This continues to be a source of massive confusion.
It’s true that at most times in the past, people used physical commodities rather than fiat currency in transactions. When economists study the transactions, though, they discover some interesting underlying conditions.
Gold, throughout history, has been almost worthless when separated from its role of money. You can’t build bridges from gold, you can’t make clothing from gold, you can’t eat gold. You can make a golden dish and eat off it with golden utensils but that’s no more than another signifier of wealth and status. Gold is a luxury product that took on the metaphoric sense of money. A gold coin was essentially worthless as a commodity because it was too small to convert into a product. It did serve as a token of barter, being easily exchanged for goods and services. Easily exchanged is the key. Any commodity could serve the same function and you could trade goats or pots or grain for other goods and services, but gold was compact, easily transported, and needed no upkeep. It’s easy to see that in that role it is completely analogous to fiat currency, paper money, something even more compact, more easily transported, and needing less upkeep.
Nor it is in any way true that gold had any intrinsic value even as a token of barter. The entire history of the Roman Empire is a series of discounts and devaluations of its gold coinage because the government didn’t have the funds to maintain it. The value of coinage - of all metals, not just gold - fluctuated constantly, set by its purchasing power, just as currency exchanges, commodity pricing, and bond rates today reflect the ever-changing value of the dollar. Something that had true intrinsic value would not behave that way. Gold and paper are exactly equal as tokens of barter. All modern economic theory agrees on this, probably the one thing all economists do agree on. (Goldbugs are not economists, but a religious cult.)
And no matter how many times you repeat the myth it is not true that the Romans paid their soldiers in salt.
Money was a token of barter even back then. Nothing has changed.
I I can ask a related question…
Are these stimulus packages being funded by selling government bonds, or by printing money?
Because if its the second, then the prospect of inflation worries me greatly.
Let me rephrase; Money has no intrinsic value other than that it is an intermediary used for the purchase of the array of goods and services people want.
If you print 1 trillion dollars in cash tomorrow and drop it by helicopter on the country, you will increase the liquid money supply by about 12%. But you will NOT be 12% wealthier. You will simply trigger 12% worth of inflation, because you will have 12% more dollars chasing the same goods.
(this is ignoring any liquidity traps or keynesian stimulus - I’m talking about giving an economy which has no idle resources an extra 1 trillion dollars in cash).
By doing this, you will actually lower GDP, as the one-time injection of cash will distort prices and cause misallocations of existing resources and an ultimate drop in productivity.
Ultimately, the wealth of a country is measured by its capacity to make the things that the citizens demand and which therefore improve their lives, and not by how much cash is floating around.
So Bernanke keeps telling us. The U.S. has injected huge amounts of capital into the economy because the velocity of money has dropped, so they are substituting supply for velocity to try to keep the aggregate money supply stable. Bernanke promises that when V picks up, he’ll be able to unwind M and restore a balance without triggering massive inflation. But Bernanke has claimed lots of things that haven’t come to pass, and it remains to be seen if there will be the political will to allow him to constrict the money supply and whether the Fed will retain the autonomy required to take such decisions.
The history of the Fed does not inspire that much confidence in this regard. The Fed’s low interest rate policy helped contribute to the current bubble, and before Paul Volcker was appointed the Fed had a history of doing exactly what I’m worried about - maintain a loose grip on the money supply at the behest of politicians, which led to the stagflation of the 1970’s.
And I linked to a bond auction the U.K. just held in which it could not find enough buyers for the Gilt it was trying to sell. Last year, the Treasury had to take a 170 million dollar kick in the teeth to clear its 30 year bond auction.
The U.S. will probably be able to find buyers for its bonds. But the question is how much it will have to give up in the form of higher interest rates to do so. If investors think the U.S. economy is heading for an inflationary spiral, they will demand higher rates for the bonds, and that will affect debt service costs today.