|
|
Our 6th June commentary included a short
piece titled "What backs today's money?", in which we attempted to
explain that money is not "backed" by anything and nor does it need
to be. Money is what it is -- the most commonly used medium of exchange
within an economy. This piece was subsequently posted as a standalone article
at a few web sites and generated an unusually large amount of feedback
(questions, comments and objections). Today we'll address the three most
common objections.
Based on the emails we received, the most controversial part of our article
related to "intrinsic value". Considering that some popular gold
market analysts and newsletter writers routinely assert that "intrinsic
value" is the most important difference between gold and the dollar, we
aren't surprised that many gold bulls reflexively rejected our statement that
gold, like the dollar, has no intrinsic value. Our point was simply that all
value is subjective. To explain what we meant we said that gold would have no
or very little value to someone stranded alone on a desert island, but would
likely have a lot of value to someone living in a modern inflation-prone
economy.
A common view is that gold has "intrinsic value" because it costs a
lot, in terms of materials and labour, to extract
gold from the ground and turn it into a readily tradable form, but it is
important to understand that something could be costly to produce and yet
have little or no value to most people. Again, value is subjective and will
often vary depending on personal circumstance.
That the production of gold requires the expenditure of a significant amount
of resources is very important, but not because it creates "intrinsic
value". It is important because it places a severe physical restriction
on the rate of increase in the total supply of gold. In fact, in terms of suitability
to perform the role of money, gold's greatest advantage over the US dollar
and all the other fiat currencies of the world is the stability of its supply
(the total aboveground supply of gold increases at 1.5%-2.0% per year, every
year). This relates to the inability of anyone to create gold out of nothing.
Looking at it from a different angle, the main problem with today's official
money is that banks and governments have the power to create it out of
nothing. If you believe that these institutions have not abused this power in
the past then there is a large gap in your knowledge of economics history,
and if you believe that these institutions will not abuse this power in the
future then you are extremely naive.
By the way, the critics of using gold as money often cite the inflexibility
of gold supply as a major negative. When they make such a claim they are
either being disingenuous or displaying ignorance of the fact that
flexibility of supply is most definitely NOT a desirable characteristic of
money. Flexibility of money supply benefits the government and the banking
industry, but because it distorts price signals it hurts the generators of
real wealth.
Moving along to the next objection, some readers argued that the US dollar is
backed by the US military. Our response is that if the US military
"backs" the US dollar, then what backs all the other fiat
currencies? Also, if the US dollar somehow garners support from the US's
global military advantage, then why has the Dollar Index lost about 50% of
its value over the past 26 years? After all, the US military has never before
been as dominant as it is today.
Rather than providing any backing for or adding any value to the dollar, the
US military is actually an important fundamental NEGATIVE for the US$. The reason
is that the expense of maintaining a massive military leads to greater dollar
supply and does nothing for dollar demand (private demand for the dollar is
primarily determined by expected real return, and foreign-government demand
for the dollar is primarily determined by exchange-rate policy).
Lastly, our view that money is backed by nothing was countered by the claim
that a national currency is backed by the associated government's ability to
tax. The reality is that the ability to tax is what backs government debt and
why buying government debt is ethically unsound. As succinctly put by Murray Rothbard, "the purchase of a government bond is
simply making an investment in the future loot from the robbery of
taxation." The ability to tax doesn't, however, "back" the
money in which a government's debt is denominated. Instead, taxation is part
of the demand side of the money supply-demand equation, which means that
although it doesn't "back" the money it does have some effect on
the purchasing power of the money.
Steve Saville
www.speculative-investor.com
|
|
