In the Economics and Finance classes I teach, the most stimulating class session covers the topic of money.

Students express a curious confusion when I introduce a specific riddle, a koan for them to mediate upon. I ask them to explain the statement:

“The prices of food, oil, gold, and property often don’t rise at all.”

[pullquote align=”full” cite=”” link=”” color=”” class=”” size=””]”One year, for example, the price of gold is 1200 dollars per ounce,” I suggest. “And one year later gold is 1300 dollars per ounce.  If I tell you that gold did not go up, what else could possibly have happened?”[/pullquote]

They wonder if I am joking and prepare to rebut my assertion with evidence of consistent increases in the prices of just about everything.

Then they try to explain the assertion with anomalies of supply and demand. . ..  I acknowledge their contributions as valid but not what we’re looking for, and proceed.

“One year, for example, the price of gold is 1200 dollars per ounce,” I suggest. “And one year later gold is 1300 dollars per ounce.  If I tell you that gold did not go up, what else could possibly have happened?”

Occasionally, a voice from the ranks comes to the collective rescue.

“The dollar went down?”

“The dollar went down!”  I affirm the epiphany and begin the debriefing:

• Money or “cash” loses value over time
• Central banks naturally have to “print” some new money to accommodate a larger number of transactions when there is economic growth
• But the supply of money has grown much faster than the economy. In the 20 years since 1995, the money supply as measured by M-3 (a discontinued metric, but estimated at about 17 trillion$US) has risen by over 400%. This implies money supply growth of 7% per year—beyond the average GDP growth of 3-4%
• We did not witness excessive inflation during this period because of downward pressure on many consumer goods due to Digital Revolution efficiencies and cheap foreign imports.
• Most commodities and property values, however, rose during the same period.
• Dollars lose value because more are constantly being created

Money is a medium of exchange, a unit of account, and a store of value.  For short-term applications, mostly as a medium of exchange and a unit of account, the dollar serves its purpose: a medium of exchange helps us value and price items to a common standard, and a unit of account helps keep track of shorter-term debts or loans. It is primarily when our “money” is used as a store of value (using dollars to “store” whatever wealth we have amassed) that we must concern ourselves with the continued loss of purchasing power due to inflation.

The dollar–as with all major currencies of the world today–is a fiat currency. This means that it only has value by decree and mutual agreement. This is in contrast to a commodity currency that is “backed” by some real asset like a precious metal, or in centuries past even salt or a quantity of grain. In this situation, the currency is a more like a note that the holder may redeem for a specific quantity of whatever backs it. This practice deters too much new money creation because it requires that more of the commodity be produced before new currency can be created.

The US went off the gold standard in the ’70s. Since then, inflation has averaged about 4% per year (it was very high at first, recently much lower). There is an important debate about the need for inflation today. In truth, prices should fall due to efficiencies or “productivity gains.” But modern economists insist upon trying to “reflate” prices today with such extreme tools—unprecedented until recently–as negative interest rates and massive asset purchases (e.g. QE ) by Central Banks. The debate itself is too involved to outline here, but the case against constant inflation seems to be gathering consensus.

So for over forty years we have had a fiat currency, and in the last twenty years our Central Bank has increased the money supply 400%, and promoted excessive debt levels in both private and public sectors.

In case you need more cause to be alarmed, few people realize how close we came to a collapse of the global financial system during the 2008-9 Financial Crisis; most US banks were probably technically insolvent in 2009. There had even been talk of nationalizing the banks.

Since that event, aside from new banking regulations formed in hindsight, little has changed. In fact, Central Banks around the world seem to be more aggressive, united, and coordinated than ever in trying to stimulate growth through monetary policy and intervention in financial markets.

Okay, so where is this going?

Stay Tuned: In The Problem of Money—Part Two, I will introduce Bitcoin and related projects that were designed as improvements to the dollar as forms of “money.”

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