Monday, March 21, 2011

The Theory of Money - (Part 2 of March 7th Posting)

(From the March 7, 2011 posting for background)

[How much is GOLD worth? Or even more basic, why is gold worth anything? Why does the Pound Sterling or the Euro or the U.S. or Canadian Dollars have value? Only because "we" say so!

The above statement is an over-simplification of a complex, and seldom discussed matter of economics - THE THEORY OF MONEY. Think of this concept: Money, regardless of country, and so-called "precious metals", have value only because the people of the world say they do. In reality, what we call money is a short-hand and efficient method of barter. After all, we use money to get ("buy") something of value from someone else.]

(Now the new information)

If money is worth only what we agree it's worth, then we could declare all money worthless, right? NO! This is because, as mentioned in the March 7th posting, whatever we use to exchange goods and services, without literally trading the bushel of corn for a pair of shoes, or 5 bushels of wheat for one pig, is a shorthand method of keeping track. I want your shoes that you will trade for 1 bushel of corn. I have none but Sally has corn. I just have wheat. Sally will trade her corn for my wheat; I trade her my wheat for her corn and trade with you, giving you my (originally Sally's) corn for your shoes. Now each of the three of us has what we want. I have shoes, you have corn and Sally has wheat.

BUT what if I want your shoes; you want Sally's corn; Sally wants Pete's painting; Pete wants George's work as a plumber; and George wants my wheat. It will all work out but it would take a week just to move goods and perform services, when all I wanted was a pair of shoes. Money, a universally accepted product/commodity/service "stand-in" makes it all very simple. We agree that (1) unit of this thing called "money" will trade-for (is worth) 1/10th bushel of corn, and that (4) units are needed to trade for the shoes, and that one hour of plumbing time will "cost" (5) units, and so on. We have created money as we know it.

Now, just imagine trying to work out the trade value of every good and service we use in this country. How do we establish the price in these units? By agreement. Essentially, we give everything a trade-value of "X" units, just as is shown above. When we are not certain, we guess. If we are right, the trade is completed - 23 units for a set of 4 chairs. If we are wrong, the chairs will be 30 units, or maybe only 21 units. IT'S ALL MADE UP! Until the majority of unit users say NO to the exchange, everything works fine.

As we look at financial markets, as we hear about the "strong Yen" or the "weak dollar" or even issues of inflation the explanation gets much more complicated.

Be patient: we will get to it a little at a time!

Author's Copyright by Richard I Isacoff, Esq, March 2011

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