Currency as Debt: A New Theory of Money
An Introduction
Part 7 of 9
 

Throughout human history two forms of natural resources have dominated as forms of currency: gold and silver. These metals are indeed durable, and although existing in the physical world and subject to wear, do so at much slower rates than other commodities. Because both metals are commodities and require labor to extract and refine, they still can be consumed and therefore are forms of wealth. Furthermore, these commodities are not easily produced, requiring intensive labor to mine. These metals have served well as currency.

Therefore, instead of defining the fundamental unit of currency in terms of eggs, why not define that unit in terms of gold or silver? Indeed, that is exactly what many societies have done. That system worked well for centuries. Then something happened that nobody could predict—an industrial revolution.

That revolution had two indirect effects: 1) provided numerous goods and services, thereby increasing the division of labor, and 2) by increasing the division of labor, improved the quality of life for most people and thereby increased population.

As both division of labor and population increased, the commonly accepted form of currency—gold and silver—could not be mined fast enough to meet the need for currency. Although all currencies by definition are designed to be circulated in order to exchange wealth, there are limits to how fast any currency might circulate. That is, circulation cannot happen instantaneously. Fundamentally then, because the quantity of currency in circulation was relatively fixed, the exchange value of the gold and silver currency, with respect to the increased availability of goods and services and population, began to increase. There simply was not enough currency to circulate quickly enough to meet the needs of the growing economic society.

Numerous ideas were tried to alleviate the problem. All ideas contained some good elements of effort, but all failed. There are reasons why.

One of the first efforts tried establishing two arbitrary definitions for the fundamental unit of currency. The United States Congress, in its Coinage Act of 1792, established the fundamental unit of currency as the “dollar,” an arbitrary definition. That Act defined the fundamental unit in terms of silver. However, that Act also fixed the exchange ratio of gold with respect to silver. Although not defining the unit of currency in terms of gold, the fixed exchange ratio effectively established two arbitrary definitions.

Both silver and gold are commodities, the value of each commodity, with respect to each other, continually changes in a free market. Because of the fixed exchange ratio, this simple effect tended to cause one commodity or the other to disappear from the market as a circulating medium of exchange. People naturally are not going to use the currency with a higher exchange value when they can obtain wealth with a medium of exchange of a lower value.

The solution was actually rather easy: to eliminate the fixed exchange ratio between the two metals, and let the other commodity float in the market as a pure commodity. People still would be free to use either commodity as currency, but the exchange value of that second commodity would be determined by the free market.

Another idea valiantly tried was to circulate paper currency. Few people will deny that a paper currency is more convenient and transferable than specie. Unfortunately, the means in which that paper currency circulated contained a flawed idea. That paper was printed with a specific promise to be exchangeable in another form of currency. That idea alone is a good idea because all popular currencies in use must be readily exchangeable with one another. However, the manner in which paper currency became exchangeable was by compelling the specific exchange value of that paper with respect to a commodity currency.

The intent of the plan was reasonable: to ensure that the paper currency could not be easily inflated. Doing so would be the equivalent of our small example society producing more eggs than were needed to help exchange goods and services.

Eventually both ideas were corrected. That is, the fundamental unit of currency was defined in terms of only one commodity, and the exchangeability of the paper currency was not defined in terms of a specific amount of that same commodity.

But other challenges arose.

Although the paper currency was correctly allowed to float in the free market with respect to the fundamental commodity definition, eventually that relationship was destroyed. That is, the original commodity definition was lost in the shuffle. Secondly, just like our egg example, nobody could prevent the original issuer of that paper currency from printing more than was needed to circulate in the market.