Are we headed for another great depression or simply working through an expected blip on the recession radar screen? If you find yourself confused about economics and wish there was a version of Whac-A-Mole, substituting economists for the furry rodents you smack back into their holes with your padded mallet, keep reading. This column begins a three-part series on money, the ’flations and the attempts of government regulators to control economic patterns during the past several decades. Let’s start with money and its economic value.
Unfortunately, money today has no intrinsic value. A dollar bill is worth almost nothing by itself, and its relative value is based on whether there is something to buy at a price the buyer deems appropriate. Before society used money, it accomplished trade through barter. If you raised chickens and your neighbor made shoes, you might trade a number of your chickens for a pair of shoes.
Some transactions could not be completed easily. For example, the value of the shoes might be 1½ chickens, but the shoemaker may want the chickens for their eggs. This kind of mismatch produced the need for an exchange medium, and money was born. Money establishes a way of converting the value of what is bought and sold, so the parties don’t have to transport live animals or suffer disparities in their transactions.
The money supply
Defining “money,” however, is not as simple. The money supply in the United States comprises both currency and coins issued by the Treasury and Federal Reserve System, but economists measure the available supply on three levels. M1, the narrowest, is based on its function as an exchange medium and consists of currency in the hands of the public, deposits on which checks may be written and travelers’ checks. M2 adds its function as stored value and is defined as M1 plus money market mutual fund balances, savings accounts and time deposits less than $100,000. M3 starts with M2 and adds “close substitutes,” including large time deposits, institutional money fund balances, repurchase liabilities in depository institutions, and Eurodollars held by U.S. citizens at banks in the United Kingdom and Canada and at foreign branches of U.S. banks.
The illusion of certainty
Before paper currency was produced, coins were made of precious metals, so the material itself could be melted down and used for another purpose. In countries with currencies supported by a gold or silver standard, you could take paper currency to the government and exchange it for its value in the precious metal, based on the government’s current exchange rate. In 1944, the United States and Great Britain agreed on an international monetary system of exchange rates called the Bretton Woods system, which lasted until 1971, based on such a standard.
On Aug. 15, 1971, President Richard Nixon ended gold trading at $35 per ounce, announcing that the United States would no longer exchange dollars for gold. This action severed connections between major world currencies and ended the Bretton Woods system.
So what backs our currency now?
Our system is based on “fiat money” and is not connected to any commodity, meaning that our currency is simply paper, and its value depends on our faith in its purchasing power. Fiat money has no intrinsic value.
What does this mean?
Let’s go back to bartering for a minute. The opportunity to complete a fair trade depends on each party having something the other wants and the ability to agree on how much of each to exchange. The perception of fairness and equivalent value makes the trade possible. The same is true with money as an exchange medium, but the transfer of goods is not directly connected. The shoemaker may buy chickens, and the chicken farmer may buy shoes. But they may not deal directly with each other.
There is a value to the money in each transaction, but its value changes throughout the economy, based on the total number of transactions and other factors. These include the total amount of money available at any point, whether people decide to spend it or save it, whether they purchase large or small items, and the supply of each item, which then interacts with the demand for it. Values change, depending on how badly people want to purchase something, how much of it is available at that time, and whether they have the cash or will depend on credit to acquire the goods. Ultimately, value is based on perception.
So, regardless of the state of the economy, your job is still to find enough people who want your service, to arrive at a price that conveys value to the customer and earns you a decent profit, and to maintain an available supply of your services without raising your capacity beyond the demand level of your market.
Next month, we will look at the effects of inflation, deflation and “stagflation” on your economic well-being.
NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached at email@example.com.