Honest Money: What It Is and What It Isn't - Part III

By: Douglas V. Gnazzo | Thu, Mar 30, 2006
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Savings and Credit

Savings

With the continued growth of commerce and the division of labor, the economy oscillates between supply and demand, buyers and sellers, producers and consumers.

When through the course of wise and prudent commerce, man produces more than he consumes, an individual will begin to accumulate their excess production - the fruits of their labors.

The same holds true for the group, society, nation, and world. This is commonly called savings or the accumulation of wealth.

A saver of money over time knows the importance of the quality of his money versus the quantity of it.

The prudent man saves his money for the future, for his later years in life, when he will not be able to work as hard to earn the money needed to pay for life's necessities, when his income will be less.

In the later years of life, man uses his saved money or accumulated wealth to turn back into income, to obtain the necessities of life: food, clothing, shelter, and healthcare.

The more the saver's money has retained its quality or purchasing power, the wealthier, and better off he will be. He will be able to procure by exchange more of the things he needs to maintain his survival and standard of living with.

This is why savings is so important. This is why the quality of money is so important, although there are other reasons as well. For now, these will suffice.

Honest Money retains its purchasing power
And is the ultimate store of wealth.

Credit

Once society chooses a common medium of exchange, commerce increases to the point that people want to borrow or lend the common medium of exchange, money, to further increase their ability to trade goods and expand commerce.

The quality theory of money emphasizes the functions of money as a standard of value through time, and as a store of value over time.

A lender of money or credit wants to be repaid with money that will be worth, as much in the future as it was when he lent it in the present, which soon becomes the past.

He wants the money he is repaid with to retain its purchasing power.

If a lender of money does not have faith that the money he lends will retain its value or purchasing power in the future, he will charge extra to loan the money out, to make up for the perceived or expected loss of future purchasing power of the money.

He will have a greater interest in being made whole, and will charge accordingly. The interest rate cost of borrowing money increases to make up for the perceived future risk of loss of purchasing power. Risk versus reward is of the essence.

Time Preference

With the advent of credit, man takes a leap into the future. What had originally begun as direct exchange in the present now became indirect exchange, not only in the present, but in the future as well. This involves present goods and future goods.

Money involves time preference - the present and the future, as man's life involves the present and the continuance of the present into the future as survival or living.

Indirect exchange overcomes the coincidence of wants
in the present by invoking the concept of value in the future.

Money is the standard of value that according to the consensus of society is most likely to continue to exchange in the future, at the present ratio or value. In other words, money is a standard of value through and over time.

The word credit comes from the root credere, which means to believe in or to have faith.

The seller believes and has faith that the money he accepts in exchange for his goods, will in the future be accepted by another seller of goods, when he goes to buy or exchange his money that he received when he sold his goods, for the goods he now wants to buy.

It is the reciprocal agreement between buyers and sellers that the medium of exchange will continue to mediate that is the belief or faith behind money that keeps a monetary system functioning, as money's main function is to procure other goods.

Money is a claim based on this reciprocal agreement. It is a form of contract promising future performance. It is a future good.

All value resides in the goods and services to be acquired - not in the money.

In this sense, it is a form of credit, as the value represented by money has not yet been had. Only when money is used in an exchange, whereby other goods are acquired, does it fulfill its function as a medium of exchange.

The seller in any exchange is giving up present goods for the promise or obligation that money represents that another seller will later accept it.

In this type of usage, money is an indirect form of credit.

With the lending out of money directly to another, a direct form of credit occurs.

A New Theory of Credit

The advent of indirect exchange allows for the easier extension of credit. Credit is the loaning of money in the present, to be repaid in the future. We shall refer to this as direct credit.

The use of indirect change and money also involves a type of credit - indirect credit we shall call it. Here is why.

Trade evolved from direct exchange into indirect exchange. Barter was no longer used. Now money, the common medium of exchange was used.

The coincidence of wants was overcome by the change from barter to money.

No longer did two traders have to possess the exact goods that the other needed. Now it was only necessary that one trader have the goods or services that another wanted.

Indirect exchange created a buyer and a seller, whereas barter did not designate between the two separate entities. Barter involved two traders - both with goods to exchange.

Only the seller needs to have goods for trade using indirect exchange.

A seller now had in his possession the goods or services that the buyer will acquire by the use of money - the common medium of exchange. No longer do both parties have to have the exact commodity or service that the other wants.

Money now fulfills one of the two roles that occurred with direct exchange, it represents the other half of what previously was fulfilled by specific goods or services during barter.

With the advent of money, a buyer no longer needs to bring goods to the marketplace with him. The buyer only needs money, the common medium of exchange.

With indirect exchange, the common medium of exchange can be traded for any good or service. This is what makes money so valuable - its unquestioned acceptance in trade.

Present & Future

However, we have seen that in direct exchange or barter that trade completed immediately within the present. Each trader exchanged the exact goods with one another in the present. The deal took place immediately.

The same is not true with indirect exchange. With indirect exchange, the process of trade has been split into two halves. Now there is the seller, who offers goods or services; and there is the buyer, who offers money - the common medium of exchange.

The buyer receives immediate satisfaction or fulfillment, he acquire the goods or services he wants. It is not so with the seller.

The seller receives the common medium of exchange for the goods he brings to market. He receives money. The money he receives is but a receipt that he can use to buy other goods or services that he wants - from another seller - at another time in the future.

However, he has not yet exchanged the money for the other goods. We have previously seen that goods and services are the real value behind money.

Until the seller becomes a buyer with the money he has accepted, he has indirectly extended credit to the original buyer, by accepting the buyer's money.

He has accepted the money as a pledge that he the seller has faith that it will be honored and valued for the same value that he gave up or sold to the original buyer.

It is this belief in the future acceptance of money as the common medium of exchange that makes money valuable.

It is this belief that allows money to overcome the dilemma of the coincidence of wants required for direct exchange to take place.

It is this faith that gives value to money, because the market has collectively agreed that it represents value - that it can be exchanged for any good or service in the marketplace.

Money does not have intrinsic value; it is the goods and services that it can be exchanged for, for which it is a receipt - that have intrinsic value. This is true even of gold as money.

Money is a future good - it is a receipt for value not yet obtained, but that will be obtained in the future. Hence, it is a form of credit - of indirect credit. Money involves credere - faith.

The loaning out of money as the medium of exchange we call direct credit. The use of money as the medium of exchange we refer to as indirect credit.

Next week we will examine how sound money retains its purchasing power, and is thereby, an excellent means of storing wealth into the future.

Come visit our new website: Honest Money Gold & Silver Report
And read the Open Letter to Congress

 


 

Douglas V. Gnazzo

Author: Douglas V. Gnazzo

Douglas V. Gnazzo
Honest Money Gold & Silver Report

Douglas V. Gnazzo is the retired CEO of New England Renovation LLC, a historical restoration contractor that specialized in the restoration of older buildings and vintage historic landmarks. Mr. Gnazzo writes for numerous websites, and his work appears both here and abroad. Just recently, he was honored by being chosen as a Foundation Scholar for the Foundation of Monetary Education (FAME).

Disclaimer: The contents of this article represent the opinions of Douglas V. Gnazzo. Nothing contained herein is intended as investment advice or recommendations for specific investment decisions, and you should not rely on it as such. Douglas V. Gnazzo is not a registered investment advisor. Information and analysis above are derived from sources and using methods believed to be reliable, but Douglas. V. Gnazzo cannot accept responsibility for any trading losses you may incur as a result of your reliance on this analysis and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Do your own due diligence regarding personal investment decisions. This article may contain information that is confidential and/or protected by law. The purpose of this article is intended to be used as an educational discussion of the issues involved. Douglas V. Gnazzo is not a lawyer or a legal scholar. Information and analysis derived from the quoted sources are believed to be reliable and are offered in good faith. Only a highly trained and certified and registered legal professional should be regarded as an authority on the issues involved; and all those seeking such an authoritative opinion should do their own due diligence and seek out the advice of a legal professional. Lastly, Douglas V. Gnazzo believes that The United States of America is the greatest country on Earth, but that it can yet become greater. This article is written to help facilitate that greater becoming. God Bless America.

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