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May 17, 2011 / 74

Some Monetary Basics Pt III

(First published, Dec 24, 2008 )

Part III

Now things get tricky.

INFLATION
What happened was that a lot of clever people in governments (only governments are allowed to make currency) decided that they could just print up as much currency as they needed and spend spend spend. When they started doing that, there came to be LOTS of currency around, so the currency lost its value. (Value of a commodity such as currency is tied to scarcity or plenitude.) When you have more currency/money being created than is needed, it’s called inflation.

Now, I’ve heard a lot of economists say that inflation is the result of “the wage price spiral” but they’re wrong. You can’t HAVE a “wage price spiral” if you don’t have enough money to allow for rising prices and wages. So inflation is NOT caused by wages and prices going up – the wage price spiral is a SYMPTOM of inflation. The ONLY cause of inflation is putting too much money into the economy. Period. And too much money in the economy will kill it just as fast as not enough money in the system.

INTERNATIONAL CURRENCY & “PEGGING”
The dollar represents value, but HAS no intrinsic value. So… say you’re a new country. You can print up some currency – say some Zlotys – but how will people know what Zlotys are worth in exchange for the stuff they want to sell you? Exactly how many zlotys would a double dip chocolate ice cream cone cost?

You go back to the historical foundation of currency and figure out that you need something to “back the Zlotys” up – something of recognized value like gold or silver. But you don’t have any gold except in your teeth. What to DO? You get a loan from someone who gives you dollars (World Bank?). Then you print up Zlotys (with the president’s picture on one side, an ice cream cone on the other). For every dollar you borrowed, you decide that you’ll print up ten zlotys, making your exchange rate 10:1, zlotys:dollars. Now, instead of gold and silver you are using the dollars you borrowed as your “reserve currency.” You hold the dollars in “Reserve” – so the Zloty is now ALSO “backed by the full faith and credit of the US Dollar.” N’est ce pas?

You say – “We are setting the Zloty at a value of ten Zlotys per US Dollar – this will be a fixed rate of exchange until we get established here, and then we’ll do something else. We’ll allow the Zloty to “float” against the dollar.” In other words people will know how many Zlotys to pay for goods, and how many to get paid for work because EVERYbody knows what a US Dollar is. Then, once your economy gets established, the Zloty can set its own value.

When you fix the value relationship of YOUR currency to another currency, like the US dollar, this is called “Pegging” – in this case, “Pegging to the Dollar.” So if the US Dollar has ten percent inflation and loses value – then your currency also loses value, and so on. A peg of one currency to another fixes the value of the inferior currency in relationship to the other.

HAD ENOUGH?

Well… we’ve talked about money – the different forms it takes, what can be done with it, and a few general economic things having to do with money/currency. But what we haven’t talked about until now is EXACTLY WHAT money/currency REALLY IS. Stay tuned for PART IV.

;-D

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