Why Money Is Valuable And When It Stops Being Valuable

Posted: Nov 01, 2018 11:39 AM
Why Money Is Valuable And When It Stops Being Valuable

Money is one of the most important factors in the development of widespread commerce and the proliferation of prosperity from the old days of barter and limited opportunity. Money is simply something that people generally and widely use as a medium of exchange. That use in exchange is the only thing that gives it value. Gold and other commodities have value for other uses, but as money, its value is it’s reliability as an exchange medium.

The dollar and other national currencies are now only pieces of paper or accounting entries, and the only reason that they generally exchanged as money is because of the dictate or fiat of the government. The dollar has no value on its own, and it is not redeemable for gold or anything else, yet, every day, people accept it in exchange for labor and goods. Why? It doesn’t seem to make sense.

There are many historical instances, such as with the Zimbabwe dollar or the Venezuelan bolivar, where people flee the official currency and use alternative means of exchange when they can, including reversion back to barter. With hyperinflation, each unit of money can be exchanged for less and less goods and services. That currency is devalued, and that gives us a clue as to why money, any money, has value to anyone.

Something holds value as money only because it allows people to exchange their own labor services and goods for a commodity that they can use to trade for everything else they want or need. Money is not really valued as money, but rather for the purchasing power that it represents, the goods and services that it buys. The more goods and services it buys, the more valuable a money is, the less goods and services, the less valuable.

As an economic good, money is subject to every economic law, such as supply and demand. The higher the quantity supplied, the lower the value, its price in terms of what it can buy, meaning that it takes more money units to buy things. Thus, the value of money depends on its scarcity.

The fundamental problem with central banks is that they have the ability to create money with just accounting entries, meaning that they could easily expand the supply infinitely if it were expedient to do so. The Fed is proud of the fact that it has kept price inflation (another word for money devaluation) to a fairly low rate, because consumer price inflation has been relatively mild for the amount of new money created over the years. Money, however, is not distributed evenly around the economy. It doesn’t only buy milk and bread, but also factories, machinery, stocks, bonds, derivatives, and a host of other assets. It is obvious by looking at just the stock market that there has been massive inflation in average prices of all the things that money can buy. The increased money supply is the source of inflationary booms and the inevitable busts, even if there is no significant increase in consumer prices. There is no other source.

The value of the gold standard when it held sway was that, because of convertibility into a specified amount of gold, the amount of money that could be issued was limited. The gold supply increases slowly, and scarcity of the dollar was imposed by the discipline of convertibility. A dollar that holds its purchasing power is one that maintains a relatively scarcity.

Most economists, especially monetary policy makers, make a fundamental error in believing that consumer prices are the only thing that matter and that consumer prices must always rise and never fall. If they kept the quantity of money from ballooning, wherever the discipline came from, The prices of everything, including consumer goods would fluctuate up and down, but increasing asset prices would cause decreasing consumer prices, and vice versa. If one sector got out of hand, other sectors would compensate. As it is done now, increasing money supplies and low interest rates cause a flow of money to assets, ballooning prices in everything but consumer items, the typical bubble-bust world we have been living through.