The Role of Money

Everyone wants money, but there have been particular times in particular countries when no one wanted money, because they considered it worthless. When you can’t buy anything with money, it becomes just useless pieces of paper or useless metal disks.

Money is equivalent to wealth for an individual only because other individuals will supply him with the real goods and services that he wants in exchange for his money. But, from the standpoint of the national economy as a whole, money is not wealth. It is just a way to transfer wealth or to give people incentives to produce wealth.

Whatever the money consists of, more of it in the national economy means higher prices.

Many countries have preferred using gold, silver or some other material that is inherently limited in supply, as money. It is a way of depriving governments of the power to expand the money supply to inflationary levels.

Gold has long been considered ideal for this purpose, since there is a limited supply of gold in the world. When paper money is convertible into gold whenever the individual chooses to do so, then the money is said to be “backed up” by gold. This expression is misleading only if we imagine that the value of the gold is somehow transferred to the paper money, when in fact the gold simply limits the amount of paper money that can be issued.

To give some idea of the cumulative effects of inflation, a one hundred dollar bill in 1998 would buy less than a $20 bought in 1960. Among other things, this means that people who saved money in the ‘60s had four-fifths of its value silently stolen from them over the next three decades.

Gold continues to be preferred to many national currencies, even though gold earns no interest, while money in the bank does. The fluctuating price of gold reflects not only the changing demands for it for making jewelry or in some industrial uses but also, and more fundamentally, the degree of worry about the possibility of inflation that could erode the value of the official currencies.

That is why a major political or military crisis can send the price of gold shooting up, as people dump their holdings of the currencies that might be affected and begin bidding against each other to buy gold, as a more reliable way to hold their existing wealth, even if it does not earn any interest or dividends.

If fighting a major war requires half the country’s annual output, then rather than raise tax rates to 50% of everyone’s earnings in order to pay for it, the government may choose to create more money for itself and spend that money buying war materiel. With half the country’s resources being used to produce military equipment and supplies, civilian goods will become scarcer just as money becomes more plentiful. This changed ratio of money to civilian goods will lead to inflation as more money is bid for fewer goods and prices rise as a result. 

An increase in the amount of money, without a corresponding increase in the supply of real goods means that prices rise – which is to say, inflation. (Conversely, when output increased during Britain’s industrial revolution in the 19th century, its prices declined because its money supply did not increase correspondingly.)

Perhaps the most famous inflation of the 20th century occurred in Germany during the 1920s when 40 marks were worth one dollar in July 1920 but it took more than 4 trillion marks to be worth one dollar by November 1923. People discovered that their life savings were not enough to buy a pack of cigarettes. The German government had, in effect, stolen virtually everything they owned by the simple process of keeping more than 1700 printing presses running day and night, printing money.

During the worst of the inflation, in October 1923, prices rose 41% per day! Workers were paid twice a day and some were allowed time off in the middle of the day to enable them to rush off to the stores to buy things before prices rose yet again. In other cases, wives showed up at work at lunchtime to take their husband’s pay and rush off to spend it before it lost too much value. Some have blamed the economic chaos of this era for setting the stage for the rise of Adolf Hitler and the Nazis.