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What Is Money?: Crash Course Chapter 6

The world revolves around it, but it's poorly understood
Friday, July 25, 2014, 10:52 AM

Chapter 6 of the Crash Course is now publicly available and ready for watching below.

Money plays an incredibly large role in the world, but yet it remains poorly understood. What exactly is it? What do the pieces of paper we hold in our wallets and bank accounts actually represent?

Developing an understanding of the underlying role of money allows us to better see when it is being used properly, or abused. And history shows that abuse is more the norm than the exception: the record shows over 3,800 previous examples of paper currencies that no longer exist.

The next several chapters of the Crash Course will show how money is currently being created and (mis)managed by the world's central planners, and why it's prudent to consider taking measures now to protect your wealth from a possible global currency crisis.

For the best viewing experience, watch the above video in hi-definition (HD) and in expanded screen mode

Coming next Friday: Chapter 7: Money Creation: The Fed

For those who simply don't want to wait until the end of the year to view the entire new series, you can indulge your binge-watching craving by enrolling to PeakProsperity.com. The entire full new series, all 27 chapters of it, is available -- now-- to our enrolled users.

Enrolled users can access the new series at www.peakprosperity.com/crashcourse

And for those who have yet to view it, be sure to watch the 'Accelerated' Crash Course -- the under-1-hour condensation of the new 4.5-hour series. It's a great vehicle for introducing new eyes to this material.

Transcript: 

Before we begin our tour through the Economy, the Environment, and Energy, we need to share a common understanding of this thing called money.

Money is something that we live with so intimately on a daily basis that it probably has escaped our close attention, which is why we are going to dedicate a few minutes to the subject now.

Money is an essential human creation, and, were all money to disappear, a new form of money would spontaneously arise in its place, such as cows, tobacco, bread, a certain type of nut husk, perhaps, or even nautilus shells.

Today there are other forms of money such as airline miles and bitcoins. Each of which are ways for people to accumulate, store and then spend other intangible things that behave exactly the same as paper Dollars, or Euros, Yen, or Rubles, or Yuan.

Without money, the complex job specializations that we have today would not exist, because barter is so cumbersome and constraining. More importantly, though, is the concept that each type of money system has its pros and cons – each will enforce its own peculiar outcomes by promoting some behaviors while punishing others.

Now, if we crack open a textbook, we’ll find that money should possess three characteristics. The first is that it should be a store of value. Gold and silver filled this role perfectly, because they were rare, took a lot of human energy to mine, and did not corrode or rust. By contrast, the US dollar pretty much constantly loses value over time – a feature which punishes savers and enforces the need to speculate and/or invest.

A second feature is that money needs to be accepted as a medium of exchange, meaning that it is widely accepted within a population as an intermediary, within and across all economic transactions.

And the third feature is that money needs to be a unit of account, meaning that the money must be divisible and each unit must be equivalent. The US “unit of account” is the dollar. And each is identical to any other. Diamonds have much value, but are not good at being ‘money,’ because they are not perfectly equivalent to each other and dividing them causes them to lose value. That is, they fail at being a unit of account.

Blah blah blah….

So what is money, really? I believe in a very simple definition.

Money is a claim on human labor.

With a very few minor exceptions, pretty much anything you can think of that you might spend your money on will involve human labor to bring it there. I say it’s a claim rather than a store, because the human labor in question might have happened in the past, or it might not have happened yet.

The concept of money being a claim on human labor is important, and we’ll be building on it later, especially when we get to debt.

As implied in the picture series earlier, literally anything can be considered money – cows, bread, shells, tobacco. A US dollar, like all modern currencies, however, is an example of a type of money called fiat money. “Fiat” is a Latin word meaning “let it be done,” and fiat money has value because a government decrees that it does.

And this brings us to the key question: What exactly is a US dollar?

Once, a dollar was backed by a known weight of silver or gold of intrinsic value. In this example, we can see that the dollar came from the US Treasury directly and was backed by a given amount of silver that was payable to the bearer on demand.

Of course, that was back in the 1930’s, and those days are long gone. Now dollars are the liability of the Federal Reserve, a private entity entrusted to manage the US money supply and empowered by the Federal Reserve Act of 1913 to perform this vital function.

You’ll note that modern dollars have no language entitling the bearer to anything, and that’s because they are no longer backed by anything tangible. Rather, the ‘value’ of the dollar comes from this language right here: The fact that it is illegal to refuse to accept dollars for payment and that they are the only acceptable form of payment for taxes.

It is crucially important that a nation’s money supply is carefully managed, for if it is not, the monetary unit can be destroyed by inflation. In fact, there are over 3,800 past examples of paper currencies that no longer exist. There are numerous examples from the United States, which may have some collector value, such as the Greenback, but no longer possess any monetary value. Of course, I could just as easily display beautiful but no longer functional examples from Argentina, Bolivia, and Columbia, and a hundred other places

How does a hyperinflationary destruction of a currency happen?

Here’s a relatively recent example that comes from Yugoslavia between the years 1988 and 1995. Pre-1990, the Yugoslavian dinar had measurable value: You could actually buy something with one. However, throughout the 1980’s, the Yugoslavian government ran a persistent budget deficit and printed money to make up the shortfall.

Does this sound familiar?

By the early 1990’s, the government had used up all its own hard currency reserves, and they proceeded to loot the private accounts of citizens. In order to keep things moving along, successively larger bills had to be printed, finally culminating in this stunning example – a 500 billion dinar note. At its height, inflation in Yugoslavia was running at over 37% per day. This means prices were doubling every 48 hours or so.

Let me see if I can make that more concrete for you. Suppose that on January 1, 2007, you had a penny and could find something to purchase with it. At 37% per day inflation, by April 3, 2007 you’d need one of these – a billion dollar bill – to purchase the very same item. In reverse, if you’d had a billion dollars on January 1st stuffed in a suitcase, by April 3rd you’d have had a penny’s worth of purchasing power left.

Clearly, if you’d attempted to save money during this period of time, you’d have lost it all, so we can safely state that inflationary money regimes impose a penalty on savers. The opposite side of this is that inflationary money regimes promote spending and require that money be invested or speculated, so as to at least have the chance of keeping pace with inflation. Of course, investing and speculating involve risks, so we can broaden this statement to include the claim that inflationary monetary systems require the citizens living within them to subject their hard-earned savings to risk.

That is worth pondering for a minute or two.

Even more importantly, since history shows how common it is for currencies to be mismanaged, we need to keep a careful eye on the stewards of our money to make sure they are not being irresponsible by creating too much money out of thin air and thereby destroying our savings, culture, institutions, our political systems by the process of inflation.

Wait a minute. Did I just say ‘creating money out of thin air’?

Yes. Yes, I did.

That is such an important process to your, our, my future that we’re going to spend the next two sections learning about how money is created.

If you’re ready, proceed to the next section.

Please join me for Chapter 7.

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10 Comments

Arthur Robey's picture
Arthur Robey
Status: Diamond Member (Offline)
Joined: Feb 4 2010
Posts: 3936
Miffed. (And Proud)

Thank for the refresher and it will be so much better when Zimbabwe gets an honorable mention.

I mean, what does a leader need to do to be noticed?

I wonder what they are doing over there now? Same old, same old I suppose;  rolling someone. It is what they do. Has anyone told the Chinese how the Zimbabweans see them?

I'll bet that the prey imagines it is the predator. Hard lessons to be learned there, Premier Li Kiqiang. It is going to take at least 5 generations in Africa before you can begin to follow the bouncing ball.

Australia thought that now those pesky Rhodesians were out of the way they would be able to plunder the platinum from the obviously inferior blacks. (Their unspoken assumption, not mine.) When BHP discovered the magnitude or their mockery they left in high dungeon quoting a politically correct "Cultural Incompatibility".

It makes me proud of my countrymen.

 

justiceseeker's picture
justiceseeker
Status: Member (Offline)
Joined: Jul 27 2014
Posts: 1
International monetary System

If you really want to understand money and not currency ( Fiat) then I welcome you to watch this video by a very renown  muslim scholar named: Imran Hosein He is tan expert on the subject if Economics, International relations, and International Monetary Fund.  He is worth of a try regardless of your creed and background.

 

enjoy,

Justiceseeker

Bankers Slave's picture
Bankers Slave
Status: Platinum Member (Offline)
Joined: Jul 26 2012
Posts: 523
Creditors in Commerce for more down the rabbit hole money info.

http://creditorsincommerce.com/videos-watch-cic-lt-001

PeteBKK's picture
PeteBKK
Status: Member (Offline)
Joined: Jul 4 2014
Posts: 14
Imran Nazar Hosein: The International Monetary System

Thanks Justice for posting - a very informative video. Sheikh Imran's views and religious take on the collapse of the USD has strange bedfellows in the likes of Mike Maloney, Max Keiser, Jim Rickards, Edward Griffin, Peter Schiff and of course Chris Martenson amongst many others.

I am not a Muslim but do see the merit in investing in Shariah compliant mutual funds. Not only are they morally more grounded but are of less risk forbidding portfolios to invest in derivatives or otherwise prevent fund managers gambling with your investment.

Jim H's picture
Jim H
Status: Diamond Member (Offline)
Joined: Jun 8 2009
Posts: 2391
Bank account holders as unsecured creditors

Thank you for the new intro to money.. I really look forward to the companion pieces to come. 

Understanding money is so important;

*  Why real assets?

    -  You won't truly appreciate the value of real assets until you appreciate the ephemeral nature of fiat money. 

*  Financial repression and negative real yields on saved capital.

    -  why money saved in a bank is in peril

A new piece by Jim Willie gets to the root of why your money in the bank is in peril if and when the derivatives counterparty bombs start going off;

  http://www.silverdoctors.com/jim-willie-derivatives-meltdown-looms-gold-...

The far more onerous and deceptive side of the Reformed BK Law is seen in provisions for the financial institutions. The failure of big banks or other large financial institutions would never again be a simple failure, with liquidation, with trustee management, with a hierarchy of losers. The entire hierarchy was quietly altered, but with almost zero publicity. It took many alert analysts a few years to discover the fine points of the revised law.

The new law dictated the derivatives would be first in seniority for satisfaction during any bankruptcy proceeding. The truly sadistic element of the new law was the accounting classifications, whereby depositors are called “unsecured lenders” to the bank, while derivative owners are called “secured lenders” to the bank. Hence, the depositors like with CD or passbook savings accounts no longer own their accounts. They technically lend their deposits to the bank and are permitted to withdraw them with interest, provided the bank is sound. The depositors found themselves to be last in line during a failure, the disadvantaged class from the Reformed BK Law.

Individuals stand behind the derivative owners. The US public had no idea what happened on the financial firm pecking order, and still largely does not. If a big bank fails, or a major mortgage firm fails, then the derivatives are handled first, and then depositors are given crumbs left on the floor. Most analysts believe the depositors will be wiped out, as the derivatives will find some salvage. It is accurate to say that the Bankruptcy Reform Act ushered in the Bail-in concept long before Cyprus hit the scene in 2013.

 

 

 

Arthur Robey's picture
Arthur Robey
Status: Diamond Member (Offline)
Joined: Feb 4 2010
Posts: 3936
A Heretic Comes out the Closet.

I cannot escape the feeling that we have got the picture all wrong by extrapolating the rear-view mirror into the future.

My nagging feeling is this "What if this time it is really different?" Here we go into the unknown unknowns, dancing along the abyss of ignorance.

We have all sort of infinite asymptotes converging at the same moment. How can we be sure of our mathematics when dealing with infinities? I am talking about the non-linear decrease in entropy (Someone invent a word for it), the Singularity and whatever else we are ignorant of. These is left out of the Big Picture.

My impression of the singularity is that it is already upon us. Various materialists have punted a wishful machine immortality, but that is because they have not done their homework and need to catch up with post 1990 physics. (You are real, the "physical world" is not.)

What does all this mean to money? Money is a way of keeping score. What if the things future generations hold dear to their hearts are not "material" in the classic sense of the world?

All Grist for my Mill.

davefairtex's picture
davefairtex
Status: Diamond Member (Online)
Joined: Sep 3 2008
Posts: 5687
derivative holders trump depositors

JimH-

My understanding is totally in line with this too.  That's what happened with AIG - they wrote (essentially) a whole lot of naked puts, and when their credit rating was downgraded, the buyers of those puts were able to demand that AIG immediately cough up assets to back up all the puts they wrote.

Once the collateral was gone (i.e. once AIG was stripped bare of liquid assets by derivative holders), that was all she wrote.

If we assume this happens in a bank that has a trading room that is playing the derivative game and there is a "credit event", derivative holders will demand assets in much the same way, stripping the bank of its assets right up until the day it declares bankruptcy.  Liabilities (to depositors & bondholders) will remain, but the assets will be gone.

So first order of business: don't be an unsecured creditor (i.e. have your deposits) at a bank that writes credit default swaps.

That would be: BOFA, Citibank, JP Morgan.

However, I don't think this has changed very much from times past.  Depositors were always unsecured lenders, as far as I know, while the secured lenders were bondholders whose debts were specifically backed by the assets of the company.  Now derivative holders are secured too, because that's how the derivative contracts have been written up.  Good if you hold derivatives, less good if you're a depositor and don't realize you're relatively low on the priority list.

 

pat the rat's picture
pat the rat
Status: Silver Member (Offline)
Joined: Nov 1 2011
Posts: 125
slow down

Some one new may not grab the concept that fast ? The pace is quick.

therooster's picture
therooster
Status: Member (Offline)
Joined: Oct 3 2011
Posts: 20
Gold is money, but not always

Gold bullion, denominated by its weight is now real-time currency with debt-free store of value characteristics married with real-time scalable liquidity. The debt free store of value is a classical feature but that didn't make gold a very good currency, historically speaking. A currency must have good liquid properties. The reason that gold didn't have good currency properties in systems of the past was not because of bullion, however. It was because of a lack of liquidity based on FIXED & PEGGED values associated to bullion (such as $35/oz) and the lack of digital infrastructure for distribution purposes. We can now digitize weight as a unit of account for reserved gold and this can be a decentralized system. Gold is real-time currency in the 21st century.

 

You cannot pour new wine into old wineskins.

pinecarr's picture
pinecarr
Status: Diamond Member (Offline)
Joined: Apr 13 2008
Posts: 2259
Good insight on derivatives' use to artificially suspend economy

http://www.silverdoctors.com/jim-willie-derivatives-casino-is-wobbling-tower/

I'm not as savvy about financial instruments as many readers of PP.  So for others like me, I found that this interview with Jim Willie, on Silverdoctors.com, helped me get a better handle on how derivatives are being used to artificially hold up the economy  (the demand for bonds).  (Apologies to JimH if this is repeats what was said in the Jim W interview you posted above.)

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