Money, money, money.
Why do we have money to begin with? Remember trading pigs for goods and services? And writing all your IOUs on a little piece of paper? Well, I suppose you personally may not remember, but you catch my drift. Money is supposed to make these types of things easier. Louis Carabini, fellow of the Ludwig von Mises Institute, eloquently states in his book Inclined to Liberty,
In a society without money, each producer would have to find
a complementary producer with whom to exchange goods and
services directly. With money as an intermediary, a producer
needs only to find someone who wants his goods or services. The
time devoted to searching for a person with a coincidence of
wants in a barter market can now, with money, be devoted
instead to the production of more goods and services. (35)
That’s why coins were so great. If someone wanted A and had B, and you just wanted B, you could “trade” him or her an amount of money with intrinsic value (meaning that it has value regardless of being considered money, like gold) for B. That person could then go buy A with the money you just supplied.
But what happens when “money” does not have intrinsic value– when what is exchanged is actually a promise to pay later, an IOU of sorts? This is definitely just as effective as supplying a coin or a bar of gold and these can be exchanged more easily, without having to break your back lugging around heavy precious metals.
Does this sound familiar? In the real world, these aren’t called IOUs, they’re called fiat money by economists, and American dollars by the global community.
These fiat dollars are only effective as long as their value remains constant. This is critical– who would want to accept a dollar as payment if it was depreciating in value each day? Money in general must maintain a steady value, granting the owner of the money a fixed purchasing power. If so, people can save their dollars and not have to worry about those savings losing their value over time.
These savings are important because contrary to popular belief, spending does not grow the economy. This is what many associated with the Occupy Wall St. crowd keep saying– that the consumers have the ultimate power because their purchases and spending fuel businesses to continue. That is partially true, but in essence, it’s putting the cart before the horse. Consumers need money to spend and where do they get that money? They get it from their jobs. You don’t need consumers to have business, you need business to have consumers.
In any case, it’s actually savings that can be used for capital investments, job creation, etc. Purchasing power stems from efficiency and production. Worker productivity is enhanced by capital, equipment and training, etc. which all available due to savings.
Savings also impact interest rates. Think of an interest rate as a price, dictated (as any other price) by supply and demand. The savings are the supply and the demand is the people wanting to borrow money. Therefore, if there are a lot of savings, interest rates go down because the supply is high. This signals to the free market that the majority of people prefer future consumption to present consumption.
The economy reacts, and people can borrow at low interest rates and make investments based on the assumption that consumption is deferred to tomorrow. On the other hand, when people are not saving their money, interest rates go up because supply is low. In the end, this reaches an equilibrium between saving and borrowing.
The problem comes in when the Federal Reserve can easily print more American dollars. As one can guess, this increase in the monetary supply sends out the false economic signal that there are more savings than actually exist. Interest rates plummet and as Peter Schiff, CEO of Euro Pacific Capital, says in his article The Fix Is In,
…ultra-low interest rates are among the biggest impediments currently preventing genuine economic growth in the US economy. By committing to keep them near zero for the next two years, the Fed has actually lengthened the time Americans will now have to wait before a real recovery begins. Low rates are the root cause of the misallocation of resources that define the modern American economy. As a direct result, Americans borrow, consume, and speculate too much, while we save, produce, and invest too little.
These booms are inevitably followed by busts, where all of these mistakes and “misallocations of resources” are corrected to balance the economy. However, the Federal Reserve urges the government to pass stimulus packages to avoid a recession. Some, like myself, believe that the recession (bust) is the cure to this perpetual disease. It’s like going to rehab and the rehab center giving its patients more drugs as its method of treatment. In the end, nobody gets better but still believes they are being cured.
If you have a few minutes, check out this video. Educational and fun!
Thanks for reading!