Economic Silliness

I have for some time now been a proponent of commodity-based money. Specifically, I am for 'free money', which means unregulated money, spontaneously issued, where the market decides which is acceptable and which is not. Under such a system, commodity-based money becomes the likely solution so that notes issued from any source are exchangeable so long as the source is trusted.

Now, the end of this is that we have, say, a gold-based currency circulating. Oddly enough, the primary argument I receive about this idea is that there is 'not enough gold in the world to cover the US economy'. This argument has been made by people otherwise quite intelligent, so seems to me to be based on a massive misunderstanding of money.

It is based on the idea that gold is currently priced correctly, but the relationship of money to gold is such that there is only enough gold in the world for a tiny percentage of the dollars out there at the current rate. This is the inherent value fallacy on first blush.

The inherent value fallacy holds that money has an inherent value. This is the primary fallacy on which economic redistribution plans are based. The idea is that a dollar is worth some irreducible amount and thus transferring a dollar from one person to another forcibly transfers that worth from one person to another. In a reasonably healthy economy, as any bank robber will tell you, this works. The reason is that the damage done by the transfer is small enough to not damage the system as a whole.

However, on a larger scale, we find that money is worth nothing more or nothing less than what people will give for it, just like every other commodity. Fiat money is confidence-based; it is worth what the receiver is confident he can get for it. Its primary value is that it is uniform, meaning each dollar is exactly the same as the next, so denominating in dollars makes it easy to make comparisons between choices.

But, if we forcibly transfer funds from one group of people to another, as our current economic system does all over the place, we devalue money itself. Those who consume do not produce as much as they consume while those who produce are not able to consume as much as they produce, leading to a disincentive to produce, as well as competition from non-productive factors for production. It is precisely this competition that leads to price inflation, which must be remedied with monetary inflation.

Now, gold is something that does have inherent value. It is a valued commodity, not a piece of paper, or worse, neatly arrange electrons. This means that gold does not lend itself to rampant monetary inflation. What this means is that fiat money stock has increased at a far raster rate than gold stock and hence the disparity between what money exists and how much gold exists.

Of course, there is really no problem; in order for gold to provide adequate backing for the dollar, gold merely has to increase in price relative to the dollar. Bad for the dollar, but good for holders of gold...

The next argument, smugly delivered, is that this means that the average citizen cannot afford an ounce of gold, if that ounce is now worth $1.2 million or whatever. This much is pretty obviously true, but the answer requires examining the common uses of money, which include currency, settlement and wealth preservation.

Currency is the most common use of money. This is trade. I receive dollars for my work and spend them for things I need. For currency, just about any script will do; it needn't be all that reliable of a money, as it only has to be redeemable as long as it takes for the retailer to redeem it. So, any bank should be able to emit notes based on gold that are redeemable when you pile enough of them together for some amount of gold. Otherwise, you simply use them to spend and acquire assets as you would dollars. In other words, for the common man, there really isn't any difference between a gold-based economy and a fiat-based economy when money is viewed as currency.

Settlement has been a common use of gold. At the end of the day, when international banks need to settle accounts, it is often easier for them to use a common value to settle with, and gold provides that. Essentially, each bank tallies how much it has been paid from another bank and how much it has paid the other bank, finds the difference and either bills the other bank that much in gold or pays it in gold. In a fractional reserve system, the actual use of gold for this is tiny, hence the low price of gold relative to the dollar. In a fully-backed world, the gold required would be much higher. This also does not affect the average man.

Wealth preservation, however, does, and here is where fiat money is truly pernicious. For starters, fiat money always declines in value over the long term because monied interests prefer it that way and the lumpen is in debt up to its eyebrows anyway, something inflation helps with, as each reduction in the value of the money causes a reduction in the amount they actually owe.

However, keeping money in those same dollars is not a good idea for precisely that reason, so people are driven to acquire assets and leverage themselves (borrow money) to buy more on the theory that money is cheap and easy to repay later. This means there is little money left for emergencies. There is also little money for opportunities. All of which means that insurance gets a larger share of the economy.

Another problem is that banks tend to make money no matter what the value of money in a fiat system because they can borrow at one rate and lend at another. This allows them to pocket the difference, which is making money. So, if they borrow money at 3% and lend it at 5%, even though money may lose half its value during the period of the loan, they still make the 2% in money that is now worth half what it was. However, they made that money not by working, producing value, or investing money; they made it by borrowing money that sourced from the fed, so was not backed by value, and loaning that, something nobody but bankers can do.

What this tends to do is make it hard for anyone but bankers to make money in investing. Bankers can borrow money at an artificially low rate, allowing them to invest for artificially low returns, often lower than real inflation, because they make money on the difference. The rest of us have to invest our real money, which means we lose money over the long haul, rather than make it. This is true of the stock and bond markets.

It is not, however, true of commodities, and this is where we see their scheme coming apart. The only bet the average investor can take short of being a sole proprietor or major partner in a business that does not allow outside investment, is in gold or silver, which are not investments in the normal sense in that they do not make money.

However, as fiat money decreases in price, its utility as a store of value will also decrease, driving more and more people to transfer fiat store into gold, silver, palladium and platinum, the traditional 'money metals'. This drives the value of the money metals up as it drives the value of the dollar down. However, the value of the dollar tends to decrease more slowly than the value of the money metals increases, causing those holding money metals to see the value they hold increase in purchasing power, meaning that during an inflationary crisis, money metals do qualify as an investment.

Now, were gold to become the currency, the increase in value of an ounce of gold purchased cheaply now would be truly staggering...