# Money - it is not what you think



## TradersCircle1 (21 December 2010)

Money - it is not what you think

A comment from a reader:

"Govt deficit spending is funded by bond issuance. Large institutions and foreign entities are the primary buyers of such debt. The private savings rate does not have to mirror deficit spending "to the penny" since there are many other private savings vehicles not connected to govt debt issuance. However, govt deficit spending does divert capital out of the debt markets that would otherwise be available for business and other forms of productive lending."

I would have to strongly disagree with this point of view. Governments do not borrow first and then spend. Government spending does not divert capital out of the debt markets. Governments spend money first, with all their spending, to the penny, appearing as a deposit in someone's bank account. Simplistically, the Government is overdrawn in their Reserve Bank Account, and the banks, collectively are in surplus in their Reserve Bank account. The Government spending has created its own surplus, not diverting it from anywhere else.

The Government can just leave their RBA account overdrawn. Whether the RBA chooses to pay interest on the banks' surplus accounts is a question of maintaining a monetary policy, not a question of the Government being revenue constrained.

If the RBA/Government choose to pay a targeted interest rate (monetary policy) to the banks with surplus cash, the Government is in effect paying interest at a variable rate. That it chooses to extend the maturity of its "debt" from 1 day to 90 days (Treasury Notes), or 5 years (Bonds) etc, is a policy choice, not as a matter of necessity.

This fact is amply demonstrated by America's quantitative easing program. When the Federal Reserve buys US Government bonds it is simply crediting the sellers bank account with the proceeds of the purchase. It is only converting the debt maturity from, say 10 years, back to 1 day. Commercial Bank accounts will be in surplus by the amount of Federal Reserve purchases of bonds. The Federal Reserve's current policy is to pay .25% interest on overnight (1 day) balances. The banks already had about $1 trillion on deposit with the Federal Reserve, and that did not spark off inflation or increas bank lending. All QE does is to convert the maturity of the debt. To the extent that 10 year debt is more risky than 1 day debt, the Federal Reserve has reduced risky assets in the economy. Their hope is that investors will start to seek out more risky assets to achieve some yield.

Australian bank lending is not crowded out by Government borrowing. American banks have about $1 Trillion in reserves with the Federal Reserve, receiving only .25% interest. I think they would be happy to lend at a higher rate. The banks have not stopped lending, people have stopped borrowing. Borrowing comes first, not lending.

The Australian currency is a promise to pay. It is not backed by gold, commodities, or real estate or anything. The concept that Australia can run out of "promises to pay" does not make sense. The concept that Australia should run a budget surplus and accumulate its own "promises to pay" does not make sense. The concept that Australia has a Future Fund with accumulated $66 billion of "Australian promises to pay", invested with fund managers who are paid a fee, who in turn are invested in some form of risky assets, whilst at the same time borrowing $174.8 billion in "promises to pay" is also a strange concept. The Future Fund owns 1.09 billion of Telstra shares, whose share price has fallen $1 since 2009, being funded by 5.5% Government Bonds - strange indeed.

Government finances are simply not the same as Private finances. We are legally compelled to meet our obligations in "Australian promises to pay". The Government is only dealing with itself, so therefore, in reality, are not financially constrained. It is all a strange concept, but as long as mainstream thought treats Government finances the same as private finances we will all be burdened by policy dross.

Michael Cornips


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## tothemax6 (21 December 2010)

TradersCircle1 said:


> Money - it is not what you think
> The Australian currency is a promise to pay. It is not backed by gold, commodities, or real estate or anything. The concept that Australia can run out of "promises to pay" does not make sense. The concept that Australia should run a budget surplus and accumulate its own "promises to pay" does not make sense. The concept that Australia has a Future Fund with accumulated $66 billion of "Australian promises to pay", invested with fund managers who are paid a fee, who in turn are invested in some form of risky assets, whilst at the same time borrowing $174.8 billion in "promises to pay" is also a strange concept. The Future Fund owns 1.09 billion of Telstra shares, whose share price has fallen $1 since 2009, being funded by 5.5% Government Bonds - strange indeed.
> Michael Cornips



Mate, what is the point of your posts? Yes, we know that Australian money consists of numbers in the RBA computers and plastic notes. So far, it is working pretty well. We haven't had any hyperinflation recently that I know of. This by itself goes against the idea that 'promises to pay' do not make sense - they work. Now whilst there is much to be said for a gold standard, the fact remains that reverting to it would cost more than maintaining the current fiat money standard. That may change in the future, but for now it is fine.


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## Smurf1976 (22 December 2010)

tothemax6 said:


> This by itself goes against the idea that 'promises to pay' do not make sense - they work.



Until such time as the promises aren't met, at which point the whole system ceases to work.

A lot of things work fine, until suddenly they don't work at all. To make a fair assessment of the "cost" of fiat versus a gold standard, you'd need to factor in a collapse of the fiat system at some point, and that's a rather large cost I would think. 

History says that fiat money doesn't last so it would be wise to assume this time will be no different.


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## professor_frink (22 December 2010)

Nice post Michael


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## burglar (22 December 2010)

If you were a diver for pearls and I grew rice, we could both eat and we could both wear pearls.
Why we need money is so that the diver for pearls can eat, even if the grower of rice does not like pearls.


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## tothemax6 (22 December 2010)

Smurf1976 said:


> Until such time as the promises aren't met, at which point the whole system ceases to work.
> A lot of things work fine, until suddenly they don't work at all. To make a fair assessment of the "cost" of fiat versus a gold standard, you'd need to factor in a collapse of the fiat system at some point, and that's a rather large cost I would think.
> History says that fiat money doesn't last so it would be wise to assume this time will be no different.



By the 'promises won't be met', you mean people will not accept aussie plastic money for payment. That doesn't sound very likely does it? And really, regarding a hyperinflationary collapse this is only possible if a reckless government gets in. Even if a gold standard exists, it cannot save us from reckless governments.

Secondly, the trend today is towards electronic money accounting, and away from coins and notes. This is because it represents the highest transaction rates, lowest transaction costs, and highest transaction ease (no fiddling with change). Note the new mastercard paypass as an example. This can only cause the monetary base to be increasing expressed as numbers in the RBA computers. The only question regarding a gold standard is 'should those numbers in the RBA be linked to the gold in the RBA'. And again, until there is proof that Australia cannot prevent hyperinflation with its currency, there is no reason to do this due to the expense of doing so and the instability during the changeover (and if hyperinflation happened - this would be the best time to switch over anyway).


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## nioka (22 December 2010)

Sooner or later someone will notice that "the emperor has no clothes".


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## Smurf1976 (22 December 2010)

tothemax6 said:


> By the 'promises won't be met', you mean people will not accept aussie plastic money for payment. That doesn't sound very likely does it?...
> 
> And again, until there is proof that Australia cannot prevent hyperinflation with its currency, there is no reason to do this due to the expense of doing so and the instability during the changeover (and if hyperinflation happened - this would be the best time to switch over anyway).



Fiat currencies in general have lost most of the value they had even 30 years ago, and virtually all the value they had when first issued.

Take the same amount of money that would have bought just about any consumer item 30 years ago and offer that as payment today. The shop will not accept it, because that money no longer has anywhere near sufficient value to pay for the item.

Within the lifetime of most on this forum, petrol cost 30c a litre, individual cans of Coke were 60c, individual lollies from the shop were 1c and many will remember prices far lower than those. Even someone aged 30 has lived through a huge loss in the value of fiat currency, to say nothing of what those aged 40, 60 or 80 have seen in their lifetimes.


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## Vicki (22 December 2010)

> Within the lifetime of most on this forum, petrol cost 30c a litre, individual cans of Coke were 60c, individual lollies from the shop were 1c and many will remember prices far lower than those. Even someone aged 30 has lived through a huge loss in the value of fiat currency, to say nothing of what those aged 40, 60 or 80 have seen in their lifetimes.




I know in '82, I was heartbroken, when the price of a vanilla drumstick went from 20 cents to 25 cents, as a 20cent piece was all I was given for 'lollie' money on a Sunday [my dad was tight], when I came back to the car &  hussled him for an extra 5c, I still remember him grumblin' "damn inflation!"

LOL Now It's gone 'round full circle, except now It's x-box & mobile phones the kids are husseling for!

On a more serious note, you would have to invest your money in something that appreciates quicker than our dollar deflates in buying power!
As keeping your money in the bank long term, would be just cutting your own throat!

i.e. 3-5% interest earnings v.s. approx. 8% average inflation rate.


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## tothemax6 (22 December 2010)

Smurf1976 said:


> Fiat currencies in general have lost most of the value they had even 30 years ago, and virtually all the value they had when first issued.
> 
> Take the same amount of money that would have bought just about any consumer item 30 years ago and offer that as payment today. The shop will not accept it, because that money no longer has anywhere near sufficient value to pay for the item.
> 
> Within the lifetime of most on this forum, petrol cost 30c a litre, individual cans of Coke were 60c, individual lollies from the shop were 1c and many will remember prices far lower than those. Even someone aged 30 has lived through a huge loss in the value of fiat currency, to say nothing of what those aged 40, 60 or 80 have seen in their lifetimes.



Agreed, but these are very long periods as far as a human life is concerned, and even longer when you look at the main period most people of concerned with - the time between pay days. You only think that those prices are cheap because they are cheap relative to *todays* earnings. People do not earn their money at 1970s prices and then have to pay for things at 2000s prices, so the actual historical price numbers are rather irrelevant.
Regarding long term holdings, most people will not hold saved money in their mattress - they will put it in an interest bearing account, they will put it in a fund, they may buy metal, they may buy floating bonds, they may buy blue chip stocks etc. All of these things nullify the long term effects on inflation for the average soul - providing he knows that the inflation is there and acts accordingly (which most people do). 
Keep in mind that gold was used as a 'promise to pay' also, and indeed as far as I know the original usage of gold coins was 'cow tokens', issued by stockmen.


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## Smurf1976 (22 December 2010)

tothemax6 said:


> Agreed, but these are very long periods as far as a human life is concerned, and even longer when you look at the main period most people of concerned with - the time between pay days...



The trouble is that inflation distorts prices in the real economy. A quick search turned up these figures from a housing forum (not sure how accurate they are, but they seem reasonable and are sufficient for the purpose here).

In 1983 average weekly earnings were $324 and the average house in Melbourne cost $50,000. So it took 153 weeks of work for an average worker to pay for an average house.

In 2010 average weekly earnings are $1223 and an average house in Melbourne costs $452,000. It now takes 369 weeks of work for an average worker to pay for an average house.

Now, there was no realistic prospect of anyone now aged under 45 owning a house back in 1983. They have been done over big time by the effects of asset price inflation exceeding wage inflation and had no opportunity to protect themselves from that. Even moreso if they are now aged 30 or 25 as most first home buyers are.

A house is a pretty big expense for most so is a highly relevant example. The lesson of history is that inflation harms the middle classes most and this time appears to be no different. The poor have little to lose anyway, and the rich are not overly dependent on weekly earnings from paid employment (and those who are, for example CEO's, are by definition highly paid and often in a position able to ensure that _their_ earnings do keep pace with inflation despite what may happen to other workers).

I doubt there would be a single employer in the country who has not expended at least some effort in regards to determining wage rates in recent years. For larger companies it is a sufficient task to warrant employing people to do nothing else. Then add in the activities of various government agencies, unions and the like. Most of that expense is incurred due to inflation and nothing else. If we didn't have inflation then for most jobs, wages would change very infrequently in response to underlying changes in the economy and the entire "industry" of setting wages, which in itself creates no wealth,  would be greatly diminished.

A bus driver today would be paid essentially the same as a bus driver 10 years ago. Driving a bus as a job hasn't really changed much over the years and probably never will. A new ticketing system and automatic transmission perhaps, but that's about it. Follow the route, stop at bus stops to set down and pick up passengers, collect fares, give directions to lost tourists, take the bus back to the depot and the end of the shift. It is essentially the same job now as it was 10 years ago and the same as it will be in 10 years time. An important and necessary job certainly, but not one that needs any real change in pay rates other than to offset the effects of inflation. 

Now consider how much effort has gone into setting wages for bus drivers over the years. Unions, employers, all sorts of meetings, even a strike or two. A small adjustment to reflect supply and demand factors in the economy may have been necessary without inflation, but most of the change in wages over the years is needed only due to inflation. It's a hidden cost of fiat money that affects every industry.


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## Julia (22 December 2010)

Vicki said:


> i.e. 3-5% interest earnings v.s. approx. 8% average inflation rate.



Um, Vicki, where are you getting these figures from?
Average term deposits are between 6 and 7%.  ( I have 8%).
Inflation is, according to the Reserve Bank's most recent report, at 2.8%.

And let's remember that people in pension phase of their super are paying no tax.


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## tothemax6 (23 December 2010)

I'm sorry mate but I simply must address your post in whole:


Smurf1976 said:


> The trouble is that inflation distorts prices in the real economy. A quick search turned up these figures from a housing forum (not sure how accurate they are, but they seem reasonable and are sufficient for the purpose here).
> In 1983 average weekly earnings were $324 and the average house in Melbourne cost $50,000. So it took 153 weeks of work for an average worker to pay for an average house.
> In 2010 average weekly earnings are $1223 and an average house in Melbourne costs $452,000. It now takes 369 weeks of work for an average worker to pay for an average house.
> Now, there was no realistic prospect of anyone now aged under 45 owning a house back in 1983. They have been done over big time by the effects of asset price inflation exceeding wage inflation and had no opportunity to protect themselves from that. Even moreso if they are now aged 30 or 25 as most first home buyers are.



I don't see how you could automatically see this as caused by an expanding money supply. I would not look, for instance, as decreasing electronics prices and say 'this is caused by deflation'. I would say 'this is caused by increasing supply of electronics (in terms of quality) for a steady demand'. Likewise with houses, I would say 'there is more demand for housing now than in 1983, for a steady supply'. Now you could claim this is a result of government action yes, i.e. allowing increased immigration, failing to free up land for development etc. But to say this is caused by fiat money does not follow. If you are claiming that the fiat standard causes bubbles, which can occur in particular assets, ok. But even under a gold standard did bubbles occur, banks are still free to extend whatever credit they wish, and houses are bought with bank debt not personal equity.


Smurf1976 said:


> I doubt there would be a single employer in the country who has not expended at least some effort in regards to determining wage rates in recent years. For larger companies it is a sufficient task to warrant employing people to do nothing else. Then add in the activities of various government agencies, unions and the like. Most of that expense is incurred due to inflation and nothing else. If we didn't have inflation then for most jobs, wages would change very infrequently in response to underlying changes in the economy and the entire "industry" of setting wages, which in itself creates no wealth,  would be greatly diminished.
> 
> Now consider how much effort has gone into setting wages for bus drivers over the years. Unions, employers, all sorts of meetings, even a strike or two. A small adjustment to reflect supply and demand factors in the economy may have been necessary without inflation, but most of the change in wages over the years is needed only due to inflation. It's a hidden cost of fiat money that affects every industry.



This is a null point. Under a gold standard the same issue remains, albeit an inverted version of the same issue. Since the gold stock only expands by tiny amounts each year, and the economy grows each year by a much greater amount, there is systemic deflation. Indeed, this is well known and it was the norm for gold-standard countries leading up to the 20th century. This of course requires constant down-adjustment of wages, and thus poses no benefit in terms of general price adjustment overheads.


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## ROE (23 December 2010)

Another Gold Bud post

The stuff they spread, hyper inflation, fiat-money, non-gold standard, promise to pay, high debt, collapse of economy and on it goes ....

Gold =  a piece of metal, unproductive, cost money to store and hold, you just hope  the guy that buy off you prepare to pay higher than your purchase price...

Business = generate an income,  have potential to earn more and more each year and hence higher income, value of the business increase due to the increase in earning

I like the idea of business a lot better


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## Vicki (24 December 2010)

Julia said:


> Um, Vicki, where are you getting these figures from?
> Average term deposits are between 6 and 7%.  ( I have 8%).
> Inflation is, according to the Reserve Bank's most recent report, at 2.8%.
> 
> And let's remember that people in pension phase of their super are paying no tax.




Hi Julia,
I was guestimating 'average' figures over the years, [I think inflation has averaged 8% over the decades?]...Also bank interest has been much lower at 'round 1% in the  past.

As for the Reserve bank or governments calculations on inflation, I could ge wrong, but I think their estimates have always appeared to be on the lower side?

Vicki


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## nioka (24 December 2010)

Years ago I had a business that took Barter card as payment for the service I sold. I used the bartercard dollars to pay for services from other businesses that took bartercard credits as payment. I paid a dentist, paid for car servicing, printing, landscaping supplies and a truck load of bricks and pavers. I paid the bricklayer to lay the bricks and pavers. I paid the landscape gardener.

Barter gets you a dollar value for a dollars value of your goods or service. Should be more of it, it cuts out the middle man.


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## tothemax6 (24 December 2010)

ROE said:


> Gold =  a piece of metal, unproductive, cost money to store and hold, you just hope  the guy that buy off you prepare to pay higher than your purchase price...
> Business = generate an income,  have potential to earn more and more each year and hence higher income, value of the business increase due to the increase in earning
> I like the idea of business a lot better



Well as far as I know shares have not been used as money in any substantial way anywhere ever, although correct me if I am wrong. This thread is about money. What you said of gold (when it is used as money) is the same for plastic money.


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## Smurf1976 (25 December 2010)

If I take $30,000 and bury it in the garden and I also take 21 ounces of gold and bury it then in 100 years time:

It will likely still be possible to exchange the gold for some sort of new or at least late model car (assuming cars are still around in 100 years...).

And it is likely that the cash will be effectively worthless. With a bit of luck it might suffice for paying a utility bill or perhaps just a bus fare. More likely, it will have value as a collectors item only, and then only if the notes are in excellent condition.

As a form of money, fiat currency notes, coins and electronic money are convenient and easy to use. But they have the downside of being high cost due to constant loss of value - they are not an effective means of storing wealth.


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## tothemax6 (27 December 2010)

Smurf1976 said:


> If I take $30,000 and bury it in the garden and I also take 21 ounces of gold and bury it then in 100 years time:
> 
> It will likely still be possible to exchange the gold for some sort of new or at least late model car (assuming cars are still around in 100 years...).
> 
> ...



Totally agree.


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## ROE (28 December 2010)

tothemax6 said:


> Well as far as I know shares have not been used as money in any substantial way anywhere ever, although correct me if I am wrong. This thread is about money. What you said of gold (when it is used as money) is the same for plastic money.



 Well if you stack that money some where it doesn't do you any good but if you invest that money in a business more often than not it return far greater amount 
Then with that u can buy your gold your cars your house what ever you fancy

I don't know many becomes millionaire buried gold in a vault 

If I took my 20k some years ago and buried in gold some where
I still be renting or homeless instead I have a debt free home and a lot left over


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## TabJockey (28 December 2010)

There certainly are allot of these anti fiat posts popping up all over the internet. Fiat system is essential to a modern financial system, does anyone actually believe deep down that living standards would be higher with a non fiat system?

It would be constrained.


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## Smurf1976 (28 December 2010)

ROE said:


> Well if you stack that money some where it doesn't do you any good but if you invest that money in a business more often than not it return far greater amount
> Then with that u can buy your gold your cars your house what ever you fancy



You could invest in a business regardless of the monetary system being used.


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## Vicki (28 December 2010)

TabJockey said:


> There certainly are allot of these anti fiat posts popping up all over the internet. Fiat system is essential to a modern financial system, does anyone actually believe deep down that living standards would be higher with a non fiat system?
> 
> It would be constrained.




I could be wrong, but North America could be evidence enough, that such a system can go a little 'pear shaped'.

Again, in my simplistic point of veiw, such a system could be easily abused, If prudent management isn't seen to...Except only perhaps, artificial short term fixes..

Vicki


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## Smurf1976 (28 December 2010)

TabJockey said:


> There certainly are allot of these anti fiat posts popping up all over the internet. Fiat system is essential to a modern financial system, does anyone actually believe deep down that living standards would be higher with a non fiat system?
> 
> It would be constrained.



The "modern financial system" is where the problem lies. It has been very good at fuelling consumption and leaving the bill for tomorrow. It, combined with other things directly associated with it, has also been very good at harming actual production of goods in developed economies.

It would indeed be constrained. We would have to live within our means, rather than building up a mountain of IOU's for the next generation to worry about.

The USA is the ultimate case in point. Yesterday's major world power in every way, today's increasingly fragile society at the mercy of others. In 1970 before all this started, the US called the shots on just about everything. In 2010, the US lives in hope that the "developing" world doesn't call in the debt collectors. 

Fiat may not be the "cause", just like oil on the road does not "cause" a traffic accident. But it has been a very key aid in the whole process.

If you put money in a generic US stock market investment a decade ago then, after inflation, you've gone backwards. Those who invested in gold or just about any other tangible asset back then will be smiling however.


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## tothemax6 (29 December 2010)

TabJockey said:


> There certainly are allot of these anti fiat posts popping up all over the internet. Fiat system is essential to a modern financial system, does anyone actually believe deep down that living standards would be higher with a non fiat system?
> It would be constrained.



Actually the opponents of fiat money believe in a gold standard precisely _because_ it would be 'constrained', and this aids living standards. The reason being, is that governments face an automatic restriction on how much money they can print (finite gold reserves) or borrow (since interest rates are set by the market). So in the situation in which countries have crap governments, yes it means a better quality of life.


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## Tysonboss1 (7 January 2011)

Vicki said:


> On a more serious note, you would have to invest your money in something that appreciates quicker than our dollar deflates in buying power!




owning real assets is the best hedge against inflation.

Inflation only devalues cash,

for example if you held you 20c piece in your money box as you noticed it lost value over time.

However if you held the ice cream itself in the freezer then it would rise in value along with inflation, Same can be said for the factory that makes the ice cream, and the property the shop sits on.


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