What is Money

Desirable properties of money Intrinsic value Easy to measure Slow in decay of value

Intrinsic value Value is a function of scarcity Value is a function of effort Value is a function of energy The relation between scarcity, effort and energy

scarcity Historically, money is gold, silver or copper, which are scarce.

The scarcity of commodities ElementPercent by weight of earth’s crust Gold Silver Copper0.007

Scarcity and Value Among gold, silver, and copper, which is most expensive, which is least expensive? Why?

Price of commodities Gold ($US per Troy oz.) Silver ($US per Troy oz.)13.62 Copper ($US per lb.)3.59 or Copper ($US per Troy oz.) Troy ounce = g, lb = 454g

Scarcity and Value scarcityprice inverse of scarcity (normalized) Gold Silver Copper

Scarcity and Value (update at Jan 22, 2008) scarcityprice inverse of scarcity (normalized) Gold Silver Copper

Effort Some products need a lot of effort, such as rope, grease, which are used by BC native people as money or stone on Yap island. (Stephen Hawrys, Eric Muller and ) If a product needs a lot of effort, it will be scarce. Hence effort and scarcity is highly correlated.

energy A system tend to move from less probable state to a more probable state. This tendency is the energy source for all living organisms. A system of low probability is scarce. Hence scarcity is often equivalent to energy source for human beings, which we value very much.

Equivalence of scarcity, effort and energy A commodity is scarcer needs more effort to locate them. More effort is highly correlated to more energy. Hence, scarcity, effort and energy resource are largely equivalent.

Money not backed by intrinsic value For most of the history in most places, money is represented by means with intrinsic value. It is only in brief periods, money is not explicitly represented or backed by means of intrinsic value. We are in such a period now. We will discuss later the consequences of paper money not backed by means of intrinsic value.

Easy to measure Gold, silver become universal representation of money not only because of their scarcity, but also or mainly because of their easy measurability. It is easy to measure the purity of gold and silver, difficult to counterfeit.

Standard coinage Standardized gold and silver coins are even easier to measure than gold and silver bullions. Hence coins become money, which reduces the transaction cost. Coins, instead of the weights themselves, become the measure of value, which increase the temptation to debase metal content of the coins. The debasement of metal content provides an easy financing to the government.

Tradeoff between easy to measure and intrinsic value

Slow to decay Most metals will rust. But gold and silver are not very reactive. Fresh fish or meat degenerate very fast. But grease is stable. Hence grease becomes money. This is also why it is so difficult to lose fat.

Evolution of monetary systems In the early stage, resources are abundant and governance is easy. In late stages, with the resource depletion, government finance becomes increasingly difficult. Debasement of coinage or currency. War and famine greatly reduced population and consumption level, which enable natural resources to regenerate themselves. A new cycle starts.

Modern Monetary system: Bretton Woods system After WWII, USA emerged as the dominant force in the world. Major currencies pegged to US dollar US dollar fixed at 35 dollar per ounce of gold. So US dollar is “as good as gold”.

The decline of a dominant power The currency of a dominant power is in such a great demand that it is tempting to print money instead of doing the real hard work. In 1958, US balance of payments swung negative. Other countries hold more and more dollars, there is a pressure for them to redeem gold at 35 dollar.

In 1971, costly Vietnam war, US government print money to finance it. Nixon announced dollar no more convertible to gold. Today, gold is over 700 dollars per ounce.

Related events US oil peak at 1970 Arab Oil embargo 1973.

Currency peg: advantages and disadvantages

Homework Chapter 3. 2, 4, 6