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Suppose you have $80 in silver coin, which is all the
currency in the world, and you spend it producing a valuable product that
according to your market analysis should sell for $100. But there is only
$80 in the entire world’s economy so you can’t possibly sell your
product for more than that. And if you knew that before you started
expending your efforts to produce the product, you never would have
started production. But without production, the world’s economy
collapses. Doom and gloom prevail.
This illustration exemplifies typical micro-static
arguments encountered in the study of monetary policy. That is, the idea
that the market value of production output cannot exceed the total
currency in circulation. The conclusion of that argument is based on two
assumptions:
- That all commercial transactions are completed instantaneously, and
- That a fixed amount of currency limits the size of a commercial
transaction.
Both assumptions are false.
You are due a paycheck on Friday as payment for your labor for the
week, and at the end of the month your mortgage payment and household
bills are due. Both examples quickly expose the fallacy that all
commercial transactions are completed instantaneously.
In any realistic economy, currency circulates in the time domain. A
single coin might change hands several times in a year. Someone works for
you and you pay him $1 for his labor. He uses that $1 to buy food from a
third person. She uses the same $1 to buy fuel from you. There was only $1
used in this example but it changed hands three times, generating $3 worth
of commercial activity. If every coin in the $80 example changed hands on
average 10 times in a year, the $80 in silver coin would support an $800
annual economy. An $800 economy does not mean there is $800 of actual
currency in existence.
With this understanding you can now sell a product for $100 in an
economy with only $80 of currency in circulation. You could sell your
product and agree to accept payment of $5 per month for the next 20
months. Each month you receive the $5 in payment and each month you spend
that same $5 back into general circulation. Each month the purchaser of
your product earns $5 from the general circulation from which to pay you.
On a much larger scale, Annual Gross Domestic Product, GDP, is the sum
of all commercial transactions taking place in a single year. Normally
this number exceeds the total volume of currency in the economy. For the
United States, a little more than $3 Trillion supports a $9 Trillion
economy. That means a typical dollar changes hands—circulates—throughout
the aggregate economy three times in a year. If the typical dollar
circulated only once every three years, the U.S. would have only a $1
Trillion annual economy. Such examples show that the total dollar volume
of commercial transactions each year is not directly related to the total
quantity of currency, but to the quantity of currency times its average
rate of circulation.
Why are such exchanges possible? Because according to the classical
definition of money, money is anything that is used as a medium of
exchange. More importantly, money is a psychological
creation; a concept; the mental image of that which is used as a medium of
exchange. A medium of exchange is an intermediate used during trade or
commerce; an expediency accepted in an exchange; that which is used as
money in an exchange. Currency is that intermediate “thing” that
circulates as a medium of exchange; anything that is in immediate,
continuous and widespread use as money.
In other words, people do not exchange money or currency, they exchange
wealth. Wealth is ownership of labor, and of anything upon which labor has
been expended, whether material or immaterial, which can directly satisfy
human wants, needs or tastes. That is, wealth is goods and services
(property) owned. The thing used to represent the concept of money merely
serves as a temporary claim check for future exchanges of wealth. Currency
is the grease that facilitates these exchanges. Therefore, by definition,
currency—the thing used to represent the concept of money—circulates
as people exchange wealth. Thus, in any economic community, the minimum
monetary requirement is enough currency in circulation to satisfy that
community’s need to exchange wealth. Fundamentally then, all currencies
are backed by goods and services.
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