3/16/2015. Michael Salemi, Professor Emeritus UNC Chapel Hill BRONZE RINGS USED IN AFRICA COWRIE SHELLS USED IN PACIFIC REGIONS DOLLARS EUROS

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1 Michael Salemi, Professor Emeritus UNC Chapel Hill BRONZE RINGS USED IN AFRICA COWRIE SHELLS USED IN PACIFIC REGIONS DOLLARS EUROS 1

2 GOLD BITCOINS 1. Money has evolved through time. 2. Money is a social contract. 3. Government plays an essential role in the monetary contract. 4. Would our society be better off with gold or bitcoins? 1. Barter 2. Commodity Money 3. Coins 4. Paper Money Backed by Coins 5. Fiat Money 2

3 1. A difficulty with barter is that trade requires two persons whose possessions mutually suit their wants. 2. Search for a barter partner is costly. 3. Primitive societies created institutions including credit arrangements to lower the cost of barter. (E)very prudent man in every period of society must naturally have endeavoured to have at all times by him a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange. Adam Smith, The Wealth of Nations SALT CHINESE KNIFE MONEY 3

4 1. Animals were money in societies where animal sacrifice was required. 2. If a ruler liked a certain kind of shell, it might become money. 3. But a commodity would have to be scarce to function as money. Money and Government As primitive peoples traveled beyond the borders of their homelands, they found that their local money was not accepted and sought alternative ways to facilitate trade. They observed that metal especially gold, silver, bronze and copper were valued in other lands. 1. Metals are durable. 2. Metal was more likely to be accepted in exchange in other lands because it could be used to make useful things. 3. Metal was more valuable per unit weight than other commodities making the cost of transport lower. 4

5 O hell, what have we here? A carrion death, within whose empty eye there is a written scroll. I ll read the writing. All that glisters is not gold. Morocco in the Merchant of Venice 1. It is costly to verify the true metallic content of a lump of metal. 2. It is costly to determine the purity of a metal 3. It is costly to weigh the lump of metal. The sovereign s image signaled the content and weight of a coin. Eventually prices were expressed in numbers of coins rather than in weight of metal. Money and Government Money and Government 5

6 The earliest known coins are from Lydia (Turkey) in the 7 th century BCE. Copper, bronze, silver and gold were coined in ancient Greece and Rome. A sterling was a silver penny used in England by the Normans around Today sterling means 92.5% pure silver. Dollar derives from the German word Thaler, a coin minted in Bohemia in 16 th century. Governments often owned the mints and collected fees from the sellers of metal. The mint owner could earn revenue by lowering the metal content of coins. Seignorage denotes revenue that a government earns by shaving coins. In 1542, Henry VIII earned six times normal crown revenues by lowering the silver content of English coins. The transition from coins to paper is rooted in the practice of allowing citizens to deposit their goods in temples and palaces. In Babylon by 1000 BCE, the Code of Hammurabi set out the rules for private deposits. Officials issued receipts for deposits and the rules allowed people to transfer their deposits to third parties paper money was born. Government and Money Government and Money 6

7 Paper money began as warehouse receipts received for deposits of coins and metals. The receipts of London Goldsmiths functioned as money in the 17 th century. Use of paper money lowered trading costs. Depository managers soon realized they could make loans to new customers by issuing receipts that were not fully backed by coins modern banks were born. In 1844, the Bank of England established a rigid link between the amount of paper money in circulation and the gold reserves of the Bank of England. For the next 130 years, western economies typically backed their paper money with gold coins. Holders of paper money could demand gold coins in exchange at a rate set by the government. Money and Government In WWI and WWII, nations suspended convertibility which allowed governments to raise revenue by issuing paper currency. After WWII, nations returned to the gold standard but the world supply of gold was growing too slowly to keep pace with growth. For a time, the International Monetary Fund supplemented the supply of gold with paper gold called special drawing rights. Angela Redish describes the transition from coined gold to papermoney-backed-by-gold with a metaphor. Gold was an anchor connected to the money supply by an everlengthening chain. Money and Government 7

8 The Demise of the gold standard occurred in two steps: 1. In August 1971 U.S President Nixon temporarily suspended the convertibility of the U.S. dollar into gold. 2. The suspension became permanent in Today we use pure fiat monies that are not backed by any commodity. Governments declare its money to be legal tender for all debts public and private. But, ultimately, fiat money is valuable because people agree it is valuable they agree to accept intrinsically useless money for useful things because they believe they can use their money to buy useful things when they wish. Money and Government Government and Money Our fiat Money works well only if the Federal Reserve manages it well. Too little money growth creates a drag on the growth of production in the economy. Too much money growth causes inflation, the modern counterpart of seignorage. In another lecture, I evaluate the performance of the Federal Reserve. Return to the gold standard An Electronic Currency Bitcoins 8

9 Benefit Cost 1. US prices were more volatile during the gold standard period than after. 2. Gold has alternative uses. Milton Friedman estimated the cost of maintaining a gold reserve to be 2.5% of GDP. 3. Under the gold standard, Central banks are not free to undertake counter cyclical policies. 4. Under the gold standard, nations all fix the values of their currency to gold which implies that exchange rates are fixed and unresponsive to market forces. Gold is scarce it would be impossible for any government using a strict gold standard to create inflation over a sustained period of time. On average, inflation was lower under the gold standard than it was in periods when central banks could create money without adding to gold reserves. Gold is valuable relative to most goods implying that a little gold would purchase a lot of goods. We produce a small fraction of the world s gold. 9

10 Bitcoins are a crypto currency. Private citizens mine bitcoins by solving computer problems. Bitcoins are scarce. By design growth in the supply of bitcoins is slowing as the computer problems get harder to solve. Growth is projected to be zero by 2140 when the supply will be 21,000,000 bitcoins. No government controls (or guarantees) bitcoins. Why Amazon is right to steer clear of Bitcoin by Daniel April 15th 2014 The price volatility of bitcoins suggests that they are more of a speculative investment than money. The Dollar Price of a Bitcoin The graph depicts an index of transaction volume from Jan 1, 2013 to Jan 1,

11 Would the US be better off returning to the gold standard than sticking with our current monetary system? Are bitcoins money? Conclusion Conclusion 11

12 The Great Courses Series The Teaching Company Conclusion 12