Here’s a definition of money that will be rejected by conventional economists of all persuasions, but will clear up analytical confusion for those outside the dismal science. Money is that which serves as a medium of exchange, a store of value, and a unit of account, has intrinsic value, and which is not a liability of an individual or entity, including that of a government. The immediate objection to this definition is that it does not describe anything that currently functions as a medium of exchange. Something must be wrong with a definition of money that excludes everything that people now think of as money.
Perhaps it’s not the definition of money that’s flawed, but present monetary arrangements. Everything that now serves as a medium of exchange, a store of value, and a unit of account has minimal or no intrinsic value and is somebody’s liability. Even the US currency is a note, or debt instrument, of the Federal Reserve. These notes pay no interest and have no maturity date, and they can only be redeemed at the Fed for more notes, but they are liabilities on the Fed’s books. Precious metals, on the other hand, which have served as money, or have been the basis of fully convertible paper currencies, are not liabilities.
Behind the curtain of present institutional arrangements, the US government issues IOUs, which are payable in IOUs issued by the central bank, which themselves are only redeemable for more central bank IOUs. The law mandates that these central bank IOUs are “Legal Tender” for settlement of all debts, public and private. While the debt ceiling limits the amount of IOUs the government can issue (although it is invariably raised), there is no limit on the IOUs the Federal Reserve can create. These IOUs are either Federal Reserve Notes or member bank deposits with the Fed (just as a customer deposit with a bank is a bank IOU, a member bank deposit with the Fed is a Fed IOU).
So why not just call these government and central bank IOUs what they are: debt? And why not call precious metals money? They are not debt and they also have the intrinsic value embedded in the resources necessary to find, mine, smelt, and refine them, their use in various industrial and consumer goods, and they’re indestructibility, divisibility, portability, measurability, and beauty. If used as a medium of exchange, store of value, and unit of account, they satisfy the conventional definition of money, although they are not currently being used as such.
These bright-line distinctions have the virtue of being definitionally accurate. They also remove the definition of money from being a social convention: that is, if people use something as money, it’s money. People today use debt as money, but that doesn’t make it money under the proposed definition, anymore than a social convention to think of cats as dogs and call them dogs will make them bark or slobber with joy when called by their masters (cats don’t have masters). Most importantly, calling things what they are allows intellectual clarity about their role in economics.
Debt imposes obligations; it must be repaid, even if it is only rolled over or paid with more debt, and in the interim the debtor pays interest to the creditor. Interest and debt repayment are the costs of debt, which can fund investment, speculation, or consumption. For a rational investor or speculator, their expected return on investment or speculation will exceed the cost of the debt used to fund it. Markets arbitrage such opportunities, borrowing to fund investment and speculation. The increasing demand to borrow pushes up the interest rate; the increasing investment and speculation reduces the expected return. A point is reached where, for the economy as a whole, the expected return on investment and speculation equals the prevailing interest rate. (Consumption yields no return on investment, Thus, borrowing to fund consumption, because of debt’s interest and repayment burden, is economically counterproductive.)
Debt, as someone’s liability, is someone else’s asset. As an asset, it can be exchanged for goods, services, investments, or speculative instruments. It can also serve as collateral against debt incurred by the asset-holder. That creditor can in turn use that debt, the creditor’s asset, as collateral for debt, as so on. In this way, debt serves as the basis for further expansion of debt. Central banks’ debt to member banks often has this multiplier effect, as the banks use their deposits with the central bank (in excess of required reserves) to fund lending and new debt that pyramids as it is progressively deposited and lent out in the banking system.
Central bank fiat debt creation increases the amount of debt above what it would be in a free-market, real-money economy and lowers its price, the interest rate. This leads to excessive investment—malinvestment—overproduction, and more speculation and consumption than would prevail without a central bank. However, it does not change the diminishing returns inherent in increasing debt. Even if interest rates were zero and debt was free for everyone, at some point the expected return on investment and speculation goes to zero, and the debt used to fund consumption has to be repaid. People are emotional and prone to crowd psychology. In the throes of a debt boom they are invariably too optimistic, misjudging returns on investment and speculation and their ability to repay debt. The actual return on additional debt then goes negative.
At the peak, debt begins to contract through both debt repayment and debt repudiation. Debtors will sell assets to raise funds to satisfy debts, but if those funds are insufficient, they will repudiate some or all of their debt. Because debts are creditors’ assets, repudiation imposes losses on creditors, reducing their investment, speculation, consumption, or using assets as collateral for more borrowing. Debt contraction begets economic contraction and deflation, but because of the distortions introduced into the economy by central bank fiat credit during the expansion, they are worse than they would have been in a free market, real money economy. The inward force of debt contraction, when aggregate debt has—through debt’s multiplicative properties—been expanded to its fullest extent, far outweighs central bank’s capacity to stop it through the creation of still more debt, which is at this point counterproductive.
Central banking and fiat debt are but new wrinkles—facilitators—of an age-old and pernicious practice: governments issuing as much debt as credit markets will allow before they impose ruinous interest rates. One of the leitmotifs of history, a recurring phenomenon, has been governments bankrupting their countries. The qualities of real money—that it has intrinsic value requiring resources to produce, and is not a liability—tether the amount of debt to the real economy and hinder governmental borrowing, slowing, and perhaps preventing, the oft-repeated march towards bankruptcy. Yet people posing as sophisticates praise central banking and fiat credit, enablers of government indebtedness, as “innovations,” while denigrating real money—precious metals—as “barbarous relics.”
This intellectual depredation is so complete that virtually everyone thinks of value in terms of central bank fiat debt, not real money, which is ass-backwards. Real money will always have value, and thus will always be exchangeable for real goods and services. Fiat debt comes and goes. Shouldn’t our notions of value be tied to the enduring, not the ephemeral? We say: “An ounce of gold is worth 1100 dollars,” but shouldn’t we say: “A dollar is worth 1/1100 of an ounce of gold”?
At this juncture, with massive debt and economic contraction, deflation, and social chaos looming, many people ponder the purchase of precious metals solely in terms of whether such metals will be worth more or less fiat debt in the future. Precious metals should instead be evaluated in terms of their exchangeability for real goods and services, come hell or high water. Here the barbarous relics’ record is quite good, far better than that of fiat debt. There are fluctuations in real money prices due to fluctuations in the supply and demand for it, but those are driven by organic developments in a market economy, not the whim of government officials and central bankers.
Over time real money retains, and actually increases, its purchasing power for real goods and services. An old adage holds that through the centuries, an ounce of gold has bought a good mens suit. Now, if one knows where to shop, an ounce of gold will buy at least two good mens suits. This is to be expected with real money. As an economy becomes more productive, everything else being equal, a given quantity of real money will have more purchasing power. This is what happened under the gold-exchange standard during the latter part of the 19th and early part of the 20th centuries, before the adoption of central banking and fiat debt. A given quantity of gold or silver buys more goods and services than it did in 1913, while a given quantity of the Fed’s fiat debt buys less. Barbarous relics indeed! For those determined to survive hell or high water, think in terms of real money and what it will buy, not fiat debt, which sooner or later will be what it’s destined to be: worthless.