It’s a simple question.
But it is one that 95% of people will answer wrong. Don’t feel bad. I would have as well if you were to have asked me 10 years ago.
Ans: They are not the same thing.
Those in power would like you to think of them as the same thing. In fact, we have been taught since we were children that they were the same. That is, if you were lucky enough that they taught you anything at all about money in school (more than just recognizing coins and dead presidents faces that is).
IT’S TIME TO DISPEL SOME MORE MISCONCEPTIONS ABOUT MONEY…
Working with Bitcoin (and having worked for more than 14 years in Wall Street’s top 2 firms) I have quite a unique perspective on money and finances. Being around the ‘heart’ of the capitalist machine sure makes one really cognizant of what money is. And these little secrets that we learn we generally do not speak of openly often as the whole business of Wall Street is to profit off the ignorance of others. There’s almost a masonic code or ritual that permeates all such knowledge and those who possess it, minus the goats.
I had previously written at length about the nature of money, but I admittedly put it as a digression on a much larger piece on Bitcoin maximalism. I felt that it was a topic that deserved it’s own discussion, as it is central to the issue of crypto-currencies, so today I will attempt to rectify the injustice done.
MONEY vs CURRENCY
Money is at it’s most basic, a medium of exchange, and a store of value. We need money to ‘bridge the divide’ that we would suffer otherwise given the misalignment of wants and needs given a pure barter system.
Currency is simply a medium of exchange. Normally this means the notes and coins issued by a central bank or government. Generally the kind we use today is known as “fiat” money as it is money only be “decree” (a fancy word for law, which is in turn, a euphemism for “threat of violence”).
Money by decree only has value because somebody is promising to enforce its exchangeability for goods or services. Its ability to store value is bestowed to it by law.
Currency, when properly employed, act as a form of money.
But, money need not be fiat money, in fact fiat money has been used many times in history, usually due to shortage of real money or due to a governments need to pay for wars with wealth that it did not currently possess. All attempts at using fiat money in the past, have failed with hyperinflation and devaluation into worthlessness. In contrast, commodity money (or what some refer to has real or ‘hard’ money) have always been the default form of money which has been employed since the advent of civilization, from salt and oxen to bushels of rice to gold and silver coins. Why this is so has something to do with the basic nature of money.
Now, I’m going to tell you something that is one of those ultimate truths that if you fully grok, many things start to make sense: Regardless of the form of money, the value of any money derives from trust.
MONEY as TRUST
Fiat money is based on the trust that the government will enforce the exchange of items in the value written on a piece of paper to those who bear it.
Commodity money is based on the trust that the commodity will be worth something to someone else at a future time. Therefore, commodity money’s store of value quality, is intrinsic to the commodity itself. Some commodities have a better store of value than others, but it depends on its intrinsic properties, not by decree.
So now that you know that a money’s worthiness depends on the trust that it is a proxy for, think about how much you trust your government’s ability to enforce the value on it’s fiat money. Even if the government has all but the best of intentions, it is a complicated task to manage the creation and deployment of money, with politics, lobby groups, public opinion and campaign contributors who’s favours need to be curried. A task that is not made any easier by the fact that the issuers of currency is not even the government itself, but a privately owned central bank. (More on this later)
Compare this to the trust that you need that something like an ounce of gold will be valued by someone as something worth trading for in the future. Theoretically, equally as illogical, as nobody can feed themselves with gold alone. But time and time again, gold has shown to defy all logic, and has been the goto money when all other forms fail. Why? This is because gold the metal itself is useful, as a medium of exchange and a store of value. Not a perfect one, given the fact that mining, refining, and storing it is a labour intensive process, but good enough to suffice when times are bad enough. This shows that anything that possesses the characteristics and qualities that make it good as a medium of exchange and as a store of value, can be valuable in and of itself — it’s usefulness as a money. What happens to make commodity money better than fiat in this regard is that its store of value feature is less dependant on politics or human mismanagement.
MONEY as PROMISES
Promises also are evaluated on trust. You value a promise from someone that you trust more than a promise from a stranger.
One very important result of realizing that money’s value has its basis in trust is that you realize that you can think money conceptually as promises. When I give you money in exchange for a blueberry pie, I am giving you an open and indirect promise to repay you later with something of requisite value. Indirect, because it need not be I who will give you the ultimate item that you desire later on in exchange for this money. Open, because you are free to transfer this promise to anyone you wish. It is tempting to think of a promise as a debt, but this is only the case if the promise has no intrinsic value in and of itself, and as we have seen, commodity monies do have intrinsic value. (That’s why we have never needed any government or authority to enforce its value!)
Commodity money is a promise that bears no debt. It is more pure. It requires much less trust, as the only thing you need to trust is that people will find it valuable in the future. For somethings like gold we know that 6000 years have taught us that humans hold an intrinsic value for the shiny yellow metal. For other commodity monies like Bitcoin that trust of future value is less certain, but one can argue that it may be more trustworthy than the promise of a fiat money of an unstable government or one that seems to be mismanaging its finances.
FIAT MONEY is DEBT
Fiat money is also a promise. As it has no intrinsic value, it is also a debt (or an IOU). If the government prints money they are magically creating more promises that any receiver of the money in the future needs to make good on. If they create too much money then they essentially create more promises than the economy as a whole can pay, and the result is things get more expensive (inflation). Let’s say that they create 100 billion dollars and use it to build a new space elevator. It seems like a worthy thing to do. The people and companies that they pay to build the space elevator will have more open indirect promises that they can use to claim goods and services from others in the economy, say to buy a new house with, which then gets passed on to the house builders, and so on. This is ideally how fiat money should be used, as the initial stimulus from the creation of money has generated productive work trickling down throughout the whole economy. Of course, if the government prints money to fight a war overseas, not so much. All that happens is a redistribution of wealth from the people who get the money last to the companies and people who get the money first from the government, usually military contractors in this case. Given that government spending always causes a redistribution of wealth, we should highly scrutinize those who would be the benefactors of this wealth redistribution. Is what they are doing or producing worth rewarding them with this new wealth?
If the above scenario didn’t sound worrying enough, the last little known secret about fiat money will certainly surprise you: the government can’t even create money itself. It hasn’t done so since 1913*. A private banking consortium known colloquially as the Federal Reserve Bank does. Similarly, central banks around the world do the same. They do not answer to the government, and they lend the government money, by buying government bonds with money that they have the sole right to create. They make a profit on this lending (at zero risk), and although they do return some of the profits of this money creation business back to the treasury, they essentially create money with debt attached to it, debt which the government has to eventually pay back, with future tax revenues. If every $1 that is created, needs to be paid back with $1.05 from future tax revenues that means the total amount of promises that are borne by the system is constantly growing. Additionally, every time fiat money is lent out at interest, more debt is created. Promises, which beget more promises… I sure hope we have enough people and productivity to make good on all these promises!
Now it should be clear why the economy needs to constantly grow, lest we all fall into a recession or depression, and the whole thing may unwind, with a lot of promises broken, trust lost, and people going bankrupt and unable to pay for basic needs.
Money is a SELF FULFILLING PROPHESY
So, which form of money is better? Simple, the one that better fulfills the requirements of a good money, i.e. good medium of exchange, and a good store of value. Given that any money must be an accepted medium of exchange to even warrant consideration, the conclusion is that the most important feature of money in question here is its store of value quality. Now how well a money performs as a store of value is a direct function of the trust that is required of you, the user, to have in it. With fiat money you have to trust that your government will be able to repay all its promises, including future debts, with future taxes/productivity (yours and mine!) and also trust that other people also to come to the same conclusion, rationally or otherwise. With commodity money you just need to trust that other people will continue to consider the commodity valuable for whatever reason. So what relative valuation would you give these contrasting trust relationships? In which money would you prefer to store your trust?
(Keep in mind that if enough of you chose the latter, then it won’t matter what others choose, if you catch my drift).
*in USA, in Europe even earlier.
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