Monday, October 24, 2011

On Money....Economics 101

Something I've noticed recently, even among Ron Paul supporters like myself, is that people seem to have forgotten that ALL money, whether gold, paper, electronic, or moon dust, is fiat.

There is no such thing as "intrinsic value".

(To those reading this who already know how money basically works, feel free to skip down a bit.  The important bits that this explanation supports are marked below.)

Let's examine this from a purely economic perspective first. "Value" is entirely subjective. One can only speak of the value of one quantity of a thing in terms of a certain quantity of another thing.

In a barter system, you have individuals delivering goods and/or services (hereinafter, simply: "resources") in trade for other resources. The "value" of each resource is determined by the parties engaged in the transaction, and can only be understood, therefore, in terms of the other resource.

For example, Ghassan the shepherd and Sharif the carpenter each have a need. Sharif needs a few sheep to feed his family, and Ghassan needs a shelter for his sheep. So Ghassan and Sharif get together and talk about this, and come to an agreement: Sharif will build one 100 cubit square shelter for Ghassan's sheep in exchange for ten of those sheep. What is one shelter worth? What are 10 sheep worth? In this transaction: 10 sheep and one shelter, respectively. We cannot speak of actual value of the sheep without reference to the shelter, and vice versa.

But perhaps Sharif does not need sheep. Perhaps he has done this same transaction with all the shepherds in the area, and actually would be happy if he never saw another sheep in his life.

So a direct transaction is not going to happen. Ghassan still needs the shelter, though. He knows that while Sharif does not need sheep, he does need shoes, and the Al-Rabi the cobbler happens to need sheep. So Ghassan, Sharif, and Al-Rabi get together and discuss it for a while, and come to the conclusion that Ghassan will give Al-Rabi six sheep, Al-Rabi will make two pair of shoes for Sharif, and Sharif will build the one shelter that Ghassan needs.

What is the actual value of each item? the shoes are worth either 1/2 a shelter or 3 sheep per pair. The shelter is worth either 2 pair of shoes or 6 sheep. The sheep are worth 1/6 of a shelter or 1/3 a pair of shoes.

As you can see, the value of a sheep has risen in terms of shelters. (from 1/10 to 1/6) We'll come back to this when we discuss supply and demand later.

Now, though, let's focus on the complexity of this transaction. In a barter society, every transaction is like this one, and requires a lot of work to complete. Also, the transaction cannot be completed if Al-Rabi has taken a long journey, since it is his shoes and his need for sheep that allows Ghassan and Sharif to meet each others' needs.

So off goes Al-Rabi to Agorabad. But Ghassan needs that shelter right now! He can't wait until Al-Rabi returns: his sheep might die! So he strikes a deal with Sharif: I know you don't need sheep. But Al-Rabi will when he returns, and you will need his shoes. I will give you right now the sheep he will need then, if you will build me a shelter right now. You can use the sheep later to get what you need.

Ghassan and Sharif have just invented currency, although very primitive, and although it is based on real goods, it is still "fiat". Each sheep's value is set at the time of the transaction. What makes this currency and not simple bartering is that Al-Rabi, who Sharif is expecting to use the currency with later to procure shoes, had absolutely nothing to do with the transaction. Whether the value of the sheep remains stable depends entirely upon how closely the number of sheep Al-Rabi actually asks for in return for the shoes matches the originally expected number.

Well, time goes on, and eventually enough of these kind of transactions occur that people who are not Shepherds are raising a bunch of sheep they don't want. It's getting sort of cumbersome to maintain and transport the currency. So they all get together and decide to use something a lot easier to carry and care for to represent the sheep. They decide to use little wooden sticks: one per sheep. They even begin calling these "sheep", even though they are not actually sheep.

Of course, the little wooden sticks are "fiat" in the universally understood sense of the word. No one in his right mind would trade a little wooden stick for a sheep. But when the little wooden stick is bound by a promise that it can be traded for one sheep...that's important. It is backed by the "full faith and credit" of the sheep owner -- or whoever has the martial ability to take his sheep from him regardless.

-----IMPORTANT BITS-----

This is the foundation of money: trust, and consequences for breaking it.

I repeat: ALL MONEY IS FIAT. There is no such thing as intrinsic value.

(If you disagree, and you got here by skipping the "basic stuff" above, go back and read it.  You're back?  OK.  If you still disagree...let me know in the comments.)

So let's fast-forward to the modern dispute over the gold standard. Gold bugs will typically say, "But Gold has intrinsic value! It cannot lose its value like paper (or electronic bits) can!" Remember: there is no intrinsic value. Gold is useless to all but the goldsmiths (and nowadays, the electronics industry).   So for everyone else, gold's "intrinsic value" is still based on the the trust that whoever needs to be paid will actually accept it as payment.

If we ever have a society where goldsmiths and electronics are not needed (post-apocalyptic survival scenario, for example), it won't have any value at all, except whatever people want to assign it for use as currency (fiat again, and very meta).

Now before my fellow Libertarians lynch me as being anti-gold (I'm not), let me qualify:  There is an "intrinsic value" of sorts to gold and other precious metals.

This value lies in the statistical likelihood that any particular party will place their full faith in the future usability of the metal as currency.  Actually, that's not quite right.  It rather lies in the individual's understanding of that statistical likelihood.  In other words, whatever "intrinsic value" gold has, it has because the people using it calculate that there is a high statistical likelihood that the other party will also value it (for whatever reason).

In fact, this statistical likelihood is what all value is, let alone "intrinsic" value.  (See above.)  The reason government "fiat" money has value is because the force of arms raises the calculated statistical likelihood (and therefore the recognized value) of it's acceptance, as long as the people trust that a) the government can and will in fact use force of arms, and b) said use of arms will be effective.

I think by now it should be obvious that the argument over whether paper money is better or worse than gold money lies in the difference of who enforces the fiat: the government's use of arms, or the circumstances of the moment (the free market).  :)

In the case of paper money, it's the government issuing the fiat, and enforcing it with the power of the sword.  In the case of gold, it's still the government issuing a fiat, and enforcing it with the power of the sword.  (See US Constitution, Article I, Section 10, cf. Section 8).

The difference is this: even if the government fell apart entirely, it is most likely that people would still continue to value gold.  It is this valuation that is referred to as "intrinsic value".

The argument put forth by the "gold bugs" (myself included) is that the difference between the people's continued valuation and the government's fiat-ed valuation would be significantly smaller, and therefore less damaging to the economy for a plethora of reasons.

One of those reasons is that it's really difficult for the government to just "print" more gold coins, gold being scarce like it is.

While this is true, we must remember that the government could still inflate or deflate the currency another way: by exercising the Constitutional power to fix the value by fiat.

To do so, however, requires openness and explicit action, with a direct, obvious-to-all consequence; as opposed to a second- or third-hand effect that is easily obfuscated, and the primary actions of which are passed off to a third party to carry out (e.g. the Fed), so that the People remain ignorant of what's really going on.

And so (finally) we reach the true point: the argument for the gold standard is not, and should not be framed as, an argument for the inherent good of some material or another, as though that material will magically fix everything.

The argument is, rather, an argument for direct, open government.  (If we are going to have government setting the value of the currency at all, that is.)

Gold and silver are the (constitutional) means for carrying this end into effect.  They are not the end themselves.

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