We all know what inflation is, don’t we? Sure, we know, it is rising prices. Is it? Why? What is the reason for higher prices? And, more important, do the prices really rise? Compared to what?
Have I confused you? Good. Time to talk a bit about the foundation of money.
What do we mean with the term money? Easy one, it is what you give away when you buy goods and what you get for work. Yep, right. So, money is a medium of exchange. But now I need to confuse you even a bit more. Dollars, the nice printed paper bills, are money only since 1971, at least since than, they where backed partially by real money, which was gold at that time.
Hey now, what do you mean by “real money”? If I can go to the store and get T-bone Steaks in exchange for those bills, than it works for me and I call that money. Fair enough. I couldn’t agree more. But mind the “If” in your sentence. What is the reason for the butcher to hand you his valued tender T-bones for an ugly peace of paper showing always the same old men on them? Because, he believes, that he in turn can use them to get what he desires, maybe a fresh tasty bread and some tuna. This is the cool thing with a money (yes this is no grammatical error, it is a money, because there can be a lot of different moneys). Everybody accepts it as a medium for exchange.
Can you imagine how awkward it would be if you wanted to get 3 eggs and all you had is 1 pound of butter to offer? You might be lucky and the farmer could be in need for butter and is willing to exchange. But, what if not? In this case you have to find someone that has something the farmer could need and, at the same time, is willing to exchange this item for your butter. With a money, you are better of, you can exchange your butter for 1 unit of a money and buy those 3 eggs with the money you exchanged.
Money therefor is a commodity that everyone accepts for exchanges. It does not matter what the money is made of. In fact, all kinds of things have been used as a money. Iron bars, horse shoes, whiskey(yep here in the United States), cigarettes,mussel shells, gold, silver, grain and the like. The important thing for a money is that it is widely accepted for exchanges.
Agreed, some items are better suited to be a money than others. What if we would use eggs as a money? Well, risky thing to do. Eggs can easily break and broken eggs are hard to exchange. And if you would save for, say a new car, how long would it take for the eggs to rot? And even the car dealer I know wouldn’t accept rotten eggs for a new car (maybe for one of his used car occasions though).
So, bottom line, a money should have some attributes like durability, easy to divide, hard to counterfeit. Wait a minute. I understand the durability thing, even the requirement to be easy divisible, but why hard to counterfeit? Well, think about it, if there was a money price of one money unit (whatever the unit is let’s say a Taler) for an egg that would mean that one pound of butter (if we take the example above) would have a money price of 3 Taler(money units), because we exchange 1 pound of butter for 3 eggs. What would happen if all of a sudden there was more money in the market? Right you guessed it. You would have to pay more money units to get your butter or eggs or whatever you like to buy.
Say “bad Joe Counterfeiter” had a way to double the amount of money in a market. What would be the effect? Right, taking our example, all of a sudden you would have to pay 6 Taler for a pound of butter and 2 Taler for an egg, even if nothing else had changed. The value of the eggs compared to the butter has not changed at all, you still get 3 eggs for a pound of butter. Yet, you have to give more money units for this transaction.
Well, whats wrong with that? If the new money, “Bad Joe’s “ that is, comes on the market, it will equalize after some time. Right it will, but in the meantime, those having the new money sooner than the rest, benefit, for they buy to a price not already in sync with the amount of new money on the market.
This is the reason, why a good money should be hard to counterfeit. It prevents Inflation. Because this is how we call the process of pushing new money into a market. The rising prices are not the inflation, as coughing is not the cold. Rising prices are a symptom of Inflation. Inflation is the inflating of the amount of a money in the market. And it leads always to rising money prices. Yet, it does not lead to rising prices of a certain good compared to other goods, all goods rise only in money prices. So 3 eggs still go for 1 pound of butter but now the money price you have to pay is 6 Taler instead of 3.
Beside the raising of prices, how does this hurt the other participants in the market?
Well, you are a sober guy and you have saved some money every week from your paycheck for retirement. Say, 10000 Taler so far. Now, all of a sudden, your 10000 Taler can only buy half of what they would have bought before. Basically half of it is rotten. You sure are happy about that, are you?
And almost as worse, can you remember how long ago you received your last raise from your boss? If you earned 200 Taler a week before Joe’s coup, and you still earn 200 Taler now, you basically lost half of your salary. Ouch…
How can that be cured? Hmm, we could take money out of the market, can’t we? Yes we can, and guess how this process is called? Yes, you are right, it is called deflation. What will be the symptoms of a deflation? Right, falling prices.
So wrapping this thing up, Inflation is pushing more money into a market, thereby rising prices without changing the exchange ratios of the goods. Deflation is the removal of money from the market and has the opposite effect.
Not a really hard to grasp concept, isn’t it?
Now, we are a lucky bunch of citizens, because our good government makes sure Joe the Counterfeiter is caught quickly before he can do real harm to the economy as a whole. Really?
Well, there is a little problem with that view. The problem is, that the government determines what a money is inside its territory. Ooops. You mean they can just print it up like Joe? Yep. And they do. They call it monetary policies. With our dollars we are completely dependent on the whim of our government. Thank god we have a democracy and they can’t do what they like, can’t they?
Naw, we have responsible politicians, that have the common good and the prosperity of the citizenship always before their eyes. And we have laws, haven’t we?
Ok, granted all super-altruists find their way into some government office eventually, let’s make a thought experiment anyway.
Suppose some real bad guys, selfish, reckless in short typical capitalists find a way to act like the altruists and convince the people to vote them into office. Just for the sake of the argument. I know it never can happen here. Now those folks had their fingers on the printing press and could spill the economy with money. What would that mean? Well first inflation, later more inflation and eventually hyperinflation(If you like to know what that means google up pre WWII Germany).
So those bad guys would be the first to get the new money and could spend it for good items while the rest of us would see how our savings and our wealth is vanishing.
But, sure that can never happen, can it?
Can someone explain, why new money in a market is needed anyway?