Reading time: 4 – 6 minutes
The first section of the first chapter in The Great Credit Contraction addresses the conflicting definitions of money and currency. If one does not have a correct understanding of money and currency then they will have flawed conclusions regarding inflation or deflation. This will lead to inaccuracies when performing mental calculations of value and result in poorly allocated capital.
WHAT IS MONEY
The terms money, money substitutes, illusions and currency are often used interchangeably. Since they do not mean the same thing this misuse can be confusing. Even many of the leading experts in this subject have difficulty agreeing on definitions. The conflation of these terms causes great problems in understanding monetary science. Therefore, we will separate and distinguish each.
EXPERTS DO NOT AGREE
MONEY
Money must have intrinsic value by being a tangible asset. This is because when A gives B the pizza, the pizza has intrinsic value. For the transaction to be extinguished, A must receive from B an asset with intrinsic value. If B exchanges a 1oz. American Silver Eagle $1 coin for the pizza, then at the time of the transaction, a pizza and a silver coin would exchange hands. Value would be exchanged for value at the time of settlement, and the transaction would be extinguished.
MONEY SUBSTITUTE
A money substitute, on the other hand, is a negotiable instrument that promises the payment of money. An example would be a silver certificate that reads: ”This certifies that there have/has been deposited in the Treasury of the United States of America (number) silver dollar(s) payable to the bearer on demand.”
Chartalism, the State theory of money, asserts the government gives money or currency its value. This theory completely opposes basic economic law. In reality, the backing of government-issued money substitutes with bullion gives the currency value.
If A exchanged the pizza with B for a silver certificate, then the transaction would be settled but not extinguished until A passed on the silver certificate for value. While A holds the silver certificate, its value could change and it could become worthless. This happened on June 24, 1968 when the Treasury of the United States of America declared it would no longer honor redemption of silver certificates.
The use of a money substitute introduces risk to A in the transaction with B because A relinquishes value when he tenders the pizza to B but does not receive an asset with intrinsic value in exchange at settlement. Instead, A must use the instrument in another transaction to receive value.
ILLUSIONS
An illusion is a negotiable that promises nothing and has no intrinsic value. It is like a silver certificate that promises the bearer no silver. It has value only because individuals are willing to bear the payment risk and other risks of the illusion. The bearer usually tolerates the risks because their cost is lower than the value placed on the utility derived from the service the currency provides to the market participants.
CONCLUSION
In conclusion, currency is primarily used to settle transactions. When money, such as gold, silver or platinum, is used to settle a transaction, then the transaction is extinguished. However, if either illusions or money substitutes are used, then the transaction is not extinguished and one or more parties to the contract are left to bear the risk of extinguishing the transaction. This risk often leads to errors in accurately assessing the value and utility from the underlying consideration in determining the price for the transaction. This is one of the largest risks with using fiat currency. As the illusions evaporate during The Great Credit Contraction, here is a free sample, it will be real tangible assets the remain and increase in purchasing power.
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{ 5 comments… read them below or add one }
Awesome article as always…..this site is on my list to check out everyday.
Just one question, do you know where I could learn more about the details of “This risk often leads to errors in accurately assessing the value and utility from the underlying consideration in determining the price for the transaction.” I’m not fully understanding HOW that ends up occuring. Any advice or guidance to point me in the right direction would be greatly appreciated, although I know you’re a busy guy these days.
Cheers
Hi Derrick, Thanks. Yes, that statement is a conclusion without much analysis. In fact, The Great Credit Contraction is to a large degree similar in that it distills many pages of economic theory into simple rule statements in order to give the reader a general roadmap with actionables without taking too much time.
This risk is deduced from several underlying principles such as the supply of and demand for money or currency. To really dig into the meat of this subject I recommend chapter 17 of Human Action] called Indirect Exchange spanning pages 396-475 of the Scholar’s Edition. Parts 1-3 setup the argument for the supply and demand of money [currency]. Part 4, The Determination of the Purchasing Power of Money, has this conclusion, “This result will be that changes in the structure of prices brought about by changes in the supply of money available in the economic system never affect the prices of the various commodities and services to the same extent and at the same date. [emphasis added]”
Chapter 17 Section 8, The Anticipation of Expected Changes in Purchasing Power, contains the famous crack-up boom quote. “He who buys, buys for future consumption and production. As far as he believes that the future will differ from the present and the past, he modifies his valuation and appraisement. … This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices …. But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money [currency] against “real” goods, no matter whether he needs them or not, no matter how much money he has to pay for them. WIthin a very short time, within a few weeks or even days, the things [illusions] which were used as money are no longer used as media of exchange [currency]. They become scrap paper [digits in a spreadsheet on a hard drive]. Nobody wants to give away anything against them. It was this that happened with the Continental currency in America, in 1781, with the French mandats territoriaux in 1796, an with the German Mark in 1923 [and with the Argentina Peso in 2001 and the Zimbabwe Dollar in 2008) [page 423].
In our case, this worldwide crack-up boom will be when capital burrows down the liquidity pyramid from the FRN$ to gold.
this is a very pertinent subject about which i have studied and considered extensively….i think that this notion of exchanging value for value is a good starting point but it is helpful to delineate the attributes of money because exchanging value for value could easily be a barter transaction….
thus an asset becomes money through a social and economic process where a substance is elevated to money because it posesses the qualities which ideal money should have…..
however, rather than elaborating on that i would like to point out that most if not all people err in the designation of the usd as a fiat currency….that is not really correct….currency may be a proxy for money…..in the case of the frn it is backed by debt and the future value of a stream of payments….thus in a perverse way it is not fiat money in the sense that weimar or zimbabwe dollars were….
however, this asset comes at huge costs because interest is a mathematical phenomena which defies the real economy…..as such the disjuncture between the currency and the money – i.e. debt – must result in a crisis….et voila that is precisely where we are today….debt cannot be money but we have made it so….
one last point….money NEVER has value because of subjective reasons – it ALWAYS ALWAY ALWAYS has value because of a certain objective property which i might explain in the future….
it is pure poppycock and horse crap to say that gold’s value derives from psychological allure or arbitrary and subjective reasons….gold is money for very measurable, real, and objective reasons….
do not let the liars and charlatans of the barbaric relic school rob you of your money……
Trail of tears Caveat Redemtor ,Vatican , United Nations , IMF , JP Morgan, Fiat Reserve , IRS , Wall Street etc. The countries of the world are puppits on a string .
Money is not man made and never in 5000 years has it been nor will it ever be . MONEY IS SILVER and GOLD.