Two Short Economic Lessons by Patrick Barron

Lesson #1: Why Gold?

From time immemorial gold has been freely chosen by the market as a medium of exchange, because it is the most marketable commodity. There is no need for legal tender laws. People will adopt gold (or silver, or some other commodity that has inherent usefulness) as the commodity of choice for indirect exchange. When that happens, demand for that commodity goes up, adding demand as a medium of exchange to its inherent demand as a useful commodity. A people can adopt anything they wish as money, even adopting more than one money. But eventually, good money drives out bad.

Gold has always been chosen as a medium of exchange because it is indestructible, scarce, easily divisible, easily transported and easily stored, does not deteriorate over time or tarnish even in the oceans’ depths, and can be reformed into a useful commodity (industrial or decorative use) and back again with almost no loss. But all this is incorporated into one word–marketability. Gold is the most marketable commodity in the world. That is why gold will always be used as a medium of exchange.

Lesson #2: Why Haven’t Prices Gone Up?

I often am asked to explain the lack of what most call inflation (what we Austrians call a general increase in the price level) given all the base money creation. After some thought, I have come up with the following (which attempts to answer the question, even though I point out that all economies ARE experiencing inflation):

According to Austrian economic theory, money must be employed in one of three ways–hold/hoard, spend, or invest. Only the two spend and invest employments affect the price level. If the combination of both go up or down, prices will go up or down accordingly. If new money is held (also called hoarding, also called an increase in the demand for money), the price level is unaffected. Here is a thought exercise: Assume that Fed Chairman Ben Bernanke whispers in every American’s ear that he has placed a million dollars in Federal Reserve Notes under his bed. All 300 million Americans think that he alone has received this new money; therefore, everyone waits a day or two before beginning to spend it. During that time, absolutely NOTHING WILL HAPPEN TO THE PRICE LEVEL. Austrians explain that the public is holding the new money in order to have the “opportunity” to buy at a moment’s notice. But once everyone starts spending, it quickly becomes apparent that the economy is experiencing shortages; prices skyrocket; and, eventually, no one will accept dollars. Currently all this base money creation has gone into excess reserves. The Fed encourages holding this money by paying interest on excess reserves. But, eventually, the banks will get their balance sheets in order and they will start lending the money. When excess reserves start to decline, watch out!

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