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May 9, 2011 / 74

Some Monetary Basics

Some Monetary Basics

(First published version – Wed Dec 24, 2008.  Edited and expanded version May 9, 2011)

I’m reading around the internet things that don’t make sense to me. They don’t make sense because apparently the people saying them don’t understand how the international banking and finance system works, and perhaps don’t understand he foundation stones of economics and finance. So I’ll give a shot at conveying some basics – so that maybe some of what’s going on will make more sense.

Okay – first you must understand currency since it’s the basis of the system.
In the OLD days, currency was either “specie” (Gold, silver, copper, etc coins) or tokens that represented specie, or they bartered goods directly – one for so many of the other. If you borrowed a gold coin from someone, you had to come up with a gold coin or its equivalent value in silver, etc to pay it back. Specie is also known as “hard money”.

The main problem with specie is that there is only just so much of it. A story is told that England was once having a shortage of coinage that was crippling the economy. The king/queen was said to have summoned the religious leaders of the day and told them to bring their “saints” (statues) from the churches to be melted down to make coinage out of – the sovereign was said to quip “Let’s get them out of the church and put them into circulation!”

So a shortage of hard coinage can bring commerce to a halt.

This gave rise to “currency” – which started out as paper or some durable token that REPRESENTED specie. An example is the US Silver Certificate – paper dollars which you used to be able to present at the US Treasury and receive one dollar’s worth of silver for it. This fixed the value of the currency at an equivalent amount of a precious/semi-precious metal. If you didn’t have the metal to back up the currency, you couldn’t print up and hand out currency.

But you still only had just so much metal!

So some wag decided that since the currency was “as good as” the metal, they didn’t REALLY need to have as much metal as currency. So they started printing more currency and just maintaining a “reserve” of the metal for those malcontents and distrustful folks who actually wanted to trade the convenient paper for the heavy old metal.

The amount of currency flourished, and so did trade. But eventually, folks saw that there was so much currency floating around, there couldn’t POSSIBLY be that much metal to back it up. So the ability to trade the currency for the metal at a fixed rate – was ended. (In 1971 Nixon unilaterally abrogated the Breton Woods agreement and took the US off the Gold Standard.)

So… did the world come to an end? No.

Did currency disappear? No.

But as before, the world of finance and the use of money changed. The unchecked printing of money creates what is called “fiat” currency. (More on that later.)

If you have questions, please feel free to ask them. If I don’t know the answer… well… Ummmm….



One Comment

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  1. MattyP! / May 9 2011 23:00

    Technically, it’s not the “unchecked printing of money” that creates fiat currency but a government declaring (by fiat, if you will) that a currency is a store of value independent of the price of any commodity (such as gold).

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