Before you ever get your grubby little paws on a dollar, it helps to adjust how you think about money. Money is something that has a lot more meaning to us now than it would have to your average person throughout human history. We do not have the same *kind* of money, even. Money is nothing more than the physical representation of the work that you have done for someone else. Ultimately, that’s what it all boils down to.
Optional – A Brief History of Money
This is not intended to be a literal historical retelling of money, but the broadly accepted version of how this came about is that human beings initially bartered for things when they had to trade with someone they didn’t consider part of their family (extended usually). If someone had two goats and someone else had twenty bales of grain, maybe they would trade a goat for a few bales of grain. However, as the economy became more complex and people became more specialized, it wasn’t so easy to trade things. A cobbler might have dozens of pairs of shoes, and have to find someone who has meat for sale who also needs shoes. This is obviously a pain in the rear. Also, what if you had two chickens, but whatever you want is really only worth half a chicken to you?
People then started trading for a common, easy to transfer and fungible commodity. (fungible means that one piece of it is just as good as another piece. Chickens and goats are not fungible as they may be healthy or sick, young or old, meaty or thin) This, for reasons too complex to go into now, ends up being gold or silver in most societies.
For an extremely long time, all trade was done in gold or silver. Abraham would have used silver, as would the Romans two thousand years later, as did the Americans in the early colonial period.
Only in the very recent past did paper money begin to circulate. At first it was paper issued by a goldsmith who promised to deliver a certain amount of gold to the bearer of the note upon request. A few goldsmiths went out of business as the temptation to issue more notes than they had gold became too much and they started to print extra money. However, after a while this settled down and people would generally accept a gold note if it was from a reliable source.
Eventually governments joined in and began issuing their own notes, and making it illegal for independent people to issue their own. Again, the cycle repeated and they gave in to the temptation to print more than they really had. As this was obvious to people, they began accepting notes at less than face value. So a seller would say, “you owe me an ounce of gold” and the buyer would try to give them the note. They would respond saying that they would accept the note, but only as half an ounce of gold, since they were taking the risk it might not get paid.
Eventually this practice became illegal with legal tender laws. At this point, the notes backed by the government must be accepted at face value and could not legally be discounted.
A few bank runs later, this eventually settled down and a dollar was worth roughly 1/20th an ounce of gold. In 1913, to pay for increasing government expenditures, they privatized the banking industry in the form of the federal reserve, a privately-owned corporation that controls the nations’ money supply with heavy government oversight. The owners are the major banks of the United States: Citigroup, Bank of America, JP Morgan Chase, etc.
Eventually, the money supply became unstable again and a decision was made to outlaw the private ownership of gold. FDR bought all the gold in the nation with paper dollars and then revalued the currency at 35 dollars per ounce of gold, preventing a further catastrophe of bank runs like had happened in the early part of the great depression.
After World War II, every major nation’s currency became exchangeable in terms of dollars and the dollar was redeemable in gold. However, in 1971, Nixon took us off the gold standard. At the time, gold was still worth $35 dollars an ounce.
Rapid inflation hit in fairly short order, leading to multiple recessions in the late 70s and early 80s. Eventually things stabilized again at roughly a 2-3% inflation per year as measured by CPI. Gold is now worth around $1400 an ounce (at the time of this writing), for a total inflation rate of around 8% a year, compounded annually when measured in the value of 1960 dollars.
Inflation and Why it Matters
We have lived in a deep period of monetary inflation that averages out to around 8% a year for the last half century. This has serious effects on the way that we save and think about money and must be understood in order for us to make good decisions about money management.
This inflation is, of course, somewhat hidden from view. In an economy with a fixed value dollar *deflation* is the outcome of improved farming techniques, improved technology, etc. You can still see this effect if it is rapid enough, when a 4K OLED TV drops from 6000 in 2018 to roughly half that in 2019. That is how prices change for everything else as well, but when monetary inflation is involved you do not see it.
A thought experiment should explain why. Let’s assume that chicken costs 2 dollars a pound today, but you can also buy this god currency, backed by the Lord Almighty, which mystically never changes value, for exactly 2 dollars. Let’s call 2 dollars worth of god currency, a “divine”. So you thought about buying 10 pounds of chicken, but you decided instead to save your money by buying 10 divines instead.
A few years later, chicken has increased in price. It’s now 2.50 a pound. You’re surprised by this, because as a good student of economics, you know things should be getting cheaper as we find more efficient farming techniques and such. But you take it in stride. You decide to sell those divines and buy 8 pounds of chicken with the 20 bucks you get back, cursing all the way to the divine store that you didn’t spend your money back when chicken was cheaper and just freeze it. When you go to sell your divines, they tell you that they are now worth 30 dollars! You could buy 12 pounds of chicken with that!
What happened? Well we know that in an absolute sense the divine can’t change value. It is, after all, backed by God Himself. Then what could have happened? Well, what must have happened is that the dollar lost its value. Now it is only worth 1/3 of a divine instead of ½ of a divine. Which means that chicken, in terms of the dollar from 5 years ago only costs 1.65 a pound. This means your instincts were correct and the laws of economics haven’t shattered into a shower of absurdity after all! Chicken has gotten cheaper. It’s just that the value of the dollar went down faster than the price of the chicken, so it looks like chicken is more expensive than it was. Therefore what will be counted by official statistics as a 25% increase in the price of chicken is actually a 17.5% decrease; so what looks like a fairly high inflation of 4.5% a year was actually a 3.7% annual deflation.
Assuming inflation/deflation was even across the whole economy (which it isn’t), you would have needed almost a 5% a year raise to keep up with the costs of everything, even as they become cheaper. With a fixed monetary system, you would have gotten a 3.7% raise every year even if your actual pay didn’t change at all, in terms of everything around you being cheaper.
Then the question becomes Cui Bono? Who benefits? Well not people saving money, that’s for certain. If you had kept your 20 dollars under the bed, it would be worth 33% less today than it was back then. However, the reverse side of this is that debt is cheaper. Let’s do another transaction with divines.
A credit company decides to give you a heck of a loan offer. They’ll loan you 10,000 dollars at 5% interest. You don’t have to pay anything for 5 years, but at the end of that 5 years they will collect the entire amount owed. You, being a smart cookie who is familiar with the 50-year trend of inflation take this bet. Instead of spending the money, you put it in divines. You buy 5000 divines.
At the end of the 5 years, you owe the credit company roughly $12,700. You head over to the divine store and sell your divines, which are now worth $15,000. You have just pocketed $2,300!
Since debt is denominated in dollars, you pay off debt later with dollars that are worth less than the ones that you borrowed. That’s why banks will give you better interest rates on shorter term loans, because they are factoring in inflation, knowing that a dollar paid in 3 years is worth more than a dollar paid in 5. If the currency were in divines, you might well get a lower interest rate for longer term loans. In fact, they may require that you not pay it back early. (This was actually common practice in the not-too-distant past: it was called a pre-payment penalty).
This, of course, doesn’t help you if you are borrowing money at a rate higher than the inflation rate, nor does it help you if you are just holding on to the dollars as they lose their value. This is not a trick to make a fortune, it’s just a reality that is important to know when you’re trying to figure out what to do about your debt.
Does all this sound too complicated? Does your brain kinda hurt just thinking about it and looking at these numbers? Does it seem like this couldn’t possibly be right? Well, that’s how they get you. If you don’t understand these dynamics, you will invariably make wrong decisions. We don’t generally think of a buck as losing its value as quickly as it does. We just feel like everything’s getting more expensive (even though it is actually getting much cheaper).
The world is a lot more complicated than when Jesus walked the Earth. Loving money may be the root of all sorts of evil but failing to understand money is how the financially educated prey on the financially ignorant. It is to the benefit of those in the know to make the system as complicated as they can, so they can bet against people making good decisions, banking on the ignorance of their prey to make a rapidly depreciating buck.
Now, to be clear, the rate of inflation is not this simple. The 8% number is just an estimate based on the current price of gold. The real world doesn’t have anything exactly like the divine. Everything moves prices in relation to everything else and for reasons that are not always transparent. But gold is a historically very stable holder of value. It may fluctuate a lot in the short term, but if you are betting whether gold will be worth more in 20 years than it is now, it’s about as safe as you could possibly get. Of course, it is not an investment, strictly speaking, as owning it does not make you more productive. And safe is not always the same thing as practical.