What is money? Wikipedia describes it as “any object or record that is generally accepted as payment for goods and services, and repayment of debts in a given country or socio-economic context.”
The definition continues by explaining that “money originated as commodity money, but nearly all contemporary money systems are based on fiat money. Fiat money is without intrinsic use value as a physical commodity, and derives its value by being declared by a government to be legal tender; that is, it must be accepted as a form of payment within the boundaries of the country, for ‘all debts, public and private.’ ”
I have a simpler definition. Money is debt.
The money in your pocket, your bank account and awaiting distribution at the Treasury Department constitutes an obligation to someone or something. If money is, in fact, debt, then it has a cost to the party holding it and a benefit to the party that produces it. Following money from its creation to the time it is used provides insight into the true cost of money. In a fiat monetary system, money is literally created by the printing press at the Treasury (we’ll ignore the printing at the Federal Reserve for now), at little to no cost beyond the running of the presses.
The next step for our dollar is usually into a bank’s reserve, which is where the cost begins. The bank’s costs associated with these reserves can range from a very small number (inflation less return on those reserves) to quite high (earnings lost by not lending it to consumers). In theory, money has become a liability to the Treasury as well, considering a theoretical promise of the government to accept its own currency for all debts, public and private.
The consumer, for the most part, never touches money that isn’t someone’s obligation. Whether we work for it or borrow it, the money we think we own is only temporary. We may think that in our economic system, capital is owned and controlled by private parties. But we really live in a system of never-ending leverage made possible by fiat currency.
The Treasury mints the money, then banks “borrow” it from the Treasury and the “private” sector borrows it from the banks.
Money in our current system does not constitute ownership of anything other than an obligation to some other party. But it doesn’t stop there. Because of the “fractional reserves” banking system, far more money can be put into circulation than can ever be assigned to a means to have produced it.
The result is that the true cost of money is the expansion of the total money supply. The more total dollars in circulation, the less value they have. In a closed system where all sales and purchases happen domestically, who cares? In our global system of fiat currencies, it can be devastating.
Forty years of the world’s central banks building up dollar reserves led to an unprecedented period of growth in the United States. The increasing value of the U.S. dollar meant we could borrow from the world at continually decreasing interest rates, allowing the entire country to borrow well beyond its means. But the dollar is now decreasing in value and soon we will not be able to borrow cheaply, if at all.
What we really need to be concerned about is the escalating cost of our money. Remember, fiat money is an obligation. As the value of that obligation declines, so does our personal wealth. The actions we need to take are simple: own hard assets, ideally productive assets; use debt whenever the cost, after tax-interest cost, is less than the rate of inflation; and own investments with foreign-currency exposure, especially domestic large-company stocks that get more that 50 percent of their sales overseas.
Most importantly, resist the temptation to borrow money for unproductive assets. The cost on that money, the rate of the depreciation of the currency, is simply too high and likely to get worse. We can’t force a change in the fiat currency system, but we can slow down one of its most important features – velocity, the rapid movement of money throughout the system.
The sooner the central bankers of the world accept the failure of fiat currency, the sooner economies can break free of the boom-bust cycles we’ve become accustomed to. •
David F. Brochu is president of Kleossum Inc.
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