The Politics of Debt

The past week you certainly have (and in the next few weeks you will) read a lot about the dollar and its relation to other currencies. Most of the articles fail to explain what the real value of money is. In some cases, I think, economists just ignore out of convenience what the impact of the weaker dollar is to the US people. In some other cases, they treat the issue with a mysticism more appropriate to religious mysteries.

The truth is the dollar has no inherent value. It used to have some, but it does not anymore. The only value attached to the dollar (or any other fiat currency, for that matter) is the exchange value for other goods. For instance, we can say that the price of 1 hamburger is 1 dollar, or say that the price of 1 dollar is 1 hamburger. Usually it is easier to carry bills than hamburgers in our pockets, and that is the reason we carry bills.

There was a time when you would carry goods in your pockets, pounds of silver, gold, or other metals. Later on, society evolved and you started carrying notes saying that whoever possessed that note was the owner of a certain amount of gold, silver, etc. Later on, the states started printing those notes, and they needed to have an equivalent amount of the material in their coffers in order to print notes. Those notes had different denominations and they usually represented a different relationship with an amount of metal. In those cases, you could tell that if currency A represented 1 pound of gold, and currency B represented 1/10 of a pound of gold, you would need 10 currency B bills to match 1 currency A bill.

The reason gold was used as a measure of the wealth of a certain country was that extracting and processing gold was a measure of the technological advancement of a certain society. In other cases, the ability to exchange goods for gold with a gain (sell them for more gold that it cost producing them) was also an indication of the advancement of society. Nowadays, a country with more gold not necessarily is a more advanced country than one with less gold (for instance today, the largest world producers of gold are South Africa and Australia, which, although great countries, you would hardly call world powers).

When did gold start to lose its luster?

In 1917, Russia, one of the largest world producers in the world became a socialist state. By the 30s, not only the dreaded communists were “richer” in terms of gold than many more technologically advanced countries in the West, but also the limitation of gold production imposed a limitation to further development of the West. This limitation had different answers around the world, with different results. In the US it produced the depression of 1929. In Germany, they tried to avoid a liquidity crisis by producing inflation, which brought about hyperinflation and the rise of the Nazi party. Previously, this limitation had produced (in broad terms) in the US the liquidity crisis of 1907.

By the 70s, this situation was not sustainable, and the Nixon administration, which was running large deficits to support the Vietnam War, decided to break completely any bonds between the US dollar and any backing metal. You may argue that such a measure was positive, because since then we haven not had any worldwide conflicts, depressions, or hyperinflations. Defining whether the alchemy works or not, and to what extent, is not the goal of this article.

Let us just say that the current alchemy seems to work, and allows governments to run large deficits to finance different ventures without the nasty limitations of the economic reality. However, this cauldron needs the watchful eyes of a number of wizards not to become radioactive and kill us all. Those wizards, you guessed, are the members of the Fed.

So, what is the value of the dollar, then?

The intrinsic value is that of the paper it is printed on. However, to the extent that people assign to it a value and are willing to exchange it for goods or work, it has some exchange value. This value, however, is a mere illusion. It is a convenient illusion that we maintain to make our lives in this particular society livable. Intrinsically, however, a 1-dollar bill is not more valuable than a 100-dollar bill, or a fake one, for that matter.

I am sure you heard that the Canadian dollar went from 60 US cents to 1 dollar in the past 5 years. What that means, is that in the past 5 years your work became less valuable to our good neighbors from the North. Let me explain this. Five years ago, when you worked 1 hour for 5 dollars you were able to go across the border and eat more hamburgers than a Canadian who had worked the same amount of time for the same amount of Canadian dollars. Now you can eat the same amount of burgers (not sure they eat as much as we do, though). Before you complain, let me remind you that the reason you are able to buy most of your clothes and goods is because the exchange rate makes the work of our neighbors to the South (as far South as Brazil and Argentina) and our good Chinese and Indian, and Asian friends less valuable than our work. This is a fact with moral and political implications that force economists to mystify the value of money until it is not clear what they are talking about.

In other terms, let us say that there is a certain commodity that you need to live and has a fixed price (you cannot trade it and the price never changes). The impossible commodity X has another particularity, you don not need more than the amount you need to live, and you cannot accumulate it.

To get enough of this impossible commodity X to live you need to work 40 hours a week for a minimum salary of US$5 an hour. Whenever your government is fiscally responsible and does not need to print money, your dollars become rarer and thus more valuable. When this happens, you need to work less to get the commodity X you need. However, when the government is irresponsible and prints money in order to finance their plans, the dollar becomes less rare, and thus less valuable, which forces you to work more for your commodity X. To what extent? That depends, you may need to work 14, or 18-hour days in order to have enough dollars to pay for the commodity X you need to survive.

How come I own $100,000,000,000 and I can’t retire?

It is simple. I have a bill for 1 Argentine peso. The Argentine currency suffered several transformations since it stop being backed by gold in 1969. In 1970 the currency was renamed, and 1 peso MN became 100 pesos Ley. To make this clearer, I am adding a table here:

As you can tell, I was not lying when I said I had $100,000,000,000. I wasn’t lying either when I said that it was not enough to retire. The last time I checked, however, the market value of that 1 peso was about 60 US dollars on eBay.

I hope this simple example gives you a clear idea of the real inherent value of money.

And, remember, when the US dollar loses its value, it is your work that is losing value relative to other people around the world.

Note: I edited the article to clarify a couple of points brought forward by readers. The table is now backwards –the calculation was backwards in the original post– and I explained a little bit more the effect of inflation on every day life. Thanks to all of you who contributed with your comments. The symbol $ is valid for US money an many other currencies, among them, the Argentine peso.

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Tags: Bernanke, communists, different denominations, dollar, Economics, economists, Economy, exchange goods, exchange value, Fed, Federal Reserve, fiat currency, gold, gold silver, government, hyperinflation, inflation, liquidity, liquidity crisis, metals, mysticism, Nazi, real value, religious mysteries, silver, silver gold, United States, value, value of money, Vietnam War, War