Posted On 20 Jan 2012
Is the U.S. dollar sound money or not?
If it is, what makes it sound? Will it continue to be sound?
If it isn’t, what should we as individuals do?
Ultimately, money is an idea. That being said, my purpose here is practical rather than theoretical.
Is money important? King Solomon: “The table has its pleasures, and wine makes a cheerful life; and money is behind it all” [Ecclesiastes 10:19]. It’s especially important if you don’t have any!
[Is money ultimately important? No. In my judgment, that is reserved for spiritual awakening. I mention this because not having money is not an excuse for living poorly.]
Where does money come from?
Our species has existed for about one-quarter of a million years. For nearly all that time our ancestors were foragers, hunter-gatherers. Presumably, there was at least occasional bartering or trading, but there was no need for money.
The First Agricultural Revolution occurred about ten or twelve thousand years ago. Once our ancestors figured out how to grow crops and domesticate animals, the advantages of doing so made the foraging way of life obsolete. Those who came to control land became wealthy; everyone else paid their taxes, which were typically in the form of crops or animals, to them.
Because of specialization (the division of labor), the First Agricultural Revolution enabled our ancestors to organize themselves for the first time into sizable communities. Towns and cities must circulate goods and services to survive. There are only three options for doing so [cf. Heilbroner’s The Worldly Philosophers].
The first is tradition. In ancient India, for example, successful economic patterns were preserved from one generation to the next by handing down specialized tasks from father to son. If you were a farmer or a brick maker or a carpenter, your son would become a farmer or a brick maker or a carpenter.
The second is dictatorship (kingship, authoritarian rule, command economy). The pyramids of ancient Egypt were built because various pharaohs commanded that they be built. If a king wants a larger army, he simply decrees that peasants from various other occupations become soldiers.
The third is the market system. Its rule is deceptively simple: each may do what is to his own economic advantage. If everyone does this, all the necessary tasks will actually get done because of the rules of the market game. The market system is the basis for modern society.
So where does sound money fit in? Although there is a helpful distinction to be drawn between money (monetary wealth) and currency, let’s here – following common usage – consider them to be the same thing. Minimally, it is essential that currency or money is a medium of exchange as well as a unit of account.
A problem with bartering is setting exchange rates. How many bushels of corn trade for one shirt? The answer becomes easy once the value of each is given a monetary price, which is a unit of account.
Money also facilitates transferring value between assets. It makes doing deals less cumbersome and more efficient, which is what a medium of exchange does.
Incidentally, there’s nothing new about this. Aristotle: “money was intended to be used in exchange” [1259b4] (as opposed to using interest to get money from money, which he considered to be “the most unnatural” way to become wealthy).
Money may also have nonessential uses as well, such as being valuable for wealth storage or for deferred payments. Lest this discussion become too complicated, let’s just set those aside.
Some physical objects used as currency or money work better than others. What criteria separate less useful from more useful?
The best money must be: portable, divisible, durable, and readily recognized as being valuable.
Land is not portable. As private property, it can be an excellent means of storing wealth, but it cannot be money. It’s divisible, durable, and (usually) valuable, but it’s not portable.
Cattle and slaves are not divisible; it’s difficult or impossible to make change using them (even setting aside questions of morality). They are, though, valuable, relatively durable, and somewhat portable.
Seashells don’t make sound money because they are too fragile and are not usually recognized as valuable.
Pieces of printed paper and coins made from nonprecious metals don’t make sound money because they may not be recognized as being valuable. However, they are portable and relatively durable. Coins are divisible. Both can be sound money when they are, and are recognized to be, receipt money, in other words, IOU’s for real money.
Here’s the point: Human beings have tried many different kinds of physical objects as money (media of exchange and units of value), but most don’t work well.
I’m reminded at this point of a lovely passage in Aristotle where he is talking about utopian philosophers (like his teacher Plato) who dream up new living arrangements:
“Let us remember that we should not disregard the experience of ages; in the multitude of years these things, if they were good, would certainly not have been unknown . . . “ [1264a1-3]
Let’s use the test this suggests: What has human experience down through the ages shown to be sound money?
Gold and silver.
That’s it. Nothing else. They are recognized today as real or sound money in all cultures around the world; they are valuable.
You may object that they are just metals, that there is nothing inherently precious about them.
Actually, silver is the second most useful natural substance that comes out of the earth (after oil). Gold, too, has industrial uses. However, set their usefulness aside.
Gold and silver are sound money because human beings take them to be precious or valuable. Who cares that, if there are any, denizens outside our solar system might not value them?
To fail to understand their value is to “disregard the experience of ages.” If you have a lot of gold or silver, you are wealthy. Period.
Notice that both metals satisfy all four of the sound money criteria mentioned above.
The only one where they don’t do very well is portability. It’s dangerous and uncomfortable, for example, walking around with pockets full of silver coins.
However, that is easily remedied by printing paper receipts that are backed by quantities of gold or silver that is safely stored. That paper may function well as sound money.
Can paper that is not backed by gold or silver be sound money?
Well, as long as there is consensus that it is money it can work as a medium of exchange. However, once skeptics question it, if confidence in it erodes, then it will cease to function as sound money.
By these criteria, no fiat currencies are sound money. Since the U.S. dollar is a fiat currency, it is not sound money – and neither are all the other dozens of fiat currencies around the world that are pegged to it.
It’s astounding to realize that the official reserve currency in the world today is not sound money!
What should you do with it? I don’t know.