Essay on Origins and Functions of Money
Essay on Money by Stephan Haller
Table of Contents
- Introduction
- Origins of Money and Credit
- Functions of Money
- The Right Amount of Money
- Origins of Money Part II
- Interest Rates - The Price of Money
- Foreign Exchange Value of a Currency and Trade Deficits
- Public Debt
- Printing Press = Devaluation of the Currency + Pauperization of breadth Parts of the
Population
1. Introduction
Peter D. Schiff wrote in his book “The Little Book of Bull Moves in Bear Markets“:
“A nation can create money and the individual cannot.“
This assertion is wrong. On the contrary the truth is:
“The individual can create money and a nation, a government or a central bank cannot.“ Of course I know, since Peter Schiff is a very smart man, that he is not talking about real money, he is talking about the colorful paper we call Dollar, Euro or Yen.
So his quotation is true regarding to fiat money.
But when I say only the individual can create money and a nation cannot, I‘m talking about real money.
In this essay I show you what real money is about, how it comes into existence and what tasks money undertakes in an economy.
Authors note: When I‘m using the term money in this essay, I‘m talking about real money and not Euros, Dollars, Yen, or Yuan, etc.
2. Origins of Money and Credit
The state cannot create money, but every time he tried to create money in the past, he destroyed it and brought major disaster over the economy and its people.
What the Federal Reserve Bank, the European Central Bank, the Bank of Japan and the Bank of England are doing at the present time is nothing more than a grand theft of the fruits of the labor of their people.
Our modern economy, just like the economy in ancient times, bases on trading goods and services for other goods and services.
In a primitive barter economy without money, it is difficult to exchange goods, because very often some goods have a much bigger value than others and are indivisible. Therefore credit came into existence.
Let‘s suppose a cattle farmer wants to buy some fish from a local fisherman, but one cow is worth much more than one catfish. So in order to settle this transaction one of the two parties must grant credit to the other party. The cattle farmer could give the fishermen one cow and the fisherman signs a contract to deliver a catfish everyday for the next 365 days or whatever amount of catfish they agree on. It is also possible that the fishermen delivers a catfish everyday for the next year and the cattle farmer delivers the cow in a year, when the calf has grown big enough.
Another option would be, that the cattle farmer trades his contract with the fisherman for other goods and then the new owner of the contract - the commercial bill of exchange - has the right to claim the fish from the fisherman.
Every one of us is granting or using credit several times a day. For example we go to work everyday, but get paid once a week or once a month. So when you are doing your job, you are giving credit to your employer, payable in a week or in a month.
In other words, you are performing a service in the present and you get your reward in the future. By producing or delivering goods or by performing a service you acquire the right for the equal amount of goods and services, payable in the future. In order to guarantee your right to receive the equal amount of goods and services, we need a security: MONEY.
So money is just the documentation that you produced a good or performed a service, without receiving goods and/or services of the same value in reward.
Most of the time your employer can‘t pay you for your service with the equal amount of goods and/or services. Therefore he pays you with money.
After receiving your wage from your employer paid in the form of money, you and your employer are even. The transaction between you and your employer is closed.
But you still have a claim to receive a certain amount of goods and services. But not against your employer, but against the market. The money you received as a payment for the goods you produced or the service you performed, entitles you to receive a small fraction of all the goods and services, which are produced in an economy.
So the most important character of money is that it fully guarantees your entitlement to receive a small fraction of all the goods and services produced in an economy in the future.
Money is an entitlement to goods and services, which came into existence, because somebody has produced goods and/or performed a service, but hasn‘t received an equal amount of other goods and services, yet.
We know now, that in order to produce money somebody has to perform a service or produce a good. Everybody should also understand now, that Mrs. Yellen cannot produce money with her printing press. When the FED is creating new money, everyone who receives this new money, owns now entitlements for goods and services, without having produced new goods and services before. Therefore everyone who owns old money is a bit poorer now.
I call this outright theft.
3. Functions of Money
a. Money as a medium of exchange
Money makes the exchange of goods more convenient. But money isn‘t just a medium of exchange. You can use money for giving a loan or to pay down debt. In order to fulfill this function the money in use needs to be widely accepted.
b. Money as a measure of value and unit of account:
Money is a documentation for the service you performed or the goods you produced in the past. It also expresses the value of certain goods and services.
c. Storage of Value:
The advantage of real money is, that the buying and the selling of goods and services don‘t need to happen at the same time. For example if you trade eggs for fish, then the buying and the selling happens at the same time. You simultaneously sell eggs and buy fish.
If you are using money, you can trade your eggs today in exchange for money and buy fish or any other good or service with your money next week. Or if you don‘t need the money in the meantime, you can lend it to someone, who needs it and he pays you interest for it.
In order to fulfill this function, money needs to be an entitlement to receive a certain percentage of all the goods and services, which are produced in an economy and this entitlement lasts forever.
4. The Right Amount of Money
Johann Nepomuk Nestroy: * “The Phoenicians invented the money - but why so little?“*
Most modern economist, especially the Keynesians, believe, that when the economy is growing, the amount of money (issued by the central bank) must grow, too. But this assumption is wrong.
In a free market economy with real money, there is always the “right“ amount of money circulating. The money supply in a country is equal to the total amount of claims for the produced goods or performed services that haven‘t been enforced yet.
5. Origins of Money Part II
We have now learned, what real money is, what the functions of money are and what the right amount of money is. The way I described the origins of money was very abstract, though.
So how does money - such as a bank note or a coin - come into existence?
For the party who has sold a good, a new entitlement for goods and services has emerged and for the party who has bought a good, the entitlement has expired. But no new money has to be printed or coined, because the buyer just transfers his entitlement to the seller. So the entitlements, or that is to say money, just circulates in an economy. But when and how did the first money emerge?
Somebody has to produce a good, which fulfills all the functions of real money, is widely accepted and functions as a guaranteed entitlement to the delivery of goods and services in the future. It is also important, that the value of the money can't be manipulated.
History has shown, that there is only one good, which has all this postulated qualities:
GOLD.
Only gold or paper money 100% backed by gold can function as real money.
I have to add that cryptos could become the new gold, but only time will tell...
I said before, that money comes into existence when somebody performs a service or to put it in other words, works hard.
Mining gold and minting it into coins is a lot of hard work.
When mining cryptos, your computer does the work, so it comes pretty close to gold.
Gold doesn‘t rot or rust and it is widely accepted.
So now we know how money, that we can use as a medium of exchange, as a storage of value and as a unit of account, comes into existence:
Somebody digs gold out of the ground, gives it to a goldsmith, who melts it down and molds it into bullion in exchange for a small amount of gold or paper money redeemable in gold. Now he gives the money to a commercial bank or a central bank. The bank stores the gold bullion into a vault in exchange for a small percentage of the gold and gives him paper money, redeemable in gold. With this new printed money the gold miner can buy a certain amount of goods and services, depending on the market price. New money has entered the market and now circulates in the economy.
But who is controlling the velocity of money and how can the market make sure, that the money circulates instead of lying under a mattress?
I‘ll answer these questions in the next chapter.
6. Interest Rates - The Price of Money
Our modern alchemists - the central bankers - keep telling us, that if the economy is in the state of a recession, you just need to drop money from a helicopter and the economy goes right back into growth mode and the unemployment rate comes down. The enemies of these Keynesians are the savers. Because in the world of the Keynesians, when people pull their money out of the circular flow of money, then the economy can't expand or falls into a recession.
This is complete nonsense. If it were true, that the printing of paper notes makes a society richer, than there would be no poverty in the world and Zimbabwe would be the richest country in the world.
I said it very often in my past writings and I have to say it again:
" A society can't become richer by printing money. A society can only become richer by producing more goods and services."
When an economy expands, there is no need for a greater amount of gold or gold backed paper bills or fiat money. It is the velocity of money, which needs to speed up.
But don't get me wrong. The rising velocity of money or an expanding money supply is not the cause of economic growth. It is just the opposite. The expanding economy causes the velocity of money to speed up and/or leads to a growth in the supply of money.
But how do we get the velocity of money to rise, or to put it in other words, how do we get the money, which is at rest, back into the circular flow?
The answer is very easy: Interest rates.
Interest rates are the price of money. If money is badly needed, because the businesses want to expand, then interest rates will go up to the extent, where the demand for money equals the supply of money.
So if the demand for goods and services is higher than the production of goods and services, the interest rates go up, because the businesses need money in order to expand their production. On the other hand falling interest rates are a sign, that the supply of goods and services exceed the demand.
7. Foreign Exchange Value of a Currency and Trade Deficits
Every transaction is bartering, it doesn‘t matter if the transaction is taking place on a national or an international level. Goods and services are traded for other goods and services. Money is just a substitute for goods and services.
The foreign exchange value of a currency shows us if a country is exporting more than it imports or the other way around. The exchange rate of a currency shows us also, how much goods a country with a trade deficit must export to a country with a trade surplus in order to equalize the trade balance. The United States have a long record of big trade deficits with Japan.
Or put it another way, the United States buy more goods and services from Japan, than they sell to the Japanese.
In a free market without currency manipulation by the central banks, the currency of the country with the trade deficit should devalue until exports and imports are balanced.
So why doesn‘t the US Dollar devalue more against the Japanese Yen and the Chinese Yuan?
There are several reasons:
a) All commodities are traded in US Dollar, therefore the US are able to spread a big chunk of the inflation created by excess money printing all over the world, because everyone has to buy US Dollar in order to pay for oil, iron ore, etc.
b) When a car is produced in Japan and shipped to the US, the Japanese auto maker can either get paid in US Dollar or insist on payment in Yen. If he gets paid in US Dollar he can use Dollars for buying US goods and services or exchange his US Dollar for Yen and buy Japanese goods and services. If he insists on getting paid in Yen, the American importer of the car has to find another person who sells him Yen in exchange for US Dollar. Usually he does this with the help of his commercial bank which supplies him with foreign currency generally with the help of the central bank.
The effect is always the same. The Japanese have excess US Dollar, because they sell so much to and buy so little from the United States.
Because the US is still the best place in the world for investing, they ship the US Dollar back to the US and buy stocks and bonds, mostly US treasuries.
So always keep in mind:
If a nation wants to keep up a big trade surplus with another nation, the only way of maintaining this trade surplus is to send money to the nation with the trade deficit. Otherwise your own currency gets more expensive and the trade surplus declines, because your products are more expensive now abroad.
If you don‘t want to send your money back to the country where it came from, then the only way of increasing your exports is to increase your imports from the country you want to export.
In a world with an international gold standard, foreign trade and exchange rates balance themselves. As soon as the exporter of a good gets paid in foreign paper money redeemable in gold, he goes to his bank and exchanges the money into his national currency. The commercial bank exchanges the foreign currency into national currency at the central bank, which finally exchanges the foreign currency into gold at the central bank of the other country.
Thus when a country has a trade deficit, gold is flowing out of the country, but when the supply of gold is shrinking, the supply of money is shrinking, too. Due to the shrinking supply of money prices and wages go down automatically. As prices and wages go down, the products of a country get cheaper and the other countries start to buy more of the country‘s products again and gold starts to flow back into the country.
Therefore big trade deficits or surpluses are not possible in an international gold standard.
8. Public Debt
Paul Krugman: “Debt Is (Mostly) Money We Owe to Ourselves.“
Most of the time I completely disagree with Paul Krugman, but this statement is mostly right. But I have something to add. You can‘t pay debt or a trade deficit with money. Yes, money is the medium of exchange to pay down debt, but in reality you pay debt by delivering goods, so you owe the debt to the future generations who will have to produce the goods to pay down the debt. Therefore it doesn‘t matter where your creditor is located. It doesn‘t matter if the Chinese are holding the US debt or if the treasury bonds are owned by US citizens. But in contrast to Paul Krugman I think that by piling up big public debt you are enslaving the future generations.
9. Printing Press = Devaluation of the Currency + Pauperization of breadth Parts of the Population
The creation of new (fake) money by the central bank is like a hidden tax on the fruits of our labor. The central bank is robbing the people‘s wealth, but they keep telling us they do it for our own good. But when the FED prints money, breadth parts of the population are losing, big time. But there are some profiteers, though. Artificially created money always drives up prices. Sometimes housing prices, sometimes the prices for stocks or commodities and in the long term always the consumer prices.
But who are these profiteers of money creation and how does the FED create new money?
In the aftermath of the financial crisis the FED kept buying mortgage backed securities and treasury bonds worth $85 billion from the banks every month.
By propping up the housing market and keeping down interest rates, the FED helped the debtors and did hurt the savers.
Government is the biggest debtor, so if price inflation his higher than the interest on government debt, the public debt gets “inflated“ away over time, because when prices and wages rise, the taxes the IRS collects also rise.
The next winners are the commercial banks.
Because the FED prints new money and buys assets from the commercial banks with this new created money.
When the banks get the new money they can buy other assets at the old prices, because nobody has noticed yet, that new money was created. If they invest the money, they drive up asset prices and most of the time commodity prices.
The commercial banks are also happy to lend out the new created money to their friends in the big businesses. These big businesses drive up prices even more. The little guy is the last one who receives the new created money, if he ever gets it. When the little guy receives the new money (e.g. through a pay raise), prices are way up. Price inflation is the main reason for the widening gap between rich and poor.
In the long term a small elite gets richer and richer and the rest of the population stays poor. Another longterm effect of the money printing is that the value of the currency disappears.
So what can we do?
I think there is no way to change the system in the short run. The central bankers won‘t change their monetary policies, until the whole financial system collapses.
But cryptocurrencies could be the first step to take the power of central bankers and commercial banks away and give it back to the people.