Economics for Dummies

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I don’t want to deceive you: I am not going to present a sort of Economics 101 for the benefit of the economically illiterate. In fact, I am myself among that number, never having studied economics. What I am suggesting is that, in the current financial crisis, economics is, in my opinion, somewhat irrelevant. It may be dumb to think that there is an economic solution to our problems.
 
My dictionary says that economics is a social science (sic!) dealing with the production and distribution of goods and services. That definition, however, is based upon one colossal assumption: that there is a medium of exchange! A sort of starting point for economics is the belief that exchanges are possible on an equitable basis. Maybe that’s taking too much for granted.
 
As a starting point, therefore, it will be helpful to consider the subject of money, the existence of which is taken for granted by economists. That the nature of the “money” is important doesn’t seem to occur to them. For example, I recently read an article about California’s financial plight in which the author related, as an example of the state’s pitiful condition, the attempt by the state to pay its bills with IOUs instead of cash. But surely “cash” is simply an IOU, except that unlike your IOUs or mine, those of the government are never intended to be paid, but to circulate IN LIEU of money. No one would work--i.e., give a portion of his life--to get pieces of paper, all of the same size, quality, and weight, although some of them are, for example, 100 times more “valuable” than others! The only “value” of these paper devices is that, having traded your work for them, you can tender them--pass them--in lieu of payment for the goods and services you want. You could say, therefore, that they have an economic value, but no intrinsic value. For most people, this is good enough. I’ve been told on many occasions, “Hey, as long as I can get something for them, I don’t care about anything else.” That attitude has brought us to our present perilous condition. The counterfeiter operates on exactly the same premise: his output can be used to “get something,” and in that respect is every bit as good as the official “money,” except that the government, supporting the bank’s monopoly on money creation, declares it legal to tender its scrip, and a crime to tender that of the competition.
 
What if someone doesn’t want to “get something” for the pieces of paper? What if he wants to set them aside for future use? It may be that they are intended for the children’s education, decades in the future, or retirement, or as an eventual down payment on a home. Does the nature of the money matter in that case?
 
Suppose that the dollar was defined as 373.25 grains of pure silver. There would be, therefore, no such thing as paper “money,” because money was silver, and the dollar was 373.25 grains of it. True, there would be convenient paper claim-checks for the money, but those would only be acceptable in trade if the recipient knew that he could take the bills to the bank and obtain the actual money. This factor of redemption, especially if frequently used, would restrain the issuance of bills, less the issuer, having issued bills in excess of his ability to redeem them, be found out, and charged with the appropriate crime.
 
In such a situation, the supply of money would remain relatively constant, or very slow growing, because silver is not easily obtained. Much of it is a byproduct of other mining operations. As the supply of goods and services increased, probably faster than the supply of new silver, the general level of prices would fall, and conversely, the buying power of savings would increase. In the present situation, the supply of “money” is increasing faster than the supply of goods and services, and the result is constantly rising prices, which, unfortunately, are often interpreted as the result of greed on the part of businessmen and manufacturers. That, in turn, is possible because no one seems to care about the nature of the money.
 
Clearly, however, the organization--modern banking--which can counterfeit with government approval, can obtain everything for nothing, since the “cost” of creating the money, including the labor required, is paid for with the money itself. In return for the privilege of counterfeiting with impunity, the banks lend to the government with no thought of repayment, although the interest must be paid, thus perpetuating the debt, and the corresponding interest payments. A sweet deal for both parties: the banks collect interest forever, and the government can finance its unconstitutional programs, including that ever popular program, war.
 
Another advantage of solid, tangible money is that, if pursuant to some contract, you are guaranteed payment of a number of dollars over several years, you would know with exactitude what you are going to receive. Presently, however, you will receive only numbers on paper, labeled “dollars,” although there is no definition of that term, and, in the absence of any definition, you cannot complain if the “dollars” you receive in the future will purchase far less than at the time you contracted to receive them. You cannot complain, in other words, that the “dollars” you receive in are not the same as the “dollars” at the time the contract was signed, because “dollar” is a term without specific meaning or definition.
 
As a final injustice, consider how much greater the proportion of your income seized as tax is if the income is 100,000 compared with 50,000, even if the larger number will buy less than the smaller number bought only a few years ago. In other words, a higher tax upon an income with the same, or less, buying power. This is the tax system our rulers invariably refer to as “fair!”
 
But if there is no concern about the nature of the money, there can be no complaints!
 

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Paul Hein's picture
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Tom Terrific's picture

My dictionary says that economics is a social science (sic!) dealing with the production and distribution of goods and services. That definition, however, is based upon one colossal assumption: that there is a medium of exchange!

I am not an economist, either. I did take two entry-level semesters of Economics many years ago, but I'd be an idiot to think that entitled me to pontificate on the subject. I do remember how the teacher defined the subject, though, on the first day of class: the study of how a community's limited resources are allocated in light of man's unlimited appetite. So defined, Economics does not require an intermediate medium of exchange, whether it be paper scrip or precious metal.

Why is currency based on gold regarded as superior? Only because everybody wants it and is therefore willing to trade anything for it. Change that fact, and suddenly gold-based currency is no longer as attractive as it used to be. What if you had all your wealth invested in gold, and then the cold fusion breakthrough occurs. Now it's cheap to turn lead into gold; we can churn out gold by the hundredweight for pennies. What happens to your wealth?

Currency can be based on anything that has value to enough people: horses, wives, Matchbox cars, stones with holes in them -- anything, so long as enough people, for whatever reason, will assign value thereto. It stands to reason, therefore, that if a government says, "This note is legal tender," and the people accept the fiat, it's as much currency as if based on gold.

I suspect the real difference is that proponents of gold-based currency are thinking that it's a lot easier to manipulate the money supply when the money isn't based on a tangible commodity than when it is based on gold; and that is probably true. But that doesn't mean that the former isn't valid. It just means its value isn't as secure.

I've always wondered how an economy with a gold-based currency can grow when it isn't able to acquire more gold. Isn't that a recipe for inflation? or would it be deflation?

Scott Friday's picture

The economy can grow without the supply of the medium of exchange increasing. What happens is that each unit of the medium of exchange will become more valuable with respect to other goods as there are more goods available. This means that prices of those goods will generally decrease (price deflation), which is what we want. This is what makes it possible for those on the low end of the economic spectrum to enjoy a higher standard of living. It makes their money go further by allowing them to buy more. Also, when the medium of exchange tends to rise in value over time, saving instead of spending is made possible. In a system where the supply of the medium of exchange is increased, the value of that medium tends to decrease over time with respect to other goods. Thus you get higher prices (again, price inflation that results from inflation of the supply of money). In this environment, saving means you lose value over time and thus the incentive it to spend the money now before it loses value. It also tends to make people take more risks with investing in their attempts to get a return on their money that outpaces the rate of inflation. In a stable monetary system, saving by stuffing your mattress is relatively safe. Barring theft or accidental destruction, it will increase in value or at worst hold steady. In an inflationary monetary system, stuffing your mattress is a losing proposition and we have seen that investing in stocks and other financials is anything BUT safe in recent years.

The supply of gold does increase every year. However, the new supply is quite small relative to the total existing supply and thus the increase is very small and tends not to experience sudden increases. Even many of the "big" gold rushes only had an effect in the area immediately around the sources of the gold. As you get out away from the source, the inflationary impact on prices lessens. However, if a large enough new supply were found and rapidly injected into the market, it would cause prices to react accordingly and they would likely go up, at least for a time.

Scott Friday's picture

Nice article!

For the interested reader, Murray Rothbard has several great writings about money. The following are listed in order of how long they are, shortest to longest. All of them are really good. The last one is his great treatise on economics in general and absolutely rocks!

The Case for a 100 Percent Gold Dollar
http://mises.org/daily/1829

What Has Government Done to Our Money?
http://mises.org/books/whathasgovernmentdone.pdf

The Case Against the Fed
http://mises.org/books/fed.pdf

The Mystery of Banking
http://mises.org/mysteryofbanking/mysteryofbanking.pdf

History of Money and Banking in the United States: The Colonial Era to World War II
http://mises.org/books/historyofmoney.pdf

Man, Economy, and State, with Power and Market
http://mises.org/rothbard/mes.asp