The True Nature of Money

Money is an instrument of debt and not a store of value as most people suggest. Issued by banks or governments, they are traditionally exchangeable for gold or silver, which are the true stores of value. In day-to-day commerce, however, money is treated as a store of value.

[Note: The Hong Kong banknote below explicitly states that it is only a promissory note, not “real money”.]

 

Banks originally issued money only to facilitate trade. Travelers and traders used to carry a lot of precious metals for trading, making them easy targets for bandits. It was much easier for a reputable bank to issue banknotes that can inconspicuously hidden in clothing to be redeemed later for the precious metals (much like a cashier’s order today).

Banks soon found that they could cheat on this system by issuing more banknotes than they have precious metals. Hence, a bank may issue notes promising to pay 10 tonnes of gold when it has only 1 tonne. This is known as fractional-reserve banking, a practice that continues today.

[If you borrowed $100 for 1% and used it to lend someone $1000 for 5.5%, you will earn $54! A bank does this, but with millions or billions of dollars. It is not hard to imagine how much profit banks can make with this simple idea.]

Things went well when banks had a good reputation, but when things went wrong, everyone wanted to withdraw their gold before the bank reserves run out. This is called a run on the bank, and governments of the world today insure all their bank deposits in order to ensure that this does not happen.

 

However, the side effect of issuing so much more money is that money becomes cheap. A loaf of bread may have cost $1 a decade ago, but is now $2. This is called inflation. Higher prices are the result of the lower value of our banknotes, not greedy traders trying to make a profit.

When governments took control over the banks and the monetary system, they got in the fun by printing bank notes whenever they needed money. This resulted in hyperinflation, the most infamous of which happened in Germany in the 1920s. Back then, bus conductors will only collect the fare when you alight since the bus fare would have increased during your journey! If you think such things no longer happen nowadays, just read about the Zimbabwe dollar.

 

In summary, money is an instrument of debt issued by a bank or government. As most of us would have painfully experienced, the other party can refuse to honor their promise to repay debt at any time.

However, rather than break their promise outright, they usually choose to print more money, causing prices to increase. They can slowly drain the wealth from people using their money through this “unofficial tax”. For instance, gold used to be US$20.67/oz in 1900. Today, 112 years later, it is US$1700/oz.

Meanwhile, most people not only treat money as a store of value for trading, they actually believe that money is a store of value. One day, people will understand the true nature of money. By then, it may be too late for them to regret for having wasted their lives serving the false god of money.