The primary function of money is that of a medium of exchange, and secondarily as a store of value. It allows us to progress beyond barter, and buy and sell goods we otherwise not be able to. Money is a good that forms one side of all transactions.
Throughout history, money has tended to be gold or silver, although it has been many other goods too – perhaps most famously cigarettes in POW camps. If you had gone to a market in ancient Rome, and presented a colourful piece of paper with Caeser’s head on it, you wouldn’t have been able to buy anything.
Our modern money systems have evolved from a pure commodity system, where gold and silver are used directly in payments, to a system solely based on paper, with nothing to back it up. In the past, you (in theory at least) could take your ten pound note to the Bank of England, and get gold in return. Try doing that nowadays!
In a barter exchange, both parties are exchanging useful goods – perhaps a butcher and a baker are trading beef and bread. Gold became accepted as a medium of exchange because it is rare, difficult to produce, and is a very good store of value. Items of food wouldn’t last long enough!
As banking developed in Europe after the Renaissance, it became common for banks to issue receipts to gold, to save hauling around all that heavy metal. Over time, such pieces of paper became accepted as money itself, and gold was used less and less. However, the only reason these banknotes were trusted was because they were backed up by a tangible asset. This process was abused, but nonetheless was largely successful. Governments increasingly decided to take over the issue of paper money, but retained the backing of gold. Although governments often manipulated the gold standard, it was able to keep control of inflation very well.
In the 20th century, the gold standard was gradually removed, and came to a complete end in 1971, when the system known as Bretton Woods was ended by Richard Nixon. Since then, as seen in the graph in my earlier post, Why are Central Banks Harmful, inflation has gone through the roof.
Our current fiat money system is based solely on paper, with no commodities to back it up. It only exists because of legal tender laws – without these, the market would rapidly switch to commodity based money. Governments can now print money without limit, and the effects have been devastating.
Can we trust government to control their printing presses? Are recent rounds of quantitative easing just the beginning? We’ve been on a worldwide paper money experiment for 40 years, and the strains are now clearly showing.
As stated at Freedom at Bethsaida:
What does this say about our fiat money system? Currency is a store of excess production (you have produced but not yet consumed, and are storing it as an agreed-upon medium of exchange – the currency). If the government can create mounds of this stored productivity out of thin air (whether by traditional printing or just by changing a couple of lines in a balance sheet), then what does that say about our measures?
It’s not like they actually produced anything when they created this excess store of production, right? They just printed paper money. They just changed the scales, the measures, the standards.
Why such creation of money is so dangerous, as well as immoral, we’ll explore in future posts on inflation.