Gold, Silver, and Paper. What is Money

To understand the current crisis, it is necessary to understand what money is, how it is created, and how the supply of money affects the prices of goods and services. While I am not an economist, I do play one on the internet, so I thought I would weigh in with my opinions. Historically there have been 3 major, long lasting, goods used as money, gold, silver, and paper. Each has strengths and weaknesses. Gold has been the the standard for many money systems since the days of Babylon, and has the advantage that it can’t be created out of thin air, and can almost always be recovered from whatever use it has been put to and turned back into raw gold. Silver offers many of the advantages of gold, but because it is more common it is less valued, and therefore easier to use for smaller transactions. Paper is the most common of the three types of money I’m going to discuss, and has the advantage of portability, and can be denominated in any amount without using more paper.

Gold has historically been of great value. It’s used both as money and as jewelry, and now has industrial applications, mostly in electronics. Because it can’t just be created it resists inflation quite well, an ounce of gold could buy a high quality suit of clothes for the ancient Roman professional or senator and today, if converted to US Dollars ($1134.40 as of 3/6/2010) will buy a suit of similar quality, style, and value for a person today. Gold, once used, is still gold and can be reclaimed quite easily. The gold in your wedding ring could have been part of a Roman emperors crown, or used by an Egyptian merchant to buy a slave. Heat it up and bang on it with a hammer and you have raw gold, able to be put to any of gold’s other uses. There are disadvantages, in that an ounce of gold isn’t that big, but has a lot of value behind it. This makes small transactions with gold difficult. Buying a typical lunch for yourself  with gold would take 1/100 of an ounce, which is small enough that you’d need tweezers to pick it out of your pockets. This is one reason for the popularity of silver.

Silver is significantly more common than gold, and due to such a greater supply it is valued less. It has the same uses as money, jewelry, and in industry. It also retains the advantage that it can’t be created, thus resisting inflation, and can be reclaimed from past uses, though with somewhat greater difficulty due to it’s higher melt point. Because of its lower value smaller transactions are easier to manage, and can use larger pieces of silver. An ounce of silver, converted to US Dollars ($17.37 as of 3/6/2010) buys that handy dandy kitchen gadget the TV is trying to sell you, or that lunch we needed tweezers for with gold, and you’ll get change from a sizable, manageable round. There are of course transactions for which gold is still too valuable, and silver is too heavy or bulky to be dealt with, and even transactions that silver is too valuable for. This is one of the uses of paper.

Paper money has a long and spotted history. When issued as banknotes with a gold or silver redemption on demand paper is merely used to represent the gold or silver that is actually the money. This makes it possible to trade the tiniest portions of silver or gold without a pair of tweezers and a super accurate scale, or the largest without a tractor-trailer and a forklift. The problem with paper comes in when there is a monopoly backed by government. Without competitors to drive a dishonest printer out of business by demonstrating that the paper is not backed by silver or gold reserves, a monopoly bank has nothing to stop them from creating as many banknotes as they want. This increase in supply reduces the demand for the notes themselves, leading to inflation. This process allows the bank or government to spend the banknotes and get things at the price the held when the notes were created. As the notes get into circulation, people realize there are more notes available and buy more goods. This reduces the supply of goods(whatever they happen to be) and increases demand. This shortage of highly demanded goods causes prices of those goods to rise in response to the immutable laws of supply and demand, which is called inflation. Eventually people realize that the paper is worthless, and begin to dump it as fast as it gets in their hands, trading it for goods before it loses value. This only makes the inflation worse. Soon enough the paper can barely buy anything and you’ll see people using wheelbarrows full of paper to buy a loaf of bread.

While all three of the major types of money covered here have their uses, gold and silver have historically been the most stable, and have generally held their value. Paper, if the government doesn’t get involved, can be a wonderful facilitator of exchange, but inflates badly leading to a crash when the government steps in. What’s in YOUR wallet?

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Published in: on March 6, 2010 at 1:45 pm  Comments (1)  

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