 I like to start this talk by talking about just how much of a pleasure it is for me as being someone who I like to say not too long ago was sitting in the same seats you're in. Then I realized that when I say not too long ago, I now mean 14 years, that's running dangerously close to the ages of some of the people in the room. So I should probably stop saying that. But at the same time, I do particularly like giving this lecture as I decided to go into economics because I'd rather study money than have any. My wife doesn't care for that particular joke, I think it's a little bit too close to home. But more seriously, I do love giving this lecture because I think like so many of us involved with the Institute, I'm a man of peace. I want to see us as people interacting in a voluntary way, a peaceful way. And I'm convinced very much, oh, I love the very end of Dr. Dorbott's talk. I talked to her afterward. I said, you were just leading into it the way I wanted to start this lecture this year. And the importance of exchange and binding people together, binding society together so that we can value one another, even people that I don't know. Even people on the other side of the world, we know that there are 8 billion people or so in the world right now. I can't possibly emotionally care about each one. I don't have the emotional capacity for caring about more than, say, my wife and three children. If a fourth one comes, we're in trouble. So I can't care about all 8 billion people emotionally. But I can recognize rationally that I am in fact materially better off because they are out there doing the thing that they are best at. And that enables me to do the thing that, well, I mean, I'd be very good at it. I'm at least better than the other things that I could do. So it allows me to, and then also enjoy this material prosperity as well. I don't know how to make the great deal of all these technological things. You notice I don't even use PowerPoint here. I certainly don't know how to make the thing. Yet I can still benefit from it. It's an amazing thing. And I'm convinced that money plays a key role in enabling this trade that binds us all together socially. And it's going to allow it to be easier for us to live at peace with one another. So to build that case, I first want to talk about how money fulfills a social role. So how is it useful to us as society? Now, one would think we shouldn't have to make this case. But here we are. There are movements like Zeitgeist, the Venus Project, which has recently lost its leader, as Jacques Fresco has passed away over the past year, claiming actually that money is, in a sense, the root of all social ills. And that we'd be much better off if we could just eliminate money. Then we can focus on really just getting people what they need. Now, let's think what the world would be like if we didn't have money. Well, I would suggest we have a few alternatives. So we could have a monetary system like we have, which we'll describe in more detail later on. I guess I'll describe it in more detail later on. You can describe it to somebody else, I suppose. So one option. Maybe just do away with trade entirely. So each of us lives a self-sufficient life, producing everything that we consume ourselves. Those who have heard this lecture before know that this is when you get my update on how my garden's going. I'm fairly confident that if I had to be self-sufficient, I would die. And it wouldn't take long. It really wouldn't. I enjoy gardening. It's kind of fun, but at the same time, I'm not very good at it. So I have this little strawberry patch, totally overrun with weeds. I think we get maybe seven strawberries out of it every year. It's not very much. And my boys are faster than I am. They don't care if it's a little bit green. So it's very hard to teach a three-year-old, no, no, you want to wait until it's all red, then it tastes better. It's a little bit red now. All right, that's fine. Or I have my patch where I'm trying to grow some tomatoes. I'm trying to grow some green beans, these kinds of things. I got very fortunate that my children actually seem to like things like peas. I don't understand it, but okay, I can try to grow this for you. I actually can't see my tomato plants at the moment. The grass in the garden is higher than the tomato plants are. So I kind of feel like we're at a competitive disadvantage between those plants. However, I was very fortunate that when we bought this house, I didn't know it. But there were apparently a bunch of roots for raspberry plants at the front corner of my house. Now, those that don't know how raspberries work, it's kind of a two-year process. So they send up the canes the first year, and then they fruit the second year. So they came up, I think it was about a year, maybe two ago, the first ones came up that I noticed. I thought, oh, great, we have all these thorny things here. I'm going to have to pull them out. Then I realized, oh no, these are raspberry plants. Once my wife realized this, I certainly was not allowed to pull them out. She loves raspberries. It's okay, we cultivate them. We did get lots of raspberries this year, but again, my children are faster than I. So I guess my kids might be fine if we're going to be self-sufficient, but I am not. So I certainly don't want to go that way. But I think we can extend this beyond just myself and my own inability to garden. But the reality is that I simply don't have the knowledge or the ability to provide a lot of the things that I need. I can't do it individually. And this is true for all of us. We can think about things that we benefit from. For example, if it was really up to me, all on my own, my sight would be very, very bad. I cannot make these things. I do not have the resources to make these wonderful lenses. I think there's some kind of polycarbonate. I don't have the knowledge to do it. I don't have the resources to do it. It requires the division of labor for me to be able to actually see the front row. I can't even, real honest, there we go. That's where my notes are clear. That might be a hindrance to my survival if I'm on my own. Or things like clothing. I don't know how to make clothes. I can sew fairly well if you give me some cloth. I can probably get kind of a sack together that I can cover myself with. But I couldn't make that cloth to start with. So there are all kinds of things that I benefit from where I don't have the knowledge to make it. I don't have the resources to make it. I don't have the ability to make it myself. Some of these I might be able to learn if I had to. But I very doubt that I could live the way that I do today, or that any of us could live the way that we do today if we had to be entirely self-sufficient. So if we decide to go the self-sufficient path, I suggest we would all end up living in utter poverty. Those that manage to survive are not going to thrive the way we can today. Even those who are relatively poor in the developed world are living quite well compared to if they had to be entirely self-sufficient. Now there is another option, though. I'm a big fan of science fiction. I love Star Trek. God, it's great stuff. So we could imagine maybe we could have this post-scarcity world where I don't have to actually know how to make stuff. I just have to walk up to a hole in the wall and declare what I want. I want T. Earl Grey hot. It does some kind of nuclear physics or something in there to rearrange the atoms. So I have T. Earl Grey hot just from speaking it. I can, in fact, in the Star Trek world stamp my foot, declare what I want. And there it is. I suggest this is not realistic. And I suggested it, in fact, it cannot be possibly realistic. In fact, even if you watch Star Trek as I do, you find out, you know, this doesn't actually work for everything. There are storylines that actually revolve around having to get something you can't replicate. Now, let's setting aside the problem of how do we get the replicator in the first place. So I think we're going to have issues here. So this post-scarcity world is totally nonsense, just in the sense that it's fantasy. That's fine, but I'm not going to pretend that the real world acts that way. So another option. So if we have self-sufficiency in all likelihood, we're all going to live very, very poor lives if we survive at all. Moving then into another possibility. Let's go ahead and let us trade with each other. We're just going to do direct exchanges or what we'd call barter. So I have a various set of goods. I come to you and we can trade between each other good for good. Now, here we run into a problem. It turns out it's a very practical problem in the system, what we call the double coincidence of wants. That is, for us to be able to trade, I must have what you want and you must have what I want. In terms of the very specific good itself. Now that means that, for example, making a living as an economics professor, I'm going to have to find some farmers that really want economics lessons. Because I'm not going to grow all my own food even if I grow some of it. So I need to find farmers that will grow most of my food for me and I can teach them some about economics and they'll be happy to do this. Sadly, I have not yet found a farmer that wants economics lessons. It's not because I don't know any. I have an uncle that's a farmer. He prefers that I not talk about economics. My father-in-law similarly has an orchard where he grows apples. The only reason I get apples from him is because he cares about his grandsons and also his daughter as well. But yeah, I definitely have not given him economics lectures in exchange. So things like just my job, I'd very much tell what exists. I'd have to specialize in something else that I suggest I'd probably be less good at. I hope. Anyway, there's this problem of how do I find the people that have what I want and want what I have and we have to try to match up exactly. And it's also not enough for me to find farmers. I'm not just going to eat. I also have to be clothed. So I have to find a tailor that also wants economics lessons. I also would like a house. I need to find someone good in construction or perhaps that already has a pre-built house. That would be nice. And I give them economics lessons in exchange for the house in exchange for the clothing and so on. We can imagine this is not going to work very well if we have a complex economy like we have today where the goods that we make are very, very specific and probably have fairly small markets. It's true we can get 160 people in this room that are interested in my economics lectures. If any of you would like to give me food and exchange or a house and so on, we can talk about that afterward. Maybe we can get this barter thing to work right now that we're all connected. But I suggest this is not going to work very well on a large scale. Now, in my work, we have a very primitive economy. Say we have one person that specializes in raising sheep or in shearing the wool. That would be one thing you could possibly do. And this might be something people want because you have to spin this into thread and yarn and so on so that you can then make your clothing. So we can have somebody specialize in that. Somebody specialize in making the clothing. Somebody specialize in growing wheat and so on. As long as we keep it fairly primitive, it's fairly clear, yes, basically everybody wants food. Yes, basically everybody wants clothing. So we're probably going to be okay. We certainly won't be able to develop the type of complex economy with these very detailed things that we have today that make our lives a great deal better. Now, one of my favorite examples of kind of this problem of Barter actually comes from Star Trek. Deep Space Nine, there's a great episode. Treachery, Faith in the Great River was the title of it. I like to appeal to works of fiction. I don't know whether I'm like under the influence of my wife here or something. She's a fiction writer, writes short stories, science fiction fantasy, that kind of thing. But I'm convinced that what fiction writers do is very similar to what we do as economists. And that you're running thought experiments. You're thinking about under the set of conditions what is going to happen and trying to reason your way through in a logical fashion so that your readers, whether they're reading economics or they're reading a novel, are going to accept that this is in fact the way the world is working internally to what you're claiming. And not only that, not only do you want it to be logical, but you also want it to be in some sense innovative or surprising, interesting. This is true in economics as we write. I want to write papers that are not just totally obvious. We won't find that to be valuable to read. Similarly, you want to write novels that are not totally obvious where there are some surprises. We end up with some surprising but logical conclusions. So I think I really like looking at fiction to see how they deal with these thought experiments. So Star Trek, Deep Space Nine, Treachery, Faith in the Great River. Deep Space Nine takes place on a space station which is just undergone an attack from an enemy. We have this war that's just starting here in this particular sequence of this arc. And a lot of the station is really in bad repair. It turns out, strangely in the Star Trek universe, despite the fact that they have these replicators, holes in the wall you can walk up to say what you want, they seem not to work at really inconvenient times. Oh, we need this one very specific medicine to save this population on this planet. Why don't we just replicate it? It's too complicated. Well, we need the specific part that we're missing because it got broken in this attack. Well, why don't we just replicate it? Well, you don't have enough energy. Okay, that's good. This is a storyline we can have then. All right, so we don't have enough energy to just produce this out of the hole in the wall using nuclear physics. Rather, we have to try to find someone else out there that has this part. So there's this entire storyline. It's not actually the main storyline in the episode, but it's most interesting to an economist. Where we have this one character going out and saying, okay, I need to find this part. It's a phase capacitor or some other gobbledygook. So I'm going to go out and find who has this phase capacitor. And he found somebody. But they're not willing to just give it up. They have this other part that they need because after all we're starting a war, they're also damaged. So I have to go down this whole line. I think he ends up having to arrange something like five exchanges to finally get the part that he needs. Also because if you haven't guessed already, I'm the type of person that might, for example, play RuneScape. Anybody remember RuneScape? I played 14 years ago. It tells you something about what I was doing while I was here. So RuneScape had another very similar quest. For those that don't know, it's this online computer game you can play. And you start the quest. You walk in, okay, I need this cup. I forget exactly the way this went. All right, well, I'll go get the cup for you. It's just down the road. So you go down the road. Well, I have the cup. But for me to give you the cup, you need to get me this other thing. It's further down the road. I see some people have taken this particular quest in the front row. And what ends up happening is you walk entirely around the entire world of RuneScape in this quest before you finally get something where somebody's willing to just give you the thing for, say, the money you have on hand. And then you walk back around the entire world undoing all of these trades to make sure you actually get the thing you originally needed. And this is what you would expect. Bar would occasionally have to work. For me to be able to get the thing I want, I have to find somebody first who has something that I want, find out what they want, which I may not have. I have to find the match there. Now, what I've done there is created this interesting idea where I'm sometimes acquiring things, not because I actually want them themselves. Rather, I want to use them purely in exchange. We'll call this a medium of exchange. We're getting closer to money. We're almost there. So I'm using this as a medium of exchange. And sometimes we have these really complicated sorts of chains of events we have to go through using multiple media of exchange to finally end up where we want. Gee, wouldn't it be easier if we could all just agree on one medium of exchange? That is, in fact, exactly what money is. As Dr. Dorbott described, money is a commonly accepted medium of exchange. So it's a medium of exchange. That is, we accept it not because we want money in itself, not because, for example, I collect these things. I actually don't. I don't collect these things. This one is in very bad shape. It's not even that old. This one's from 2006 or something like that. It's not particularly old in my mind. So it's not because it's that beautiful. It's actually not particularly great art. It's very intricate. I'll give them that. But they mass produced these things. So it's not that unique. So why do I accept this? It's not because I find it valuable in itself. I'm not going to eat it. I'm not going to eat it this year. I'm not going to do it. It doesn't have that direct value. I can't really make stuff out of it. The proportions are very bad for making paper airplanes. Being the one thing I didn't think of that I'd make out of it. You might be able to make one of those cool dollar rings, which I'm not very good at, but you could maybe do that. But it's not particularly useful in itself for production or for consumption. But it is very useful because I know that if I collect enough of these things, I can go to my barber and he'll give me a haircut, which I desperately need. I had planned to get one before I came this week, but it didn't happen. So that's why it's valuable because I know that it will be accepted and not just by my barber. I can also take, if I get enough of these to best buy, and get a new television. If I get enough of these, I can pay for a plane ticket and come here, that kind of thing. So I know that people are going to accept this. We don't have to any longer argue about the exact form that payment is going to take. I'm willing to accept dollars. Basically everybody's willing to accept dollars from me. So that is the great thing that money does for us. It simplifies this double coincidence of wants problem. I no longer have to find that weird farmer that wants a lecture about economics. Rather I just have to find a farmer that's willing to take my money and give me an exchange food. And I just have to find students that for some reason have to take an economics class despite the fact that they're music technology majors. They pay their tuition and I get paid. I accept this money and then can use it to buy the things that I actually need. So it's commonly accepted meaning of exchange solves this double coincidence of wants problem precisely because everybody wants this and basically everybody has at least some of it. So we no longer have to negotiate about who exactly has the thing that I want specifically. That's kind of a nice thing. Describing this as being kind of a nice thing doesn't explain how it actually happened. It's one thing to say elevators are useful it's another to describe how it comes into existence. So how is it that we end up passing these things around? Well there we have to think back again to that world of barter and what things are like. We actually already have part of the answer here. It's very possible someone in this world of barter recognizes that it might be useful for them to accept something that they don't necessarily have any direct use for. But that nonetheless most people do. So I could imagine for example let's suppose we have somebody that's a cobbler, they make shoes but they're also gluten intolerant. Somehow they knew this in this very primitive economy with very poor knowledge of medicine. But that means that they're not going to eat bread. Nonetheless we know that many people in this economy do eat bread. So it might be perfectly possible that this person is very willing to exchange their shoes and exchange for bread. Because they know that this bread is going to be acceptable for example to the butcher that this person can actually eat. So we can imagine somebody having this insight, ah! I can accept something even though I don't want it myself because it's easy to get rid of. There are plenty of people out there that want the thing. And that is how we see the meaning of exchange first arise. But then it ends up spreading. Because what happens as soon as that one person that gluten intolerant person starts accepting bread suddenly it becomes more acceptable. As it becomes more acceptable there's all the more reason for me individually even if I don't like bread even if I have no direct use for it I may as well take it because it just got a little bit easier for me to get rid of it. And we see then the spread of this medium of exchange throughout the economy as people then converge on whatever it happens to be. Probably not a paper bill at first. Right? How many people want this to start with? Probably not many. We'll get to it. So what ends up happening we can see this in history that money's tended to be things that were pretty obviously useful to most people. So we might have something like say cattle. It seemed to be one way that money was often used. You can imagine most transactions that use this were very large barter handling the smaller transaction. Then we see movement from there to things like grain. It ends up stores fairly well as long as you keep it reasonably dry. It's also smaller in its denomination so we can trade smaller amounts than an entire cow. That's kind of nice. And over time we see different people coming up with ideas for things we could potentially use until eventually the market seems to converge on using gold or silver. This is the way things seem to go. So why gold and silver? Well let's back up a moment and think about the various functions that money has in the economy. Now the most fundamental, really the primary function is that of serving as the commonly accepted medium of exchange. Now we know that this is somewhat vague. It's commonly accepted. 70% of people accept it. 93% accept it. Take a deep breath. Get over it. It's going to be a little bit vague. That's okay. It's commonly accepted. What commonly means, we don't have to be that precise. As long as I have a reasonable expectation people are going to accept it. We're okay. So a commonly accepted medium of exchange. So medium of exchange is one of the functions that money fulfills. We also see money fulfill this medium of exchange role in an inter-temporal transaction. So what we'd call credit transactions. So when I lend to you, I may lend to you in money. Then you can go on and buy the stuff you want. When you repay me, you repay me in money. So this standard of deferred payment is the typical way of stating this. It's really just a medium of exchange applied to credit. Another that we tend to see is that it tends to become a store of value. And this is something where what we mean by a store of value is that it allows us to transmit value so that I can take whatever this money is, I can put it in a warehouse or something like that. I can leave it there for a while and I can go back and it's basically the same thing. So for example, we tend not to see milk being used as money. It's not a very good store of value. I can take this dollar bill. I actually don't know how long it's been in my wallet probably for several weeks at this point. I could not do the same thing with a small bag of milk. Even if it fits in my pocket, it's not the same bag of milk after a couple weeks. It's fundamentally different. Not true of this dollar bill. It's a little bit more worn, maybe a little bit more of a germy from being all in my hands, but it's basically the same. So it doesn't change fundamentally. It holds its value reasonably well over time in most circumstances. So the store of value is something we see that money tends to be used for. And this makes sense simply because I don't always know when I'm going to want to buy the things I want to buy. So it makes sense to keep a store of money on hand in the case that I happen to want to buy something. So I carry a few dollars in my pocket because you never know. I might decide that I want to stop by a vending machine and buy a bag of chips that's horrifically overpriced. What is overpriced mean in Austrian economics? Don't think about it. Move on. I carry a store of these with me precisely because I don't know the exact timing of when I'm going to buy stuff. So I carry a store of money being used as a store of value. It's not the only one. You might hold other things as a store of value as well. For example, my house is a reasonably okay store of value. Of course it's certainly not money. Or we also see very importantly used as a unit of account. That is we do monetary calculation using monetary terms. Since it is used as a common meaning of exchange we then can use in a sense money as a common denominator, more properly as a common numerator, and being able to compare things in actual quantitative terms. I can calculate profit. I can do plus and minus these types of things using money because it's all the same unit that I'm doing. It's not like capital, as I know Dr. Garrison is going to talk about, capital is not all the same thing. You can't just add it up in terms of physical units to know what we're going to have. These are the things we want money to do. What kinds of traits would money have to have to be able to fulfill these kinds of roles that we see? One, we would want money to be very portable. If it's going to be used as a medium of exchange I have to be able to get it to where I'm going to be doing exchanges. Portability means having a high value for its weight and high value for its bulk. That's something we would want. Things like dirt, not a very good money. It's not very portable. You can get a lot of value from dirt it turns out. You just have to have a whole amount of money to be divisible. This is probably why we moved away from cattle because it turns out that two halves of a cow are fundamentally different from a whole cow. Not the same thing. Not the same set of uses you can have. Not so true though with two halves of a gold coin, but it can actually be fairly easily bound back together. So it turns out divisibility is an important thing. It allows us to then undertake both large and small transactions using the same commodity. It should be fungible. That is each unit should be basically interchangeable. Now this is where things like jewels tend not to be very good money as they are all a little bit unique compared to the other. We have different qualities, different sizes and so on that would change for the value of each unit. But it turns out things like gold and silver coins, we can make very uniform so it doesn't matter particularly which coin I'm dealing with. It should also be somewhat scarce. This is tied to this portability, having that high value to weight and to volume. So it should be something that is not so easy to come by and should also have a broad based demand. So a lot of people should demand the thing to start with. Again, it's going to be commonly used from the very beginning. We want it to be something that I know I can get rid of easily. So these are the types of things we would expect money to have as traits. Gold and silver we can go through this list and see it fits fairly well. We tend to see fairly high value to the weight to the bulk. We see it is fairly easily divisible and in fact you can bind it back together without too much problem. Controlling as you have to for quality, you can make it fungible fairly easily, certainly scarce. Broad based demand is perhaps the most difficult one, although my wife assures me that gold is something where there is a significant demand for it. Okay, not a funny joke. But thinking historically, we know that things like gold and silver took on a very important religious significance and religion was very important socially within these realms and we can see that not necessarily because it was considered valuable to start with but it had these connections with the stars. There is almost a mystical import put on gold and silver, giving it a very broad based demand as people were involved in social religion. So we can see where each of these traits would come around and move us toward gold and silver. Turns out gold and silver are also wonderful because they do not want a store of value simply because they tend not to degrade over time. Silver will tarnish a little bit, that's not too bad. Gold won't even do that. So they're going to do extremely well in fulfilling these various roles. So how then do we move from this world of gold and silver coinage being used as money to the world where we live today, where basically everywhere in the world we're using this stuff. This paper, occasionally you'll find people, generally they tend to say, oh well the reason we like dollars is because they're backed by gold. If you were alive long enough ago that may have been true in a sense. Not so true anymore it turns out the value of this dollar is simply based on the fact that people will accept it. I can't take it anywhere and say oh please give me the gold backing this. You can't do it. So why is it how do we move here? Well it turns out originally there was this connection between gold and silver and the paper monies we know because it was found that there was this very nice innovation we could make to gold and silver that still allowed us to have these nice traits portability and so on but increased security. Because one of the problems with carrying metal with you is that metal tends to make noise so I have to be very disciplined not to reach my pocket or you get that kind of thing while I'm lecturing and it's very distracting. Now being distracted is not so much a problem when you're walking on the way to market but thieves are. These are a significant problem and you don't want to advertise how much gold you have so it would be kind of nice if there was some way that I could hide that. So what do we do? Well maybe there would be a business here I could start. I will accept your physical gold. I will give you an exchange or a receipt saying yes you have claimed this physical gold. You can then take this receipt which is very quiet. This receipt is very quiet. It's not going to alert anybody that you are carrying a bunch of money with you. You can carry that. I have a good reputation. People will trust this because they know that I do actually have the gold in the vault so they will accept this. It's as good as the gold. They will bring this back to me. I will give them physical gold if they want it. So this is what we would call a money substitute. It is not money itself but it represents money in a sense. It is a claim on money that then can be redeemed. So that then gives us this rise of these paper money substitutes that are in fact backed by gold or silver. But it turns out that people that open these money warehouses start to get clever and realize they have such good reputations they don't actually have to have all the gold in the vault. There is this nice side business we could start up. I lend out some of this gold in the vault. Technically someone else's money, yes. But I can lend it out. I can receive interest. As long as people hold on to these paper receipts for a while it's not going to be a problem. We of course recognize this as fractional reserve banking. That is, you are putting all these reserves here in my bank where I will store some fraction of them. The rest I am going to lend out. Well it turns out fractional reserve banking for reasons that we will be gotten into later this week is not particularly stable. And we ran into problems with it. That led eventually to cutting the tie between these paper and the gold that was used to underlie it. But at this point the paper was such a part of our economy that people were accepting it and treating it as money. Cutting away the gold tie had remarkably shockingly in my mind the impact on people's willingness to continue to accept and use these things. So paper money now has come as a result of banking and intervention in banking. So now we just have paper money. So now let's look at not just kind of the social value of money and it serves in allowing us to have the complex economy we have but the specific value of money. What is it that makes a dollar worth a dollar in exchange? One of the brilliant insights from Mises is one of those amazing things where he said well you know maybe money isn't all that different from other goods. Maybe supply and demand which we know works for things like wheat works for things like bread works for things like televisions maybe it works for money too you can use simple supply and demand reasoning to understand how money works. So the price of money is determined by the supply of and the demand for money. But then we have to think about what exactly we mean by the price of money. The price of a T-shirt is $7 say we know what this means if I have $7 I can exchange it for a T-shirt if I have a T-shirt I can exchange it for $7 how does this work with money? The price of a dollar is a dollar? That's not really an exchange at that point it's just saying what the thing is. Now money being on one side of virtually every transaction in a monetary economy then has a number of prices or purchasing power so I could use this dollar to buy a very small fraction of a house I could use it to buy a somewhat larger fraction of a car I could use it to buy a third of a cup of coffee or a fifth of a pie so I have all of these various things that I could exchange the dollar for now this is going to be something where coming to a single number is not going to be possible but nonetheless conceptually we can understand but if money is more valuable it means I'm going to get more stuff in exchange for that money if money is less valuable I will get less stuff so it is going to be the supply of money and the demand for money that determines the purchasing power that is the value that this money has in exchange so then we can do all the standard supply and demand kind of reasoning if we increase the supply of money what's going to happen to its value it has with anything if you increase its supply it tends to lose value the purchasing power of money is going to tend to fall you'll need more dollars to buy stuff if there are more dollars in existence or we can think about the demand for money if people are less inclined to hold on to a lot of this stuff for long periods of time if that happens it's going to lose value you're going to need more dollars to buy any particular thing so standard supply and demand reasoning can be used to understand the value of money but then we start running into issues as we try to get a little bit deeper into specifically the demand for money so let's actually be good methodological individualists which I've not been doing so far so think about the individual level and how individuals interact with and think about the value of money based on the story we have I first observe that money is valuable in exchange people are willing to accept it it has this objective exchange value and I therefore decide that it is valuable to me I want to have some of this money because it is acceptable to other people this then creates my subjective demand for money of course we know demand then is part of what determines the value of money so if you're listening carefully you notice a circle we start with money is valuable out there and therefore I have a demand for it and this demand creates the value of money circular reasoning is something that generally we don't look kindly upon suggests that I may be just switching a bunch of words around but really not actually saying much of substance so one of the great insights was that this reasoning is not nearly circular as it sounds once we realize that time is in fact a thing that has an influence on us our minds exist in time we observe time and we observe things in time so when I observed that money had value I didn't observe it at the same time as I had that demand for that money I observed it previously so yesterday I saw that money had a certain amount of value that led me to believe that I need a certain amount of money to make the transactions the various purchases that I'd like to make the next day that led to what my current demand for money is the value of money so time allows us to break the circle instead we break it out into a line so the value of money today is based on my demand for money today my demand for money today is based on the observation I made about money's value in the previous period of course that money's value move my timeline that money's value came from the demand at that point in time which came from the observation of the previous period this feels like I maybe didn't solve the problem because I'm just going to keep moving my timeline further back in time where does it stop well we know that originally when money arose it had to have arisen out of barter where we had the good had a value established in the market not on the basis of the fact that people accepted it but rather on the fact that it was actually useful the first person that decided that they were going to accept grain in exchange despite the fact that they had no direct use for grain themselves did it because they knew that grain was actually useful to other people that was where the value originally came from so it had to have been that original monetary commodity had to have had some kind of direct use value that was recognized by the market this is known as the regression theorem so we take the value of money can regress through time eventually to that last day of barter where we had some kind of commodity that did actually have some direct use value to the people that wanted it so we've broken the circle we've broken this infinite chain back through time it stops right there at the end of barter so that's money's demand when we look at money supply there are a few observations we want to make the first is that strictly speaking there isn't really an optimal level of the money supply at any level of money is going to work so we could imagine say two economies side by side that are basically identical one of them has twice as much money as the other what I would expect to happen is they would just see prices twice as high and one is in the other when transactions happen all of the accounting looks twice as big but in terms of real value of what's happening it's exactly the same as in the neighboring economy so that means producing more money isn't in itself going to be that valuable to the economy as a whole any amount of money is going to be good enough but now this is it ends up not actually strictly true it is true for money as money but if we remember that money is sometimes other things so for say using gold money producing more gold is not useful my wife assures me no the more gold is actually useful because there is also this commodity value I can use the gold as gold for things like jewelry and so on now if we have something like fiat money that doesn't actually have any outside use anything beyond money then this is actually going to be true producing more of it is not actually going to be socially valuable the amount we have now is perfectly fine so then what happens if we do actually decide for whatever reason to increase the quantity of money now here is kind of the standard way of thinking about it sometimes called the angel Gabriel model or the helicopter model to be on who you ask we kind of imagine what would happen if we take say the American economy and then run helicopters over it and drop money on this economy so everybody weirdly gets money in exact proportion to how much they had before it's a very very specific helicopter so everybody ends up with twice as much money on the previous day oh this is wonderful we come out the next day and then we realize there isn't actually any more stuff so the way that the helicopter model or the angel Gabriel blows his horn and then everybody has twice as much money the standard result is well we just end up with moving from that economy with less money to the economy with more prices go twice as high nothing really changes Mises says this is in fact exactly wrong because that's not the way people react when they get more money if you give me more money I don't then say well I'm going to spend twice as much on each of the things that I had before that's not the way I react I change my spending pattern right so even if we did weirdly manage to have money be spread evenly throughout the economy we wouldn't actually expect this lock step the economy stays the same just prices twice as high of course the reality is even worse than this that when money enters the economy it's not through a helicopter coming out of the sky to each of us in proportion to the money we already have rather money enters at specific points in the economy now it turns out this is a really good answer to why would you bother increasing the money supply if it's not socially valuable right let's say I print another billion dollars may not be socially valuable but it's me valuable I'm in fact made better off by increasing my own money supply relative to that of other people and this is in fact we would expect those that have the ability to increase the money supply to want to do they want to increase their own personal money supplies because it allows them then to have a greater command of a resources compared to those around them this leads to what we would call canteon effects right so we see then a change in relative prices right so those that first receive the money let's assume for whatever reason I don't I don't know that Janet Yellen even knows who I am well let's suppose that she decides to send me a billion dollar check of brand new money right so the first effects we're going to see are in those things that I am going out to buy because that is where we're going to see the first effect on demand for these goods so we start seeing right the prices of the various goods that I buy so I don't know I guess maybe the price of hulu is going to go up sorry right right so hulu netflix becomes more expensive right movies become somewhat more expensive restaurant meals become more expensive places that I spend the money we see an increased demand that pushes up the prices of these goods now this in turn is going to benefit those that receive the money second after all now there's they're selling their restaurant meals for more they're selling netflix for more and so on and this has happened before their costs have increased so they're in fact made better off as well and this continues down the line except there are a bunch of people they're not being made worse off right the rest of you that are paying for netflix or hulu or what have you are paying more for it because my demand is greater you're made worse off you're less able to afford this or other things you have to make choices you're going to end up with less than you had before so you get this redistribution right from those that don't receive the money first they receive it further down the line right toward those people that do receive it first so if you really want to understand why it is that it seems that the largest skyscrapers all belong to banks think about the line of where new money enters the economy I'm not going to say much about that but take a look at the skyscrapers in various cities and see the names that are on them and you'll probably have some idea of where new money enters the economy and who's benefitting from this so get this redistribution now one last point that I do want to talk about because it is so essential to understanding the problems that can arise in the monetary economy we have to talk about hyperinflation I like to say if you want to destroy an economy first you're a terrible person but I generally don't lead with that but it's true but if you want to destroy an economy you have two options the first is the slow option that is adopt widespread central planning this works extremely well in destroying an economy you should take a little bit of time for it to work if you want to destroy the economy quickly though use hyperinflation easy so what is hyperinflation exactly I won't define it in precise terms but it's a process through which money loses its value as money through which people find that they can no longer actually use this money as money it stops being commonly accepted now the way this happens is in three stages it begins first with an increase now typically historically the way this works is that governments find that they're having a hard time funding themselves so they decide to print more money in order to do this turns out taxing people people tend not to look kindly upon that you're much better off politically running on low taxes than high taxes that's not a good way to raise money it ends up eventually if you're running deficits all the time people don't want to lend it to you anymore so borrowing is also limited it ends up dollars are cheap these are something the neighborhood of 7 cents last I checked might be 10 cents now that's pretty good it's a 90 cent profit every time I make one of these things not bad there's a fairly good way for us to raise money and not only that but people are very unaware of the effects this is going to have I can easily blame these evil capitalists for raising prices did they raise prices well technically yes but they're responding to demand where did the demand come from new money it all starts with this increase in the supply of money typically because governments are running into funding problems now this is naturally going to lead to a drop in the purchasing power of money now often though in the first stage people don't really realize that this is going to be a trend so instead they look around and they say wow it looks like gas is more expensive food is more expensive housing is more expensive maybe I'm going to hold off on buying stuff for a little bit let these prices fall what this really means is there's an increased demand for money people are going to hold on to money for longer they have an increased demand they want to hold on to it that's going to prop up the purchasing power of money a bit so it won't fall quite so much as it would if people didn't expect prices to come back down to normal but over time we at the second stage the supply of money continues increasing and people realize prices are not going to fall back to normal in fact rising prices seem to be the new normal once I realize that an asset that I'm holding is going to be losing value over time I stop wanting to hold on to it so much I want to get rid of it so people start divesting themselves of their cash holdings we have a drop in the demand for money and as the demand for something drops including money its value drops as well so now we have this speeding up of the loss of value in money increasing supply continuing to drive down the value of money plus people don't want to hold it quite so much as they used to now eventually this comes to what we would call the crack up boom where people just totally abandon money they don't want it at all to real values they're willing to get rid of money to get anything else because it is losing value so so quickly when we hit this stage you start seeing really bizarre things happening in the economy I heard the story but in Ecuador they went through this hyperinflationary episode that actually led to them eventually adopting the dollar as this was going on people are being paid twice a day you're paid right before your lunch break so you go out and get rid of the money just buy whatever happened to be available you're paid again at the end of the day so you go out and get rid of that money again as well that way you wouldn't have to hold it overnight where it was going to lose value insane absolutely insane and it's easy to laugh at it because it does things like makes me I'm a multi-trillionaire now this is Zimbabwe money, $180 trillion I paid $15 for this on eBay that included these sleeves it's probably worth more than what's inside I suspect and it's easy to laugh at this how could this happen but at the same time we have to remember the great human suffering that is caused by this when the monetary system breaks down where are we we're back in that world where now we can no longer engage in this kind of complex great economy that we have now we happen to live in a world where we have multiple currencies so Zimbabwe have stable currencies so the economy can continue without actually too much problem so we saw they adopted things like the euro the rand, the US dollar all operating side by side in order to allow a monetary economy to continue so hyperinflation, one destroying economy that's the way to do it so I hope that in the end of this I've shown to you that money is a useful thing in binding us all together and in fact managing money well in turn somebody come see my later lecture monetary policy reforms, we'll talk about how we can perhaps make our monetary system work better maybe protect against that type of thing but I hope we've proven that money plays a key role in binding us all together thank you very much