Money serves as a medium of
exchange and store of value. Price provides an important clearing mechanism
in a society. Here we are going to explore the interesting dynamics between
money and price.
In a free market, when the
quantity of money is fixed, the fact that the price of an apple is $1 and
that of a Parker pen is $2 has tremendous implications. It takes knowledge,
ingredients and time to grow an apple while it involves branding, material, and
capital to produce a Parker pen. What the market says here is that the total
efforts put into producing the pen are worth twice as much as the efforts of
growing the apple. There are thousands of valuations communicated through the
market by this simple exchange. Over time, with advances in technology, it
takes fewer efforts to produce more goods. The same farm that used to grow
10,000 apples can now grow 20,000 in half the time. While the ratio of
exchange between apples and pens might still be 2 to 1, since it also takes
less to produce a pen, in a world where the quantity of money is fixed the
price of both apples and pens should decrease (i.e. 80 cents for an apple,
and $1.60 for a pen).
The decrease in the price
level of goods represents an economic advance and an increase in the value of
money. As the human race progresses and wealth is being accumulated,
shouldn't people be able to buy more with less money? Shouldn't people be
rewarded for their savings over time with increased purchasing power of their
money? Obviously, the exact opposite is taking place in this world. What's
going on?
A picture is worth a thousand
words and the chart above is no different. There is 1,500% more paper money
today than there was in 1970.
Oil
Price Since 1960
Hey, where did all this
money come from? Doesn't more money mean more economic progress?
The huge increase in the paper
money supply is from borrowing at all levels from consumers, corporations,
and government. Every dollar borrowed is a dollar created out of thin air by
the banks. The process is legitimized by "the fractional reserve
system", as the bank literally prints dollars in its computer and writes
a check to you upon your loan approval.
To answer the second part of
the question - there is no positive correlation between the money supply
growth and real economic growth. As we explained, the world can function and
advance with a fixed money stock.
What's wrong with more
money? It stimulates consumer spending, creates more interest-income for
savings and promotes higher housing and stock prices. More of everything is a
good thing!
To that argument, I say: What
if the Fed through its ingenuity and generosity, doubles everyone's savings
account balance? Does that create progress? By the same token, to combat
price increases, did Venezuela fix anything fundamentally by issuing a new
currency, "Strong Bolivar", that essentially chops a zero off the
old Bolivar? Here are 4 more points to consider:
1. Fairness - Arbitrarily,
some are allowed to borrow more than others. Does it make sense for a
government to have unlimited borrowing power while it hardly produces
anything? And what is so special about a banker in that he can lend to
whomever, for however much he wants, with the money that's not even his?
2. Price Distortion - Since
new money is not distributed evenly, the prices of various goods and services
increase in a cascading fashion, depending on who gets the money first (like
a ripple effect). Think of a lottery winner. He is likely to outbid others
for the things he wants, thus causing prices of his desired items to go up
first. Let us be clear: The random introduction of new money impairs the role
of price as a proper clearing mechanism.
3. Bad store of value - With
online banking and credit cards, today's money is a great medium of exchange.
However, the ever-increasing quantity of paper money makes it a terrible
store of value. Remember: Every time someone borrows, new money is brought
into existence, diluting the money you and I have meticulously accumulated.
Should a retiree rely on the risky stock market to retain his wealth?
4. Moral Hazards - How is it
fair that bankers can borrow billions of dollars to spend and invest? And
when banks and companies become too indebted but are too big to fail, they
are bailed out. How does that serve as an incentive for those who make cars,
sew clothes, and plant trees to save?
When unfairness, price
distortion, corruption, and loss of true wealth reach the extreme, the result
is a loss of confidence in the paper-money system.
I quote John Keynes from 1919:
"There is no
subtler, no surer means of overturning the existing basis of society than to
debauch the currency. The process engages all the hidden forces of economic
law on the side of destruction, and does it in a manner which not one man in
a million is able to diagnose."
Paul Volker was right when he
said in 2000:
"Inflation is
related to monetary policy. It's related to the issue of money. The issue of
money is a governmental responsibility predominantly, and to use that
authority in a way that leads to inflation is a system that fools a lot of
people, and to keep fooling them you have to do it more and more; [that] is a
moral issue. I put myself in that camp."
And Bill Gates said at Davos
world economic forum in January 2005:
"I'm short the
dollar. The ol' dollar, it's gonna go down.
We're in uncharted
territory when the world's reserve currency has so much outstanding debt. It
is a bit scary."
How do you short the dollar?
With ECB printing Euros no slower than the Fed printing dollars, it's clear
that gold is the only refuge of savings. Gold has raced from $428 to $850
today since Bill spoke in 2005. Is it too late to join gold? The right price
for gold today is a long topic that's best be left for another day. However,
judging by how oil rocketed from $10 to $100 within the past decade, gold has
not nearly reached its potential. We manage a gold fund and have written much
about gold and currencies at www.goldmau.com.
I invite you to read up.
