What Is Money?YouTube↗  IA↗(long shot)
Education  65.7K views 987 likes 101 dislikes   20 Sep 2009
Shane Killian 21.4K subscribers United States YouTube↗


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I've had to make quite a few videos going back
to the basics as far as economics is concerned.
But one thing that became fairly obvious
from the comments was that, sooner or later,
I was going to have to make a video
talking in very basic terms about what money actually is.
I finally realized this had to be done
when The Amazing Atheist proferred the myth
in a recent video:
"Now the line fed to us by
"the Ron Pauls and the Alex Joneses of the world
"is that we traded our real wealth, which is gold,
"for fake wealth, which is paper money.
"But, of course, that doesn't make any sense,
"because it's all just a matter of human value perception.
"It's only valuable because human beings
"perceive it to be valuable.
"Just like paper money is only valuable
"because human beings perceive it to be valuable."
Nothing could be further from the truth,
but to see why, we have to take a look
at what money actually is.
Without money, you're left to barter.
If you have a dairy cow, you can milk your cow
and then go and offer the milk as payment
for something that you need.
If you need a loaf of bread,
then you have to ask the baker how much milk
they're willing to accept as payment for it--
and if the baker doesn't need milk,
you have to go find another baker who does,
and you have to do it before the milk spoils.
In an extreme situation,
you might imagine the baker needing his horse shod,
the blacksmith doesn't need bread but needs a new apron,
and the tailor doesn't need any smithing done
but--aha!--needs milk!
So, having put in a lot of legwork to discover all of this,
you give your milk to the tailor in return for an apron,
give it to the blacksmith in return
for shoeing the baker's horse,
and the baker then gives you bread in payment.
Whew! There's GOT to be an easier way.
Money is what cuts out all of the extra work and headache.
If you have a commodity that everyone values,
then you can just sell your milk to the tailor
and buy the bread from the baker.
Everyone else can then work out their own needs separately.
In order to properly fill this function,
money must have four aspects:
it must be a medium of exchange,
a unit of account, a store of value,
and a standard of deferred payment.
The medium of exchange is what we just witnessed in our example.
In each case, every player in the market
was willing to accept the money
in exchange for some good or service.
Why would they be willing to do this?
It isn't as simple as people just perceiving it
to be valuable, as TJ believes.
It needs five separate characteristics.
The first is that it must be transportable.
In our example, the dairy farmer must be able to collect
the money from the tailor and deliver it to the baker.
The second is, it must be divisible.
If the price of the bread is lower
than what he sold the milk to the tailor for,
he needs to be able to divide it down
and pay the smaller price to the baker,
saving the extra money for something else.
It must have a high market value
in relation to volume and weight.
It must be recognizable as money.
In this case, the dairy farmer, the tailor,
the blacksmith, and the baker
all have to recognize and understand that
the money is a valuable medium of exchange.
And finally, it must be resistant to counterfeiting.
The Unit of Account is related to the idea
of the money being divisible.
By having a standard unit,
it's easy to tell how much you have.
By being divisible, it can be broken down into smaller units
without losing any of its overall value.
It must be fungible, meaning that each unit
must be perceived as equivalent to any other unit.
And it must be verifiably countable.
The store of value is incredibly important.
Money doesn't create value,
but it does let you hang on to it.
In this way, it's kind of like a battery.
Batteries do not generate electricity,
but they help you store it for later use.
Not only must it be able to be saved, stored, and retrieved,
but it also must be valuable when it is retrieved.
Finally, it must be a standard of deferred payment.
If the baker is kind enough to give us a loaf of bread,
trusting us to pay him for it when our cow is ready to give milk,
then in this way we can defer the payment.
The money must be considered as the appropriate way
to settle our debt with the baker.
The money becomes what's known as a "tender."
When the government establishes a form of money
for deferred payments, it's called, "legal tender."
Gold works extremely well for all of these functions.
It's universally recognized as valuable,
so it makes an excellent medium of exchange.
Since every ounce--or gram, or whatever unit of weight you want to use--
is the same as every other ounce of gold
(assuming, of course, the same level of purity),
it's fungible. If divided in two, the two half ounces together
are worth the same as the full ounce.
It's a store of value--in fact, gold holds its value
incredibly well over time.
And since it is so reliable at holding its value,
it makes a good standard for deferred payment.
But what about paper money?
TJ says that it's just the same, because
human beings perceive it to be valuable.
It's not true, but in order to understand why it's not true,
you have to understand something that may sound surprising:
there really is no such thing as paper money.
Paper is not a medium of exchange.
There are different types of paper that have different values.
A $100 bill has just as much paper in it as a $1 bill.
Paper is not a store of value,
nor is it a standard for deferred payment.
People don't actually think that there's $100 worth
of ink and paper in a $100 bill.
They understand instinctively--
even if they may not realize it intellectually--
that the paper is acting as a proxy for a different kind of value.
This is a $20 gold certificate from 1905.
If you lived in 1905--or any time up until
the United States went off the gold standard--
you could take this $20 certificate into any bank or assayer's office
and receive that amount of actual gold.
The $20 would then be taken out of circulation.
By the same token, you could take your gold
to the bank or assayer and get the appropriate certificates
corresponding to the amount of gold you gave up.
This would represent new money in circulation.
So, what about today's money?
If paper money is a proxy, and we're off the gold standard,
what is our money a proxy for?
Our monetary system is known as "fiat money."
In other words, the money is declared
to be valuable by government fiat--
it has value because the government says so,
because the government says so.
This mandates its use as a standard of deferred payment.
If a debt is owed, the person to whom the debt is owed
must, by law, accept US dollars as payment for the debt.
That's the concept of "legal tender."
What has been absolutely destroyed is its store of value.
If you have $10 in your pocket, it is NOT worth the same
as that very same $10 bill would have been last year.
The reason why is that the government--
or, more accurately, the Federal Reserve--
has complete power to print up however much money it wants.
And it doesn't take much to run a printing press.
With the gold standard,
the way in which new money enters the system
is with people mining and extracting gold.
This takes up resources, far more resources
than simply switching on a printing press.
For example, you have to pay the miners for their labor.
So with the gold standard,
the new money represents actual, tangible value--
the value of the workers who mined the gold,
the value the investors put into it,
the capital used to make it all happen, and so on.
With fiat currency, it's all just ink and paper.
The new money does not represent any significant amount
of resources being used to initially obtain it.
Initially, newly-created fiat money
causes an expansion of the economy.
The new money appears to be additional sales and investments,
which encourage businesses to step up production.
But that is not what's happening.
In reality, since the mere act of printing money
does not increase economic wealth,
the newly-created money represents a portion
of the same level of economic wealth as was there before.
This means that the value of everyone else's money goes down.
The economic expansion is an illusion, and the price is soon paid.
In the United States and most other countries
with fiat money (which is most other countries),
the new money is injected into the banking system.
This exacerbates the problem.
First, the fractional reserve system multiplies
the amount of newly-created money,
as I explained in a previous video.
The new money pushes interest rates lower
than where they otherwise would be.
Since the interest rate is the price of a loan,
loans are now cheaper, and so
more people and businesses go into debt.
All of this sends fake signals into the economy,
resulting in malinvestments and capital being put into areas
that would otherwise have been avoided.
In the most recent crisis, this was the housing market,
as the artificially-low interest rates
helped to disguise the risks of the loans
in the secondary mortgage market.
Obviously, this can't go on for long.
The economy responds with a credit crunch--
known more informally as a "bust"--
and the economy goes into recession.
The recession helps to reallocate the monetary assets back
to where they need to be for a sustained, efficient economy.
Although most political economists claim
that this description is incorrect,
it is the only model that has successfully predicted
every bust since and including the bust of 1920.
There is more about this in my video on the Great Depression.
It makes sense if you think about it:
since money needs to be a store of value,
its value needs to be able to seek equilibrium based on
supply and demand just like every other commodity.
Again, the only way new money can be created in a gold standard
is to spend the resources to mine new gold--
but people are only going to do that
if the money they create by mining the gold
is worth more than the resources they put into it.
So this serves as a protection from
money getting too valuable and causing deflation.
Conversely, if money starts getting less valuable
and threatens to cause inflation,
more people are going to trade in their money for gold,
taking it out of circulation and thus arresting the inflation.
As the value rises again, they may trade
their gold back for more money,
keeping the system in balance.
But with fiat money, there's no consequence
for the government printing however much they want.
Printing a note, whether it's $1 or $100, costs 3½ cents.
If you could get an instant $100 return
on an investment of 3½ cents,
wouldn't you do it? A lot?
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