What is Money?

Money is fiction.

That is right. Money does not exist. What we know as money and refer to as money is a form of paper that we agree to accept in exchange for goods and services. The key here is value of money or in other words the buying power associated with a stack of bills is what we really care about. Not the stack of bills itself.

Still confused? Let me explain. Imagine a scenario where you have ten dollars with you and let us say you can buy a sandwich combo i.e. sandwich, chips and drink for ten dollars. Now, imagine a second scenario where I give you another ten dollars i.e. you now have twenty dollars. However, if you can still buy only one sandwich combo with the two ten dollar bills, then what happens to the value of one ten dollar bill? It reduces to half of what it was before. That is to say, the buying power of the initial ten dollar bill has fallen by 50 percent.

So, the next question is if the sandwich combo in the first scenario costed ten dollars, why did the same sandwich combo cost twenty dollars in the second scenario? This my friend, is referred to as inflation i.e. rise in price of goods and services.

So, when there is too much money in circulation retailers and producers feel confident to raise the prices of their goods and services. Consumers feel confident as well with steady flow of money and are willing to pay more for the same goods and services.

Federal reserve uses monetary policy as a tool to control inflation and deflation. The recession of 2008 has allowed the Fed to go crazy! It has kept printing money out of nowhere to buy toxic assets and inject money into the financial system. The steady growth seen in the economy for the past few quarters is a result of this monetary policy followed by low interest rates.

So if this is all good, is there a catch? You bet, there is.

The national debt has been increasing steadily and is now about 16.3 trillion or 108% of GDP. Not all this debt is due to Fed reserve policy. However, the Fed did contribute about 3 trillion dollars towards the debt.

So, the next time someone comes and says they have A MILLION DOLLARS, remember the only thing relevant is the purchasing power associated with that stack of bills.

Next week's topic:  Is gold money?