Belief in money

This week I was musing about money. I recently re-listened to Terry Pratchett's Making Money, a wonderful story about what happens when you con a conman into becoming the Master of the Mint and put him in charge of the future of the banking industry. Moist von Lipvig, our lovable rouge, introduces the idea of paper money to the city of Ankh-Morpork and we get to watch the issuing chaotic transition (among other things). In addition, a recent video on Vsauce about money explains how fiat money, the current currency in the US, works, or rather how we believe it works.

If you think about it, you have to believe that something is worth something in order for it to be worth anything. Regardless of whether the money is "backed" or not. For instance, gold, one of the more rare and stable elements, has been acknowledged around the world as an almost uniform measure of exchange. Periodic Videos got to go inside the gold vault at the Bank of England and talk about the worth of gold. However, when the zombie/alien/natural Apocalypse comes and all of society is destroyed, what good does a gold bar do you? As Moist comments to Mr. Bent the head cashier of the bank, (paraphrased) - 1 dollar worth of a potato is better than 1 dollar worth of gold when you're hungry. The same is true on a sinking ship. Gold will do you little to no good there.

So what happens if people stop believing in the system? I had to contact another source to try to figure this out. From his blog The Art of Finance and Economics BH Allred has "spent more than 20 years in public finance as an investment banker and an additional 13 years in utility and state or local government settings." He is well versed in economic theory and it wasn't until I took an economics class myself in college that I got a good chuck of the life lessons he gave me. He was able to provide me with some good information that I will use to build conclusions on.

Granted, economics is not a "hard science" no matter how badly some people want it to be. We cannot establish economic laws based upon past performances. This is one of the arguments of the problem of inductive knowledge - how do you know that past observations (economic or otherwise) of objects or events will in fact allow us to make accurate predictions about their future state or standing. BH Allred discusses this in his psudo-review / discussion of Nassim Nicholi Taleb's book The Black Swan. This means that no matter what I look at to formulate my answer it could be drastically different or wrong. BH Allred points out:

Actual events can even be so different as to be considered highly improbable by our reckoning prior to the actual event happening. This is one of the great difficulties of economics, all there really is available is past data. There are enough unknowns out there to mess up anything we may postulate, predict, envision, or propose that we regularly are thrown for a loop and the size of the loop we will likely be thrown for is also one of the many unknowns.

Back to a loss of faith in the system. What would happen if people no longer trusted the worth of their money? Like a run on a bank, they want to get out of the system. However, unlike a bank run, they can't do that simply by withdrawing their money from the system. In a review of Thomas E. Woods, Jr's book Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse David Gordon for the Ludwig von Mises Institute quotes Woods: (my comments in [brackets])

When the public realizes that the monetary authority ["the system"] intends to continue inflating the money supply and thus reducing its value [just making more money. more stuff = less worth] they scramble to unload their currency before it can lose any more purchasing poser [get out of the system]. In what is called the "flight into real values," consumers seek to abandon their currency at all costs, exchanging it for whatever goods they can find. [ditch the worthless money for worthy goods i.e. gold for potatos]. (pp.123-124)

The quote is addressing inflation and is describing the results of hyperinflation - a fact that is not just limited to real world economies - but I believe it also makes a good demonstration of a cause of losing faith in a the system and what might result. According to the basic concepts of supply and demand, the more there is of something the less use there will be for it. We see that with inflation the more money there is -> the less worth it is -> the more needed to buy = price increases beyond what people can earn. We can use these same supply and demand to show distrust. The less people distrust money, the lower the demand  -> the less they want of it -> the more of it there is for others -> the more money there is ->..... and the cause of inflation is now the result of distrust.

Distrust for the system could start in any number of places, the biggest probably being by distrusting the government in general. Because of the system of fiat money that we use, the inherent worth of the money is in that the government tells you that it is worth $1, $2, $5, $10, $20, $50, or $100 dollars. It is not backed by anything, just a statement from the government. Even if it was gold backed, that only goes to limit the amount of money in the system - generally a good thing - but you wouldn't see any of that gold. Like Mr Bent, our banker from Making Money points out, "It is the promise of gold, assuming that no one actually ask for any." Pratchett captures the unspoken fact of a gold based system. In the event of a "run on the bank" do you think the government would really allow people to show up at Fort Knox and turn in their dollars for gold bricks? So whether the system is fiat or otherwise, if people stop believing in money, the money becomes rather worthless. And if enough of them stop believing, it becomes worthless for everybody.

So, do you believe in your money?