Currency - redux?

[Thrawn]

I aim here is post what I hope is my definifitive arguement about the dangers of massive currency expansion.   I find myself posting the same thing over and over here, and usually the same rebuttals come up.  So I figured might as well have it out in one place.  This way I can also just referrer to this thread if they come up again.  Besides, I'm doing laundry and have some time to kill.


Currency makes devision of labour more efficient.  Instead of everyone having a warehouse full of stuff to trade, they use a representation of wealth.  Say you are a rancher and have some cows, you want to buy (or barter for) some eggs.  How many eggs is a cow worth?  One metric crapload would be my guess.  Where are you going to put them all?  What if you only want to buyone a dozen?  How do you get change for the cow?

I suppose if you wanted change, the chicken farmer could give you an IOU for the eggs owed....Ha Ha, but now you've got money happening.  That IOU is a piece of paper that has value.  You can trade it for other stuff.  This promotes division of labour.  Which is good, because people can specialise on producing one thing.  Your village smith doesn't have to break up his time making cows or wheat etc.  He can concentrate on making metal stuff, which he is good at.  So currency is pretty damn useful.


But does currency have inherant value?  It depends.  Typically currency has been backed by or made of a commodity that had inherant value.  If we look at our bartering rancher, his cows have inherent value, you can eat them.  What about the IOU he got from his chicken farmer friend?  It doesn't have much inherent value, it's only a piece of paper.  The IOU is only as good as the chicken farmer's word.  Of course if the chicken farmer renegs on the IOU, he won't find many people willing to accept his IOUs anymore.

What of these commodities that back currencies and that currencies are made of?  Well in feudal Japan it used to be rice.  Their base unit of currency (correct me if I'm wrong) was the equivalant to the amount of rice a family of four needs to survive for a year.  Precious metals are used to back currencies and for a long time, currencies were made of precious metals like gold and silver.

Gold and silver have inherent value, you can make stuff out of them.  But what has more inherent value, one of our rancher's cows or it's equivant in gold?  I'm going to with the cow.  I can eat the cow, there's not to many I can do with gold.  During the colonial period, the British imported commodities and resources.  The Spanish imported gold.  The actual resources and commodities where.  Which do you think was better the better import?  You can build ships out of wood, you can't build them out of gold.  

So not a whole hell of alot of inherent value there.  Why is it worth so much then?  It's worth alot because it's so damn useful for exchange and it doesn't rely on chicken farmer keeping his word.


Okay, let's say our rancher, chicken farmer, smith and few score other people live in a closed community.  There is about 500 ounces of gold distributed about the community that they use as currency.  Our rancher is walking about the back forty when he finds a chest filled with an additional 500 ounces of gold.  "Ho ho," he says, "I'm rich!".

The actual amount of cows, eggs, horseshoes and all resources haven't increased in the community.  Only the amount of currency.  The amount of currency goes up, value of it goes down.  Although our rancher's purchasing power has gone up, everyone else's has proportionally gone down.  The rancher is richer, everone else is poorer.  There are no more resources in the community than there were before, but the rancher can buy more of them and everyone else can buy less.  I think we can see that the creation of currency (or expansion) is and of itself not helpful to this communities overall economics but infact skews it.


In the next post, I'll talk about examples of real world currency expansion and thier historical effects.

[Thrawn]

So where did paper money come from and what good is it?  Paper money is typically just a form of IOU (or promisary note).  Gold and silver was more convienent to carry carry around than a cow, a few chickens and some nails for change.  Paper was even more convienent.

Banknotes emerged, which where paper contracts that banks gave out that represented gold and/or silver.  They said that if you brought this note to the bank that issued it, they would give you gold or silver in exchange.  Great stuff eh?  You could deposite your gold in a branch on the east coast and get a banknote.  Travel out west, and pick up gold in branch out there.  And you only had to carry a piece of paper if you so chose.  But some banks were simply shells and people were defrauded.  So gold was still gold, and important as currency.

During the late 1700s you started to see the US state and federal governments start to get into the currency business.  This involvement increased and 1913 the Federal Reserve Act was legislated.  The US government would lend money to the banks at an arbitrary rate, then the banks would could lend that money at a higher rate and make a profit.  The net effect was the creation of alot alot of money.  And although the US economy was becoming more productive.  The increase in production didn't match the increase of currency.  Alot of that extra cash was being lent to people so they could make speculative investments.  But, as their was no actual increase in resource to match the extra cash, you had a misallocation of what resources thier was on iffy investments.  Due diligence isn't as important if money is less scarce.  That goes for individuals and banks.  The banks were flush with money, why not loan it at a higher risk?  They could always borrow more from the Fed.

But factories, mines, and products are built with actual resources, not gold or paper money.  By issuing more paper money to banks, the Fed was decreasing the value of paper money for everyone else.  People who were smart, and saved got screwed because their saved money was worth less.  Thank goodness people still had gold....then government stole their gold.  Legislation was passed that people had to hand it over in exchange for paper money.  This was done in repsonse to the effects of trying to counter the previous money expansion.  Wonderful, so people have less value for thier saved money because of expansion, then the government steals thier hedge against expansion.  Well...damn.

The market correction for the expansion caused by the Federal Reserve we call the Great Depression.


Next, gold standard to fiat currency.

[NUKE]

Let me give a quick breakdown on where I think Thrawn is going woth this:

1. The US prints too much money
2. China owns the US
3. The US is living an unfair, higher lifestyle then we deserve
4. the US economy will collapse.

[Thrawn]

For all intents and purposes the US dollar became a fiat currency within the United States when the government stole people gold in exchange for paper dollars.  It didn't matter if gold backed the dollar, people used dollar for exchanging wealth.  And that worked because people accepted it and didn't have much choice in the matter.  But what about international trade?

Each country (more or less) had their own currency.  They didn't use US dollars.  So in order to exchange US dollars for foriegn goods, there had better be something tangible backing it, like gold.  Now the Federal Reserve had tons of the stuff, after all it did steal a bunch of it from the citizens.  So great.  People can trade stuff to US in exchange for dollars.  Because those dollars where representations of gold.  They knew that if there was a trade inbalance the US would ship gold to balance it.  Say one year france exports $100 dollars in wine to the US and the US exports $100 US dollars in exhange for it.  France (if push came to shove) could ask for those $100 US dollars be redeemed for gold in the US treasury, and all was good.....for awhile.


In the early 1970's other countries started noticing that the US was printing off whole of of US dollars and had some trade inbalances.  A group of them led by France under DeGaul said, "We we have a bunch of US dollars from your trade inbalances with us.  We want to exchange them for gold.".  Nixon decided that the US didn't really need gold to back the dollar and by executive order, switch the US dollar to a fiat currency system.  US imports where increasing compared to exports, the costs for Vietnam were huge, and LBJ's socialist programs as well.  Most of the world followed suit and started using the US dollar to back thier currency.  And why not?  If you weren't going to use gold, the US economy seemed like a good bet.  Massive economy and production, pretty damn stable decomocracy.  The the US government and econimists lobbying for it helps with the decission as well.  So most of the world sans commies, switch over the the US dollar as the backing for their currencies.  This idea becomes so pervasive that the US dollar starts being called "Hard Currency".  How crazy is that?!  You and I know that hard currency is gold.

Next, the effects of the US dollar being accepted as the world's reserve (or backing) currency.

[Maverick]

Thrawn,

I assume you are taking a basic economics course at this time. If not, then you really do need to take one as this concept you are posting about is explained in a class of that type.

There are a couple things here.

ALL applications of value are subjective. It doesn't matter a whit if the value is assigned to a cow, a chicken, a lump of gold, platinum, silver or manure. It all depends on what you are willing to exchange for that item. Barter is a basic means of exchange of items considered "wealth" or things of "worth". It is still barter if you exchange a cow for a lawn mower or $100.00 for the mower. The use of any kind of fiat (gold is fiat as well) for a piece of goods simply makes the system easier to use, stable and consistent. Rather than the inventory of cows as in your example.

Now you can continue to worry about it and lose sleep or you can simply accept that almost the entire world has accepted the concept of fiat (of any type) and deal with it. As I said before, value is subjetive and or situational. To a man dying of thirst a gallon of water has incredible value. To a man with a viable well it has virtually none.

[Thrawn]

Let's go back to our rancher.  Say instead of finding just a chest of gold, he finds a magical endless chest of gold.  I get the feeling that he isn't going to be ranching for much longer.  Ranching takes time, work and investment.  He can buy want he wants with his gold.  Now, the community still wants cows as the supply of cows goes down it becomes a good investment for someone else to start producing them.  As the years go by and the rancher is buying stuff with gold, people are probably going to get tired of it.  They are all sitting on heaps of gold, and that gold isn't doing them much good.  The gold is decreasing in value.  They might decide to say, "Screw the gold, let's start using something else.".

In which case the rancher has a problem.  Someone else is already producing cows, he's out of practice, his ranching infrastructure is going as well.  The rancher has some hard times ahead.



The US got it's "endless chest of gold" in 1971.  Look, at the trade balance from then on.

http://www.census.gov/foreign-trade/statistics/historical/gands.txt

It's been printing US dollars in massive amounts and it's only increasing.  The US government, due to massive spending.  Pays interest on the dollars it's that are printed, to China and Japan.  For this they need to print more dollars.  The US government also sells debt to the Federal Reserve, which in turn prints off even more money.  So we have an absolutely increadible amount of currency expansion.



Some people have said that the US defaulting on it's obligations can't happen.  But it already has, in the 1930's and again in 1971.  


Other's say that, for example, it's bad for China if the US doesn't buy thier stuff.  I'll use an anaolgy to explain why I think it's wrong.

You have a tech support company called...Chinatech.  They have several clients, one of thier major clients is named Uncle Sam.  They allocate a techmonkey to handle Sam's calls.  Now Sam has been paying for the service in IOUs.  Chinatech pays it's employees in cash, not in IOUs.  If Chinatech tells the employees to take the day off and not service Sam's calls, yet still pays the employees.  How does that hurt Chinatech or the employees?  It doesn't.  But Sam is out those services.  

What if Chinatech tried to buy something off Sam with the IOUs and Sam told China to piss off?  Would Chinatech be will more or less will to accept IOUs from Sam?  

What if other companies started accepting less and less of Sam's IOUs, would thier value go up or down?

What if Sam kept giving out ever increasing amounts of IOUs?


These things are happening.  China couldn't buy Unical, serveral countries are diversifying their reserve currencies.  The US trade deficit, and government deficit spiral upwards.  US dollars are printed with abandon.  Personal debt increases as people invest what is in effect money from currency expansion into the housing boom.  All this is reminicent of the the precursors to the Great Depression.  But in my opinion many times worse.

Gold has increased in value by 60% in the past three years, the US dollar has fallen by 30% in the last 6.  Central Banks of various nations are diversifying from the US dollar.  I don't think that other citizens of the rancher's community are going to using "gold" for much longer.

[Thrawn]

Originally posted by Maverick
ALL applications of value are subjective. It doesn't matter a whit if the value is assigned to a cow, a chicken, a lump of gold, platinum, silver or manure. It all depends on what you are willing to exchange for that item.

I know, did I say differently?

Barter is a basic means of exchange of items considered "wealth" or things of "worth". It is still barter if you exchange a cow for a lawn mower or $100.00 for the mower. The use of any kind of fiat (gold is fiat as well) for a piece of goods simply makes the system easier to use, stable and consistent. Rather than the inventory of cows as in your example.

You are using the terms, "barter" and "fiat" with a completely different meaning than I understand them.

Here are some definitions.

Barter

"Definition: A barter economy is an economy that lacks a commonly accepted currency, so all exchanges must be made with goods and services because money does not exist in these economies."

Fiat

"Definition: Fiat money is money that is intrinsically useless; is used only as a medium of exchange."


Although, gold has little inherent value you can still use it to make stuff.  At least more stuff than a small piece of paper with a picture of dead person on it.  What's more because of gold's relative scarcity it's alot more difficult to expand it, especially compared to paper money (or electronic money).  And history has shown this.  For example....

Now you can continue to worry about it and lose sleep or you can simply accept that almost the entire world has accepted the concept of fiat (of any type) and deal with it.

Well sure, I hope to protect myself and my family from it's inevitable inflationary effects as well.

As I said before, value is subjetive and or situational. To a man dying of thirst a gallon of water has incredible value. To a man with a viable well it has virtually none.

Again, I'm not sure where I said differently.  But if I have implied that I believe differently I apologise.

[Staga]

When a guy writes "in next post" it's usually a sign that he's going to continue his post and I find it hilarious some have to drop their opinions between the posts.

Anyways would be nice to hear Miko's view; IIRC he was working as analyst or something ?

[Thrawn]

miko posts over at agw.bombs-away.net

[Maverick]

Frankly from what I saw of miko's posts before he left, Thrawn is providing a reasonable immitation. It's much ado about nothing given that the entire worlds economy is based on fiat.

As to the value of a piece of paper vs gold, it's a wash. If you bring in a lump of gold you exchange it. It gets exchanged for paper money or even for less, a representation of paper money ie. a check. Try to buy a weeks groceries with a gold nugget and see what happens.

Like I said before, if you want to fuss about whether the economy has too much cash or not is up to you. There is no viable alternative in the economy at this time. I suppose you could join some of the other folks living "off of the grid" and live in a cabin in the woods without contact with the economy. I wouldn't recomend it but you'd be free of any effects of dependance on paper money.

[Gunslinger]

You have a tech support company called...Chinatech. They have several clients, one of thier major clients is named Uncle Sam. They allocate a techmonkey to handle Sam's calls. Now Sam has been paying for the service in IOUs. Chinatech pays it's employees in cash, not in IOUs. If Chinatech tells the employees to take the day off and not service Sam's calls, yet still pays the employees. How does that hurt Chinatech or the employees? It doesn't. But Sam is out those services.

The only thing I have to add is that in this scenerio you are referring to a "service" and not a "good".  IIRC from basic economics goods and services are completly different.  The argument that China needs us as consumers holds just as much water as the fact that we need them (among other countrys) as manufacturers.

WIthout sale of good to the US the chinese (and probably asian markets) could collapse as much as the Americans.

[Dago]

Originally posted by Thrawn
miko posts over at agw.bombs-away.net

yup, I recognized mikos cut and paste when I saw you sticking it here.

Miko was banned from this board, lets leave his nonsense off the board.

[Thrawn]

Originally posted by Maverick
Try to buy a weeks groceries with a gold nugget and see what happens.

What do you think people use during periods of hyperinflation?  

There is no viable alternative in the economy at this time. I suppose you could join some of the other folks living "off of the grid" and live in a cabin in the woods without contact with the economy. I wouldn't recomend it but you'd be free of any effects of dependance on paper money.

I think that there is viable alternatives.  But I don't think that's an issue as I don't think things will change until after a massive market correction.  But I hope I can either be refutted or if not refutted people might take notice and do what they can to protect themselves and thier families from the effects of the correction.

Originally posted by Gunslinger
goods and services are completly different.

But both have value.  Both require investment to produce.  They are effect by supply and demand.  Goods are tangible but that doesn't really effect the analogy.  Chinatech is still producing something that same has a demand for, and getting paid in IOUS for it.

WIthout sale of good to the US the chinese (and probably asian markets) could collapse as much as the Americans.

Why?



PS: Dago,

"Miko was banned from this board, lets leave his nonsense off the board."

How about I'll post what I want as long as HTC doesn't object, and you feel free to ignore it.  If what I posted here is such nonsense, it should be a simple matter for you to refute it, and I gladly welcome you to do so.

[Gunslinger]

Originally posted by Thrawn
What do you think people use during periods of hyperinflation?  


 

I think that there is viable alternatives.  But I don't think that's an issue as I don't think things will change until after a massive market correction.  But I hope I can either be refutted or if not refutted people might take notice and do what they can to protect themselves and thier families from the effects of the correction.




But both have value.  Both require investment to produce.  They are effect by supply and demand.  Goods are tangible but that doesn't really effect the analogy.  Chinatech is still producing something that same has a demand for, and getting paid in IOUS for it.




Why?



PS: Dago,

"Miko was banned from this board, lets leave his nonsense off the board."

How about I'll post what I want as long as HTC doesn't object, and you feel free to ignore it.  If what I posted here is such nonsense, it should be a simple matter for you to refute it, and I gladly welcome you to do so.

well just to answer your question directy do me......If china all of a sudden found they had no way of selling their goods to the US they would develop supply of said goods with very few customers.  Anyone know's that a business that has too much product on hand that they can't sell is a liability.  Their stock loses value, investors lose money, markets reflect.

Here's an examply, for a very short time I worked in the silicon business as an R&D Tech.  The company I worked for was having problems because of the asian market crisis, in fact most business in this sector were having major problems.  Asian companys ordered all sorts of fab equipment right before their market went bust.  When that happened they found they had to cancel the orders and now my company was stuck with all this equipment that they spent all this money on developing and manufacture and now had no way to sell them, and no profit/income to show for their effort.  In a matter of weeks the stock lost 30% of it's value and I lost my job.  Supply and demand, it works both ways.

[lasersailor184]

Most of what Thrawn has been saying is pretty much right.

The two points he is missing majorly on are Supply and Demand, and Power.

Everything is driven by supply and demand, even your Fiat currency system.  Hence we have inflation and hence an egg isn't literally worth the exact amount of change as it was 40 years ago.

However, this is nothing to freak out about.  The only way you really lose money is by either keeping it in a stationary (no interest) savings account, or hiding it under your mattress in your house.  Pretty much any standard Savings / Bank Account will accrue you more interest then you lose VIA inflation.  

I.E. If Inflation is 5%, you should have your money in a 7% savings account.


The next point is Power.

Almost every single large country out there does not have a commodity as the backing of their money.  It's almost impossible to do.  There doesn't exist 100's of trillions of dollars worth of gold in the world, or silver, or platinum.  

The real power of the money comes from the power of the country.  I.E. Military and World power.

As of right now, the countries with the most power are China, Canada, US and Possibly Britain, though that is debatable.

The real problem are countries that do not have any military backing to their Power.  I.E. Most of Europe.  Right now, most of europe is weak.  The moment they are challenged militarily, they will be beaten.  And as such the worth of their money will drop like a rock.

So they try to form the EU.  This seems like a good idea, but the problem is that it is filled with European Countries.  The banding together of all those countries still does not overcome their power deficiencies.  And yet again, the moment the EU is challenged, the EURO will drop like a rock.

Case and Point is USSR / Russia.  The moment the USSR collapsed, the Rubel(might be off) collapsed with it.