Tyler Colford: Common misconceptions about fiat currency

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There are some common misconceptions about today's money. One is that our currency is backed by the gold in Fort Knox and we can exchange our dollars for gold. Another is that money, somehow magically, comes from government and that the government has to bring money into being before the society can start utilizing the "wealth" that the government creates. But what actually constitutes something as money?

To flesh this out we must first look at the function of money. Money, in general, acts as a medium of exchange.

Think of a world with no money. This would be a world where people bartered, making direct exchanges with one another. Say, for instance, a hunter wanted to trade a half a pound of venison for three loaves of bread. Now if the baker is actually a vegetarian than the venison has no value as a consumer good to him. The baker, finding no value in the venison, will not accept the exchange.

Not being able to make a direct exchange with the baker, the hunter, possibly knowing that the baker enjoys maple syrup on his freshly baked bread in the morning, decides to go to the sugarer to trade a pound of venison for two half-pints of maple syrup. Keeping one-half pint to himself and trading the other half-pint of maple syrup for three loaves of bread. In this indirect exchange, the hunter just used maple syrup as a medium of exchange.

But maybe the baker had already bartered with the sugarer that day and already has a half-pint of maple syrup by the time the hunter proposes the trade. If the baker is planning to use the maple syrup as a capital good, baking pastries and sweetbreads for consumers, he might still value the maple syrup enough for the trade of one-half pint for three loaves to occur.

Or say the baker had already achieved his foreseeable desired ends involving maple syrup, as a capital and/or consumer good. Any more maple syrup will not satisfy any of his current wants but might still be used as a medium of exchange. This being the case he might only be willing to trade two loaves of bread for the half-pint of maple syrup.

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The diminishing value the baker holds for maple syrup is called the Theory of Marginal Utility, however, the value an individual holds in any good or service is subjective and cannot be quantitatively measured.

Three individuals — the hunter, baker and sugarer — is a very small and basic societal model, and maple syrup isn't the most durable commodity, but there have been and continue to be commodities, used as money, that can be consumed and/or go stale, such as salt and cigarettes.

A commodity can become money if enough of society finds the commodity itself valuable. A society will often progress towards the easiest transferable form of the commodity or a representation of the commodity-like promissory notes.

The dollar used to be a promissory note that could be exchanged for gold until 1933 when private ownership of gold was banned. Although the words "Will Pay to the Bearer on Demand", a promise to redeem the owner of the note in the underlying commodity (usually gold or silver), remained on the currency until 1968.

Currently, the dollar is the official medium of exchange in the world. The dollar, however, is not backed by any commodity and is only worth anything because the government requires that they receive taxes in the form of dollars and because, somehow, they were able to convince multiple countries to back their own currencies with the dollar.

As long as we can continue to convince enough of the world to use the dollar as a reserve and use it in the global market the dollar won't go the way of the Venezuelan bol var, but instigating a trade war with a country that owns more than a trillion dollars of U.S. debt or placing trade sanctions on countries that would be utilizing the dollar in global trades increases the risk that countries will look elsewhere for a global medium of exchange.

Tyler Colford writes from Jacksonville, Vt. This column first appeared at the heartland newsfeed.com and is part one of a three part op-ed about money and markets. The opinions expressed by columnists do not necessarily reflect the views of the Brattleboro Reformer.


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