Sarah Wendell What is Money?

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The Ring of Fire

and the

Money Supply


Sarah Wendell

What is Money?

Once upon a time, back in pre-history, a person accepted something that he had no use for in exchange for goods or services. He did this with the intention of trading the item to someone else for something that he did want. That was the first step: but it wasn't money, not quite, not yet. That first item accepted may have been a pretty rock, a seashell or a leaf. The best guess is that the item was something of aesthetic value. It was goods of a sort. Something about it had trade value. The next step, the one that made it into money, was when someone was persuaded to take something that had very little to no trade value in exchange for something that did have value. In effect, the something was sort of an open IOU. It was probably an accident. Someone; call her Anne, gave someone else; call her Betty, an IOU. Then Betty gave the IOU to a third person; call her Carol. When Carol showed up at Anne's cave with the IOU, Anne honored it. Thus, money was born. Money’s mother was trade and her father was debt.
For something to become money it must meet two criteria: It must not be something that the person accepting it ‘wants’, and that person must have the expectation that it can be traded for what he does ‘want’. If you don’t expect that you will be able to trade it for what you want, you will not accept it. If it is something you do want, it is goods, not money. Here is the sneaky part. What the above describes is a debt, not a commodity.
That is all an item needs to become money. For an item to work well as money over any length of time, the item needs a third thing – scarcity – or more accurately, a controllable supply of the item.
Intrinsic Value
There is a common belief in 'intrinsic value', but it's just that - a belief. There really is no such thing as intrinsic value anymore than there is ‘intrinsic beauty’. Value, like beauty, is in the eye of the beholder and not inherent in the thing. Anything can be used for money except especially useful things. Useful things eventually reach someone that has a use for them and fall out of the money supply. The use of goods as money, especially expendable goods, like tobacco in early America, or cigarettes in up-time prisons, is a good sign that an economy is not really working right. The use of goods as money is a hallmark of an economy of distrust. Mostly, this happens in dependent or primitive economies where trade is limited and not that complex. Using useful things as money always means that real money is unavailable or not trusted.
Money has value because people accept that it has value. If money is too easy to get, people will stop accepting that it has value. People often believe that gold and silver have been used as monetary metals because they have 'intrinsic value'. In fact, their 'intrinsic value' is because they have been used as monetary metals for a long time. The first recorded gold coins needed a guaranty that the government would exchange the coins for goods before the coins were accepted. In this first recorded use of gold coins, the guaranty was ten goats per coin. The king had to make this promise to get people to accept the silly little pieces of yellow metal.
Before the Ring of Fire, I saw a movie called “Earth Girls are Easy”. A girl in the movie wore earrings made from her dad’s credit cards. Using gold to make jewelry is a bit like cutting up a credit card to make jewelry, or using hundred dollar bills as wallpaper. Doing these things advertises wealth. It doesn't hurt that gold is easier to work than iron, but lead is also easier to work than iron. When we talk about the beauty of gold, well, we're back to ‘beauty is in the eye of the beholder’. How much of that beauty is a reflection of perceived value? Gold was not chosen as a monetary metal because it had value. That happened later, because it was a monetary metal. The reason gold first became a monetary metal was that it was easy to mint and not all that useful. The reason gold stayed a monetary metal is that it had naturally occurring limits on the supply.
Limited supply can be achieved in a number of ways. The limit does not need to be natural. Another show I saw, either a National Geographic special or on the History Channel, showed a tribe in Africa, or maybe South America, as an example. This tribe used leaves as money. The leaves were scraped and dried by the older tribeswomen to make the money. In that case, it was the effort of the women that limited the supply. Additionally, restrictions on which people were allowed to scrape the leaves added to the limited supply. I think only widows were allowed to scrape the leaves, but I'm not sure. The trees on which the leaves grew were common to the region. This unnatural limit also acted as both work and an old age pension for the ladies of the tribe. Note that if the leaves had a medicinal value or were good food, the natives of that area would probably have found something else to make into money.
Gresham’s Law requires a law.
Gresham’s Law states that "Bad money drives out good" but Gresham was talking about a specific situation.

Gresham’s Law was formulated by Sir Thomas Gresham to explain to Queen Elizabeth I what was happening to the English shilling. Henry VIII had adulterated the English shilling, by replacing 40 percent of the silver in the coin with base metals. Of course, the adulteration was discovered and this ‘bad money’ drove out the pure silver shillings then in circulation. People would save the good shillings and circulate the bad ones; hence, as Gresham observed, the ‘bad money’ (Henry’s adulterated coinage) would be used whenever possible, and the good coinage would be saved and disappear from circulation.

For Gresham's law to work, you need two kinds of money, one that is perceived as ‘bad’ and another that is perceived as ‘good’. You also need a law, or some other force, that requires the person selling something to accept the bad currency in exchange for what they are selling, and to accept the bad currency at the same rate that he would accept the good money. Don't lose track of the importance of perception here. The perception of the populace in England at this time was that a high silver content was good and a low silver content was bad. This perception is what made the ‘bad money’ bad and the ‘good money’ good. Money is all about perception.

One other thing is needed to for ‘bad money’ to drive out ‘good’. There has to be enough bad money in the economy that the ‘good’ money is not needed. If the total money supply is needed by the economy the 'bad money' and the 'good money' will circulate together quite well. In other words for ‘bad money’ to drive out ‘good’, you need to be in, or on the edge of, an inflationary situation.

Gresham's law simply doesn't work if there are two or more kinds of money trading in a free market. This is because the seller will not accept the ‘bad money’ or will only accept it at a lower rate. For those of us in the Ring of Fire to invoke Gresham's law we would have to make a law that set the exchange rate and then we would have to enforce the law. We cannot enforce this type of law and have never tried to do so. My Dad does say that in the early days of the Finance Subcommittee, some people wanted to make this kind of law.
A better statement of Gresham’s law might be "People prefer to give bad money and get good money." However; even that doesn't describe what really happens. Different people have different views on what makes money ‘good’ or ‘bad’. Those viewpoints affect each other. When everyone seems to want a particular type of money, that perception will make that particular type of money worth more.
Money and Cash
In the tribe where the ladies made the money by scraping the leaves, the amount of money and the amount of cash were the same. That was not true in the up-time world, and it wasn't true in Grantville the day after the Ring of Fire either. In the rest of Europe, at the time of the Ring of Fire, it was sort of true that the amount of money and the amount of cash were equal. Paper was being used, in the form of bills, invoices, and letters of credit. These papers mostly reflected coins sitting in a vault somewhere. Those papers that didn't reflect coins mostly reflected goods in a warehouse somewhere. On the other hand, there was fractional reserve banking, so even before the Ring of Fire, quite a bit of the paper represented paper which represented paper which represented coins. {So I guess, when you get down to it, it wasn't true in the rest of Europe either at least not in the business world it. Most people thought it was though, and a lot more of the money was cash then it was up time.} ******What? First sentence is incomplete. What is the ‘it’ you are referring to in both of these sentences? Maybe: So, I guess that the amount of cash and the amount of money weren’t the same in the rest of Europe, or at least not in the business world. Still, most people thought that the amounts of money and cash were the same. There was a lot more real cash downtime than there had been uptime.” I’m not sure I made that clear, but hope you get my drift.)******

Cash transactions were mostly not the way money worked in up-time America. Nor could cash transactions be the way money worked in Grantville right after the Ring of Fire. There simply was not enough cash to make it work that way. Cash in our case is both coins and pieces of paper, or bills. Money includes coins, bills and the numbers recorded in your bank account. The money in your bank account can be exchanged for either goods and services or cash. For the most part, money is exchanged for goods and services. While the amount of cash inside the Ring of Fire did put some limits on the amount of money in the Ring of Fire, it was not a one to one relationship. Instead, it was a flexible relationship that depended on how much ‘walking around’ cash people felt they had to have and what they could come up with in a hurry to act as cash.
Debit and credit cards were a blessing in the early days because they decreased the amount of cash that was needed by a pretty large factor. There were enough card readers that most businesses inside the Ring of Fire could have one. The fees for using debit cards were removed. The bank and credit union were encouraged to issue debit cards and people were encouraged to use them. Debit cards let people use money without using cash. This let us use less cash than we would have needed otherwise, at least inside the Ring of Fire. Since most of the transactions in American dollars in those first months were inside the Ring of Fire, money moved much faster within the Ring of Fire, which made what little cash we did have go farther. We also used cashier’s checks as though they were cash. The use of cashier’s checks also reached outside the Ring of Fire.
Inflation is a Cold. Deflation is the Plague.
The limit on the money supply must fit the overall economy. Too much money and the money will lose its value. Too little money and something else will take on the role of money. In the time it takes to find that something else, new businesses aren’t started and old businesses go broke. The amount of goods and services will try to match the money supply. The farmer pours his milk on the road because he can't get a fair price for it. A hamburger costs a nickel but no one has a nickel. Almost no one, that is. For the people that actually have what little money there is, it's a time of great power and the opportunity to manipulate their money into even greater wealth. That happened a few years before the Ring of Fire, at the end of the 'kipper und wipper’ business.

There is actually a fair amount of flexibility in the system but most of the flexibility is on the inflation side of the equation. When the money supply gets high, people spend faster but this effect is naturally limited by how much money they have. Within reason, inflation actually has a positive effect on the economy. People spend money on goods and services that in turn employ the people that make the goods and provide the services. The amount of goods and services increases to try to match the money supply.
When the money supply gets low, people start hoarding their money. That takes it out of circulation as though it had been buried in the back yard. This in turn decreases the money supply even more, causing more people to hoard their money. The feedback in the system means that small scale deflation rapidly becomes large scale deflation. Meanwhile, the people that would have been employed in providing the goods and services that would have been bought with the money that is being hoarded are unemployed and not producing anything. Everything is cheap but there is less and less of it. Again, the economy tries to fit itself to the money supply.
Money and Speed
How much money there should be in the economy is also affected by its speed of flow. Up-time money flowed really fast. Within the Ring of Fire, it mostly flows pretty darn fast, too. Outside the Ring of Fire money moves a lot slower. That means we need more money for the same sized economy. If a dollar is used in ten transactions a day it's the same as if there were ten dollars used in one transaction per day. When you put your money in the bank, that money doesn't stop being used. Most of it gets loaned out and keeps right on being used in other transactions. Money in the bank is not removed from the money supply the way money in your pocket is removed from the money supply. When you use your debit card to pay the grocer, the money goes straight from your account to her account and is never removed from the money supply. When you use a dollar bill to pay a merchant who puts the dollar in his cash box and takes it to Magdeburg, that dollar is out of the money supply for a couple of days. It's not much, but it adds up to the fact that for every dollar needed up-time for an economy of a given size we need several dollars down-time, because each dollar moves slower. There are fewer transactions per dollar per day.
That's what all the business about fractional reserves means. When the bank loans out the money you put into it, that money goes back out into the economy to act in other transactions. This has the same effect on the economy as having more dollars. Money gets counted in weird ways. People start talking about the money supply and money starts getting counted several times. For example, Fred deposits a thousand dollars in the bank. The bank then makes a loan to Joe and Joe deposits the loan in the credit union. That money now gets counted as a deposit at the bank and at the credit union. Once the credit union has the money, it makes another loan and so on. If there is a ten percent reserve, the money ends up being counted a little less than ten times. Every dollar equals ten dollars or a touch less as it moves around the economy. It isn't that there is more money or that there is fake money. It's just that the money is moving faster and being used more constantly. The effect on the economy is just the same as if there were several dollars to every dollar there really is. This happened down-time too, just not so fast. The effect of the difference in speed is that as money moves away from Grantville and electronic banking there seems to be less of it.
Who gets the Money?
When you add money to the money supply, it is going to appear first in someone's pocket, some institution's vault or as an addition to some account in a ledger or on a computer somewhere. In the tribe where the ladies made the money by scraping the leaves, it appeared first, in effect, in their pockets. They spent it to support themselves. This provided for them and put the money out in the community. This system was nice for them and a convenient way for the tribe to support the aged and infirm. Before the Ring of Fire, the money first appeared in the pockets of the owners of the mints. These were the people who had acquired the right to mint money. In up-time America the money first appeared as an addition to an account in a Federal Reserve Bank. It also disappeared from there but we'll get to that later.

That first use of new money is tremendously profitable for the person that gets it. Everywhere throughout time economies have needed some limiting factor. For the ladies of the tribe the limiting factor is the simple effort involved in making the money. If the money they make goes down enough in value they stop making it for a while and do something else more profitable. For the minters before the Ring of Fire, and even now in most places, the limiting factor is supposed to be the scarcity of the raw material, silver and gold. The minters are supposed to buy the raw material, convert it into coins and only make a little profit. Instead, they often debase the coins, so they can make more with the same amount of silver, and increase their profits. Even if they didn't do this, it would not solve the basic problem. The amount of gold and silver you have to make money with depends on how much gold and silver is found, not on how much money the economy needs. With a gold or silver based money, the amount of money introduced into the system is, at best, loosely related to the size of the economy.
For the up-time Federal Reserve Bank, the limiting factors were a combination of things. Probably the most important limitation was that they couldn't spend the money any way they wanted to. The Federal Reserve Bank could buy government securities or loan money to member banks, but that was about all. The only profit they acquired was the interest that was received. If they loaned too much money out, inflation kicked in and decreased the value of the dollar and therefore the value of the interest they received. On the other hand, if they didn't loan money out they didn't earn the interest. This also meant that in general, the inflationary effect happened before the profit occurred, not after.
There were other factors. The board of the Federal Reserve was politically appointed and hired on the basis of the overall health of the economy. The Board was not hired based on how much profit the Federal Reserve made. The people who received the interest weren't the people who determined how much money to loan out. Money was only loaned to other banks which made it harder to do ‘sweetheart’ deals. The Board couldn't loan money if no one was borrowing, which meant that they had to lower the interest rate to something the market would bear or loan out less money. They had to go to the Treasury to get the actual cash and they had to pay for that cash. Like the government, the Federal Reserve Bank had a number of checks and balances on it. Our Federal Reserve also has checks and balances, although they are a bit different.
Standards: Gold, Silver and Other.
While the ultimate determination of the value of money is ‘what people think it's worth’, there are a number of ways to convince people that money is worth something. One way is to tie the value of money to something else. The gold standard says that one dollar equals a certain amount of gold. That doesn't mean that it uses gold coins, it just meant that X amount of currency can be exchanged, for a specified amount of gold on demand.
The bank florin, which is generally called a guilder, of the Wisselbank van Amsterdam is based on a fixed silver weight of a reformed coinage as determined by a monetary ordinance of the States General of the United Provinces in 1619. This florin/guilder is used simply for reckoning or accounting purposes in the Wisselbank: all merchants who deposit coins, bullion, or paid bills-of-exchange (Checks) into the bank are credited with values reckoned in guilders. If you give the Wisselbank a pound of gold you get so many guilders. If you give them a sack full of debased coins you still get guilders, give them a check on someone else's account and you get guilders. By the time of the Ring of Fire there were a lot of paper guilders floating around Europe and a lot of silver and gold, coins and bullion in the Wisselbank vaults. Wisselbank provided the basis for a silver standard paper money. This silver standard paper money was better than silver coins because you know how much silver a Guilder is worth and it's fairly hard to be sure just how much silver is really in a silver coin.
Whether it's gold, silver, tobacco, or goats, commodity standards have some real drawbacks. They are very dependent on the quantity of the commodity. They require a large reserve of the commodity, either in the money itself or the commodity stored by the issuer. That is, you must trade the commodity directly as with gold coins where the commodity is the gold in the coins, or the issuer of the money must have a large stock of the commodity, as in Wisselbank notes where for every note there is a weight of silver sitting in the bank. This means that the issuer is not in control of the amount of money circulating in the economy. No one is in control of the amount of money in the economy. It becomes an economy of random chance. The other problem is that the commodity takes on the value of money. When this happens, it tends to inflate the value of the commodity beyond all reason. This is a good reason for people to use monetary metals if they are going to use commodity based. Monetary metals are not good for much else and if their value gets artificially inflated, the inflation does less damage to the over all economy.
The other standard for a money supply is the full faith and credit standard. This is often called fiat money because the standard is usually established by law. It is the hardest to get to work but avoids the problems inherent in commodity based money. It is not backed by a single commodity but by the full faith and credit the issuer. Which means that the issuer can control how much money is in the economy by adding money gradually as the economy grows, or even shrinking the money if the economy shrinks. It can be used as an effective tool to encourage economic growth. It carries its own potential drawbacks, which are mostly focused on the temptation to issue money. If the issuer is corrupt or just desperate for money, he can create more money by just deciding to do so. Figuring out how to have a credit based money supply, without massive inflation, whenever the issuer had the need for a bit of extra cash, was probably the most important economic knowledge brought back with the Ring of Fire.
In most of Europe today the silver standard is dominant. Most transactions are based on silver coins. How much silver is in any of the coins is often uncertain. Germany went through a primarily fraud based inflation in the first years of the war. It was called 'kipper und wipper'. 'Kipper und wipper' refers to the special scales they used to determine if a coin was the proper weight for the value it was supposed to have. The cost of the war meant that the princes had money minted like crazy, which caused inflation. Then, in 1622 the use of the 'kipper und wipper' money was outlawed. This regularization left thousands of people destitute. It also drastically reduced the money supply.

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