kidmercury

Long, long ago, in the time before there was paper money -- i.e. dollar bills, credit cards, euros, pounds, yen, etc. -- people bartered.

This was obviously cumbersome. After all, you could only do business if someone had what you wanted. If I made shoes, and if you made hammers, and if you needed shoes but I did not need hammers or any other goods that I wanted, we might have trouble doing a trade.

Eventually, astute participants in these markets realized that the best way to gain wealth was to seek to acquire the goods that were most easily traded. For instance, in the example above, I might accept a hammer in exchange for a pair of shoes even if I did not need a hammer but thought I could easily trade the hammer for something I did need.

To use a more relevant example, think of prisons. In prisons, cigarettes are often used as money -- they allow inmates to trade goods and services. Even non-smokers will accept cigarettes for goods/services. Why? Because they know cigarettes can easily be traded for something else that they may want.

As societies evolved, it naturally became advantageous to allow paper notes and now digital transactions to replace people exchanging buckets of gold coins or boxes of cigarettes. But even still, there were economies where the currency was backed by a commodity. In the United States, prior to the Great Depression, you were able to exchange 20 US dollars for an ounce of gold.

This is not important because of gold. It is important, however, because it limits how much money can be created. If every dollar must be convertible into 1/20th of an ounce of gold on demand, than the supply of money that can be created is dependent upon the amount of gold the government has accounted for.

The chart below illustrates the M3 money supply (more on this later). The last remnant of the gold standard -- meaning the US dollar's convertibility into gold -- was eliminated in 1971. Compare the growth of the money supply during the '60s, and then look what happened afterwards.


If money is put into an economy faster than the economy's productive capabilities increase, than there will be more money chasing after the same amount of goods and services. This causes rising prices.

It is important to note that this is a tax. The value of the newly created dollars is taken from the value of dollars already in circulation. And thus, the recipients of the newly created dollars -- who often happen to be the recipients of government spending -- get this money from you.

This is how wars are financed. Note that you will always see currency devaluation during wars. And thus, to end wars, we must end the ability of governments to infinitely expand the money supply.

Sound money -- meaning a money supply without volatile swings in the value of money -- is essential to creating a free, peaceful, and prosperous society. With sound money and free markets, human ingenuity can easily solve virtually any problem thrown its way.

This is the first in a series of posts I'll be doing on money supply, monetary policy, basic economics that everyone should know, and other stuff like that. Hope you enjoy it, and tell others about all the fun we're having here at KidMercuryBlog.com.

And while cigarettes can, as this post illustrates, lead to world peace, that will be true only if we use it as money -- not if we smoke them! So say no to smoking cigarettes, yes to commodity-based money.