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Are We Burning Through Our Wealth?

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Paying Off The Debt?

Paying Off The Debt?

Something has bothered me since I was very young.  I have this mental picture, derived from a story that I was told regarding the circumstances surrounding the Great Depression.  I’m sure you’ve heard the story, too.  It’s the one about the two tycoons, dressed like the character from the game Monopoly.  They’re laughing and joking, bragging about how rich they are, and one of them lights a cigar using a burning $100 bill.  Stuff like this is probably why I ended up majoring in Economics…

What bothered me about the above story is the utter waste of it.  The destruction of value.  The excess of the upper crust.  Ok, I admit it, what bothers me about it is thinking about what I could have done with that $100!  Why didn’t he just let me have it?  Why didn’t he share it with me???  Nobody “deserves” to have that much!!!!  (Sound familiar?)

 

What if I told you that he was voluntarily making a payment toward the national debt?

 

Yep, something that Warren Buffett won’t do, even after someone reminded him that he can, following his speech about “income inequality.”  Let me explain.  It has to do with the nature of money.

Man is, by his nature, a trader.  My rice for your corn.  Your violin for my car.  My labor for your goat. Your Manhattan Island for these shiny beads… whatever.  The problem arises when I need something from you, but I don’t have anything you want.  The next step is a three-way trade, with a third person and a third commodity involved.  After a point, though, for maximum flexibility and convenience, and to maximize the value of trade, it becomes useful to introduce an intermediate good- something that is recognized far and wide as having value.  It helps if it is durable and compact.  How about gold?  It facilitates transactions between disparate parties.  Gold has been used as a store of value throughout the history of mankind.  Seriously, the Egyptian pharoes weren’t buried with stacks of cash.

Even gold, though, has its limitations. Beyond a certain point, it becomes hard to carry.  The need to physically secure and transport gold gave rise to our modern banking system.  Instead of carrying gold, I now carry a “note”.  Note, as in “deed” or “IOU.”  “This $20 bill denotes a deposit of one ounce of gold” (that ratio of $20/oz was fixed by Congress) if you want to think of it in those terms.  The Treasury held the gold, but didn’t own it- currency was issued when people put gold on deposit.  The currency simply reflected the value of physical deposits of gold.  You could go to the bank and swap your dollars for gold at the established rate (literally so- this didn’t end until Nixon, and the official ratio then was $35/oz).

So what that tycoon was doing was giving up his claim on his gold!  With the destruction of that $100 bank note, he no longer had any claim to what would have been, at the time, 4 ounces of gold.  The gold itself, though, still existed. Since the prima facia evidence of ownership is possession, this just means that the government now claims the asset- the wealth- the underlying value.  The tycoon simply relinquished ownership as surely as writing a check to the IRS.

What is a dollar?  Your answer is probably going to be “a unit of value.”  My answer, now that we are 40+ years from the gold standard, is “a used piece of paper.” Seriously, they have no nutrition.  With about $3 trillion of them in print, each one represents a tiny share of “the full faith and credit of the United States of America.”  Thanks to fractional reserve banking and credit money, even that is diluted by a factor of several tens by dollars that exist only on balance sheets or electronic accounts.

I am no longer distraught about the actions of that tycoon.  Granted, it wasn’t my money to begin with, but now I realize that nothing was lost- the wealth- the underlying asset- the gold is still there. That is an important concept that I will cover from a different angle in my next article.

 

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