Money

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One of the things we as average American citizens need to know about is money. What is money? Where does it come from?

Money is a medium of exchange. That is, it’s what you use to buy and sell stuff. It doesn’t matter what you use, as long as you can use it to buy or sell stuff, it’s money.

There are two types of money out there. The first and most primitive type is commodity money. This is simply money that is literally a commodity—a good that is commonly bought and sold. We are used to things like gold and silver, but other cultures at other times have used different things as money. Commodity money may be valuable in and of itself, like grain or salt, or it may have no or little intrinsic value, such as precious metals.

The other type of money is fiat money, or in other words, make-believe money. This is what most modern economies use for their money. It’s money that is money because people say it is money. There is no limit on how much can be created. The US Dollar is fiat money.

Now, fiat money isn’t necessarily bad money. There’s a reason why everyone switched from gold and silver in the modern era. There’s a reason why, after the switch, the world’s economies have grown much faster and much larger than ever imagined. But there is a danger to it, a very real danger we are facing today.

If you consider an economy, you must consider its money supply. That is, how much money is there, and how is it being used?

In any economy, if you have too much money chasing too few goods and services, the prices tend to rise. This is called inflation. It’s effects are particularly noticeable to the middle and lower classes because it means your salary buys less food, clothing, shelter, health care, and entertainment.

To those of us who aren’t good at working amortization tables, inflation can be a killer. You can quite literally lose your life savings during periods of inflation. Inflation hurts the poor the most because they are really bad at math. It also hurts those on fixed incomes, such as retirees, because they don’t really have a choice.

Deflation is the opposite of inflation. During deflation, too little money is chasing to many goods and services. During these periods, the prices tend to fall. It’s effects are particularly noticeable to the middle and lower classes because while prices are falling, we lose our jobs. See, as we stop buying so much stuff, because we expect things to get cheaper, we also put each other out of work. A factory that isn’t selling anything doesn’t have any need to employees, neither does it have need of raw materials.

You can tell deflation is happening because you have a strong urge to throw every penny you have in a bank, or under your bed, or some other place where it won’t earn much in return. People on fixed incomes are living it up, but jobs are mysteriously disappearing.

Deflation is doubly bad because it leads to a feedback loop on itself. Some deflation leads to more deflation. Even more deflation leads to even more deflation. It doesn’t really stop until the economy collapses or someone creates more money.

As an economy grows, there needs to be more money chasing the new goods and services. Otherwise, there would be deflation. On the other hand, as an economy shrinks, you need to decrease the amount of money out there to prevent inflation.

On the other side of the equation, if the economy neither grows nor shrinks, but there is more money, you get inflation. Less money in the same conditions gives you deflation.

At this point, economists start debating loans and bank accounts and savings and such. I won’t bother. We really can’t control who decides to do what with their money. We can’t really control what banks decide to do with theirs either, nor who is going to ask banks for loans or credit. This kind of activity is really a reaction to market conditions and government policy anyway.

The one thing we, the people, can control is how much money is printed each year. This has a direct effect on whether we experience inflation or deflation.

As we talk about the federal budget, we need to think carefully about how much money the government is printing. Unfortunately, the congress no longer controls the amount of money printed each year, even though the constitution gives them direct control over this. We have to trust the Federal Reserve to do the right thing and print just enough money to cover the economic growth for the year, but not so much as to cause inflation.

If we were to abandon the Fed, and simply have congress print the money, then congress could write a budget that would include the amount of new money that it decides to print that year, without borrowing a dime to fund it. This is a great way to balance the budget while spending more than we tax.

If the new money matches the economic growth, then we can actually have an economy without inflation or deflation or taxes. That is, we can spend, freely, as much money as the economy grows that year. In fact, we have to spend that much money or we risk deflation.

In our economy, this year, if we maintain a 3% growth rate (which is low), then that’s $426 billion. If we grow at a much faster rate, say 5% or 10% (which we would without any taxes at all), then we’d see $710 billion or $1.4 trillion in free money. That’s more than enough to cover our national budget.

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