11. Money—What is it?

SINCE ALL OF THE propositions at that eventful dinner relate to money, let’s look at what money really is. Today, governments monopolize money, but this was not always the case. Money emerged as a medium of exchange to facilitate the trading of goods when the division of labor replaced self-sufficiency and bartering became impractical because of the increasing variety of available goods and services. Various forms of money evolved that sellers were willing to accept in lieu of someone else’s goods or services. Some of those early forms of money were seashells, tobacco, salt, spices, and metals.

In a society without money, each producer would have to find a complementary producer with whom to exchange goods and services directly. With money as an intermediary, a producer needs only to find someone who wants his goods or services. The time devoted to searching for a person with a coincidence of wants in a barter market can now, with money, be devoted instead to the production of more goods and services.

To illustrate the utility of money, let’s say John produces eggs, and Bob produces wheat. If John wants wheat from Bob, but Bob doesn’t want John’s eggs, John could give Bob a facilitator—for instance, nails—for his wheat. Bob, in turn, could trade the nails for milk if the dairyman doesn’t want his wheat. The dairyman could then use nails to obtain eggs from John. The ability to trade indirectly using money provides each person the opportunity to get his preferred choice. In this case, John gets his wheat, Bob gets his milk, and the dairyman gets his eggs.

In a volitional exchange, each party values what is received more than what is given up. In other words, when Bob accepts nails for his wheat, he is valuing that quantity of nails greater than the quantity of wheat that he gives John. Conversely, John places greater value on the quantity of wheat than on the quantity of nails.

In a similar scenario, John could give Bob an IOU for a specific quantity of eggs instead of giving Bob nails. As before, Bob doesn’t want eggs, but he accepts John’s IOU in exchange for the wheat because he knows that the quantity of eggs the IOU represents has value to others. Bob then uses John’s IOU in exchange for milk from the dairyman. The IOU can continue to be used in further exchanges until someone redeems it, simply by going to John and getting the eggs, at which time the IOU is voided.

The willingness to accept John’s IOU depends on John’s reputation. The more reputable John is, the more readily his IOUs will be accepted. If John defaults on his IOU, his reputation will suffer, and, as a result, he may be relegated to trading his eggs only by direct barter with someone who can actually use the eggs. Let’s say John always honors his IOUs, so that everyone who requests redemption gets a full quantity of eggs. In time, John’s IOUs become so popular that only a few ever cash them in for actual eggs. At this point, John may be tempted to write more IOUs than the quantity of eggs he is capable of producing to meet all the outstanding IOUs. John does so, and finds that he can write about four times as many IOUs as he possesses in eggs at any given time.

The system appears to work well, since everyone who wants to redeem IOUs gets eggs. John is living a more prosperous lifestyle—actually a lifestyle about four times better than before, since he has garnered four times the goods from others than he was able to get before. Since John is enjoying life to a greater extent than his productive contribution to the community warrants, the rest of the community must, by deduction, be enjoying life to a lesser extent than the sum of their productive contributions.

As John’s IOUs become more popular as a medium of exchange, fewer people find the need to redeem them. So John increases the ratio of IOUs to his production of eggs until there are literally one-hundred IOUs for every dozen eggs. John is now living a great life of splendor, yet contributes little to the community. The community is not wealthier with all those unredeemed IOUs circulating about, since no one is eating the eggs represented by those IOUs. Even when the members of the community realize that John can’t possibly honor all his IOUs, they continue accepting them in trade for their goods, believing the next person in line will accept them, as well.

Eventually, John drops the use of the word “eggs” on his IOUs to prevent even those few who may want to redeem them for actual eggs from doing so, or to thwart a possible “egg run.” Like other goods, as the number of IOUs in the community increases, their exchange value decreases. Whereas at one time an IOU for a dozen eggs could attain a gallon of milk, now it will only attain a fraction of a cup of that same milk.

Well, by now you may be thinking, “John behaves just like the government.” Not quite. Only if John were to prevent others in the community from competing with him and forcibly require everyone in the community to accept his IOUs in payment of all debts would his actions be equivalent to those of government. In a free market, money like John’s IOUs would encounter more and more competition long before it would reach the inflationary level described above. As confidence in the issuer of an IOU fades, competitors seize upon the opportunity. All the new competitors try to reassure those who accept their IOUs that theirs, unlike John’s, are backed by something real and redeemable.

No government today issues money that is redeemable for anything of value. U.S. dollars were, at one time, IOUs redeemable for gold. But when more and more money was printed with no commensurate addition to the supply of gold, the government was compelled to prevent redemption to avoid a “run” on its gold supply. In 1933, the U.S. government simply declared the ownership of gold by U.S. citizens illegal, in effect, reneging on its earlier promise of redemption. Then, in 1971, the government had to renege on the redemption in gold for the dollars held by foreign entities, as well. Since then, there has been nothing redeemable for a U.S. dollar; it is deemed money by edict, and must be accepted to satisfy any debt.¹⁹

As we’ve seen, one who issues an IOU without the ability to meet its full redemption enjoys the fruits of the labor of others without working and contributing to the welfare of the community. In the above example, John, the issuer of unbacked IOUs, is a free rider, getting a benefit without a cost. Governments are no different. Their issuance of money by edict (fiat) is simply another form of taking, akin to taxes and tariffs.

As governments issue greater quantities of fiat money, the unit value of that money continually falls, harming primarily those with savings and, in particular, the elderly, who have saved their earnings for retirement. The money that they have worked most of their lives to save has depreciated to such an extent that many cannot afford to retire.

Due to inflation’s devastating effect on the elderly, the process of increasing the fiat money supply is the most insidious form of taxation. Absent any inflation of currency, goods in general would fall in price because of new technology and competition, thereby giving one’s savings more purchasing power and making one’s plans for retirement more feasible.

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¹⁹The Continental Congress first authorized the printing of fiat currency to finance the American Revolution. Without gold or silver backing, the continental dollar quickly became worthless. Thus, the expression “not worth a Continental” came into vogue.