What is Real Money?
By Steve Gillman
Those who are "hard money" advocates like to refer
to gold and silver as real money. They see paper currencies as
false money, of course, or at least those that are not backed
by gold, which includes all the currencies of developed nations
now. This is a very limited view, and in the end, money is as
valuable as people make it.
It's true that the dollar was at one time backed by gold.
It is also true that if a currency is fully backed by gold a
government or central bank cannot manipulate the money supply
so easily. Contrary to popular myth, though, this does not guarantee
the value of a currency, nor are all the effects of such a system
For example, if a currency is based on gold, and there are
major gold discoveries, the value of such "real money"
would drop because of the new supply. In fact, imagine if science
found a way to easily and cheaply extract the gold atoms found
in sea water. We could see the supply expand by a factor of ten
very quickly, thus destroying most of the value of a currency
based on gold.
Furthermore, an expansion of the money supply is difficult
when it is limited by the gold a government or central bank holds.
This may at first glance appear to be a good thing, but it isn't
necessarily so. Economies expand as more real goods are created,
and if the money supply doesn't also expand, the prices of everything
drop over time. Some people might like this, but not owners of
real estate and other assets. In fact, prices did drop for decades
in the late 1800's, exactly because the money supply could not
be easily expanded when based on metals. As you can imagine,
there would be some problems getting loans on homes and land
if their values were always falling.
Is Paper Money Just a Confidence Game?
It is commonly said that paper money or "fiat currency"
only maintains its value as long as people have faith in it.
That sounds very precarious as a system. On the other hand, the
same can be said of gold or silver. After all, you cannot eat
them, and few people have personal uses for these metals other
than as investments. In fact, although both metals have real
uses in industry, and so have some real value beyond just monetary,
much of the nominal value they have is only because of
the faith people have in them. Take away the investor demand
for gold and the price would plummet, even though it would still
have its industrial uses (silver is actually more useful and
so the price doesn't rely as much on investor demand).
Now, it's true that as a perceived value, gold has done better
historically than most currencies. We have much more confidence
that others will want our gold in the future than in others wanting
our dollars or pesos or rubles. But this does not mean that paper
currencies are destined to fail, even if most do.
Consider our current situation. As the Federal Reserve monetizes
the government debt, effectively creating more money than ever
in history, we are likely to see inflation eat up the value of
the dollar. On the other hand, this is a choice, and is not inevitable.
They could choose to be responsible, or future laws could prevent
such irresponsibility. And if the supply of money is grown at
a reasonable rate (in line with economic expansion), we have
no real reason to think that the dollar would become valueless
just because it isn't backed by precious metals or anything else
Part of what keeps the value of a currency intact is the web
of contracts denominated in that currency. You can't pay your
mortgage payments in anything but dollars, so you have to get
some. The same is true for your other debts, and for the agreements
among businesses. The trillions in contracts that are denominated
in a currency assure some demand for that currency. Add to this
the fact that by law you have to pay taxes in dollars, and you
can see that even though you can talk all day about how our money
is just worthless paper, you still want some.
Real money is whatever people readily accept in exchange for
real goods. And although a currency backed by gold might seem
much safer and less prone to the manipulations of an irresponsible
government, such irresponsibility makes any money suspect. After
all, how would we know if the gold was really there? With or
without precious metals or other things backing it, a responsible
government could maintain the value of any paper currency if
it decided to. That responsibility is what makes a sound currency,
not the gold or silver promised for the bills.