Currency, Money and the Economy

This is the first post in a series entitled Currency, Money and the Economy.

When we think about our investment portfolio, we associate it with dollars. We hear terms on the news, such as inflation and budget deficits, and those are also associated with dollars. However, have you ever stopped for a second and figured out exactly what a dollar is? Over the next series of posts, I will be covering the basics of currency and money, and discussing why we are living in a very dangerous age.

As we explore this topic in depth, you will find things that will seem unbelievable and other things that might make you feel depressed. However, throughout the series I hope you will keep an open mind, for it just might change the way you view the economy forever.

In this first post, we will establish some definitions that will be used throughout the series.

Currency is a medium of exchange used to purchase something of value, such as goods and services. Currency is always associated with the price of something.

Money is a form of currency that has value in itself. Money is always associated with the value of something, not the price.

In order to clearly differentiate between these two definitions, let’s take a look at two examples. First, let’s take a $100 bill. We can purchase something that is priced at $100, such as two pairs of shoes that are priced at $50 per pair. However, if you think about it, the bill has no actual value, except for the minuscule cost of the paper and ink. Since the $100 bill is associated with price, but not value, it is currency, not money.

Now let’s take a look at a one-ounce Gold Eagle coin issued by the United States Mint. The coin has $50 stamped on it, meaning if we took it to a store, we could buy a pair of those $50 shoes. However, if you have followed the news you may have heard that gold recently topped $1000 an ounce. Therefore, while the price of the coin is $50, the value of the coin is $1000. Therefore, since the coin has price and value, it can be considered both currency and money.

In order to know the value of something, you must measure it against something with value. For example, a house might be priced at $300,000, but what is its value? One simple way to determine value is to divide the price of the house by the price of an ounce of gold. $300,000 divided by $1000 is 3000. This means that the house has a value of 3000 ounces of gold. You can also divide the house price by anything that has value, such as ounces of silver, barrels of oil, and bushels of wheat.

Here are two more definitions you need to know:

Inflation is an expansion of the currency supply such that each unit of currency has less purchasing power. Since there are more units of currency in circulation, the value of goods revalues themselves upward (rising prices).

The fear of a nation of savers is inflation because each new printed unit of currency devalues every other one that is held in a bank deposit. That is because when they withdraw their currency, they will find it will purchase less due to rising prices.

Deflation is a contraction of the currency supply such that each unit of currency has more purchasing power. Since there are fewer units of currency in circulation, the value of goods revalues themselves downward (falling prices).

The fear of a nation of spenders is deflation because falling prices creates a higher leverage ratio on debt. For example, if your house falls in price to $200,000, but your mortgage is still $400,000, you cannot simply sell the house and payoff the loan because your debt leverage ratio has increased with deflation.

Now that we have established these basic definitions, we can take a look at these dynamics in action. In the next post, we will discuss currency and money used in ancient times.