have alternative uses.  And directs these limited resources to where their use is valued most.   By automatically flowing to the highest bidder.  This is the hallmark of capitalism.  And why you can walk into any American supermarket and be overwhelmed by the choices available.  But when you interfere with prices you have shortages.  And rationing by government bureaucrats.  Such as the gas lines during the Seventies.  When price controls made gas cheap to buy.  But it was almost impossible to find any to buy.  Because that cheap price for a scarce resource (made scarce by the Arab oil embargo) allowed people to buy it up until there was no more left.  Had we allowed the price to rise we would have bought less gas.  Guaranteeing there would be gas available for those who needed it most.  And who were willing to pay the higher price.

During the height of the Cold War when Soviet defectors came to the United States the American supermarket astonished them.  They never saw anything like it behind the Iron Curtain.  For communism didn’t use prices to manage their resources.  Bureaucrats managed their resources.  Their decisions filled stores with things no one wanted to buy.  And made people stand in line for hours to buy their ration of soap or toilet paper.  Things these defectors could fill a shopping cart with on any day of the week in any American supermarket.  And have money left over to buy so much more.  Thanks to capitalism.

Prices are relative.  Prices that may seem high serve a purpose.  They make sure scarce resources that have alternative uses are always available for those alternative uses.  Yes, the prices may be ‘high’ from time to time.  But these high prices guarantee these scarce resources will always be available to buy.  Unlike a low price.  Which, if too low, it will make a scarce item unavailable.  At any price.  Such as gasoline in the Seventies.

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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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