What is money?

What is money?

In ancient times, money used to be something tangible, such as gold, silver or copper. Business transactions, be it trade of physical goods or capital transaction, were done with physical money changing hands.

But the world has evolved into a credit world. Business transactions have long gotten rid of changing-hands of physical money. Transactions have been done through credit: a promise to pay in physical money in the future.

With the adoption of computer technology, money is just a number on the ledger. It is an accounting entry, a mere measurement of wealth. It no longer takes a physical shape.

So in essence, money is just a promise, a credit, or a trust. When the trust in money is broken, such is the case right now, money becomes elusive. When the central banks around the world are freely printing money to bail out financial institutions and businesses that are deemed too-big-to-fail, what is the worth of money we are holding? At what point, the trust in paper money will be completely broken?

We have already seen people fleeing paper money to find refuge in the physical store of value, such as gold and silver. Gold price is approaching $1000.

But the question is: should we go back to gold? Will commodity-based money cure the ill of paper-based (or promise-based) money?

The answer in my view is no. We are not going back to the days when physical money was the primary medium of business transactions. Credit money is here to stay, which means, even in a commodity-based monetary system, money will still be just a promise, a promise to pay in gold, silver, or what ever commodity the money is backed with, in the future. When business transactions (trades of goods and flows of capital) continue to expand, credit money will also expand. Credit money will always be greater than the ACTUAL physical reserve the central banks hold. In times of financial crisis, when people come to redeem the credit for physical money, central banks won’t have adequate physical money to meet the redemptions. At that point, the decoupling of money from its commodity backing will have to occur (such was the case in 1971 when President Nixon formally decoupled US dollar from gold).

My view is that we should not go back to gold or silver standard. And I do not believe commodity-based monetary system is the answer. The answer is proper regulatory oversight of the financial institutions.

Money is a trust. We need stringent regulation to safeguard the trust.