This means the difference between one Dow Jones average and one oz of gold is getting smaller. The trend suggests that the gap will continue to close between the Dow and Gold. With the Dow above 10,000 today and Gold making all time new highs, could it still be the time to buy gold? Could this market rally be a result of inflation? And with the dollar losing so much is the Dow even in a market rally?
Wednesday, October 14, 2009
October 14th, 2009 Economic Update
Hello everybody and good afternoon. Today is Wednesday October 14th, 2009. Today the Dow Jones hit 10,000 for the first time in a year, just 7 months after hitting its 12-year low of 6,547. The Gold price settles down to 1064 after testing 1070. Silver prices had a volatile day, reaching 18 dollars only to plunge and find support at 17.50 then closing at 17.80 continuing its uptrend. The dollar index continues its downtrend closing today at 75.77. An interesting chart I want to focus on today is the Dow Jones/Gold. This chart measures the Dow Jones in terms of the spot Gold price. This chart shows a downward trend.
This means the difference between one Dow Jones average and one oz of gold is getting smaller. The trend suggests that the gap will continue to close between the Dow and Gold. With the Dow above 10,000 today and Gold making all time new highs, could it still be the time to buy gold? Could this market rally be a result of inflation? And with the dollar losing so much is the Dow even in a market rally?
This means the difference between one Dow Jones average and one oz of gold is getting smaller. The trend suggests that the gap will continue to close between the Dow and Gold. With the Dow above 10,000 today and Gold making all time new highs, could it still be the time to buy gold? Could this market rally be a result of inflation? And with the dollar losing so much is the Dow even in a market rally?
Sunday, October 11, 2009
Gold/Silver: The First Global Bull Market
Acamar Journal
Oct 9, 2009
In September 2009, the price of gold closed at its highest level in history, on a monthly basis. And this month, gold has reached its all-time highs.
Gold is the only asset category I can think of that is higher in value/price at the end of September 2009 ($995) than when the crisis began in July 2007 ($665), except US bonds but that is only due to massive government intervention. Gold today is higher than the stocks markets in North America, Europe and Asia during the same period; higher than real estate virtually anywhere; higher than the US dollar.
Gold has caught investor attention now that it is holding above $1,000. Barrick Gold (one of the largest gold miners in the world) announced that it was raising $3 billion to close its hedge book. Within days it had to increase the offering to $4 billion!
It is believed to be the largest primary common-equity offering in Canadian history!
Why the frenzy? Because Barrick was losing money on its gold hedges as the price of gold rose. It clearly anticipates that the price of gold is going much higher and investors appear to concur.
I believe gold is now entering its parabolic growth phase in the first global bull market in history that any investor in the world can participate in relatively easily.
Throughout history, investment booms have been local affairs. A tulip craze going too far mostly affected just the Dutch in 1637. The South Sea bubble, American railroads, etc., etc., affected the people of the country involved and some rich overseas financiers.
The Internet boom of the late 1990s was the first real global phenomenon (ironically, it was the internet itself allowing information to be transmitted easily worldwide that helped fuel that bubble) but a non-US investor still had to have an account with a US broker (or a major global financial services firm) to participate.
The global stock market and real estate boom in recent years? How many of you bought significant amounts of Brazilian real estate or Taiwanese stocks?
But gold? Gold is potentially the first real global asset bull market. Sure, oil went from $12 in 1998 to $147 in 2008 but what did that mean to a peasant in China as an investment? How do you stockpile barrels of oil under your bed?
Gold did have a major run in the 1970s. But the involvement of retail investors, the wealth creation for the middle classes in the emerging markets, the scale of global investment capital and flow of information is so different that the mobilisation of capital in gold this time will be of a different order of magnitude.
Gold (and silver, as gold drives the price of silver) is different. As a commodity, it is fungible (it is the same anywhere and interchangeable). It is not primarily brand differentiated, it is easy to buy and store, it has universal appeal as jewelry and as a store of value (and as a safe haven). It does not take any sophistication to buy gold and it can be done by anyone who has a little bit of savings.
More importantly, if I own gold, a peasant buying gold in China can directly affect the value of my holdings through the increase in demand when he buys it in his local village since we are both holding the same thing!
Until 2003, it was illegal to buy gold in China under communist party dictat. Since then, China is set to overcome India as the largest consumer of gold in the world in six short years (as well as becoming the largest producer of gold).
Here's another thought from Richard Russell. The government of China has recently been urging its citizens to buy gold and silver.
Here's Russell's take on this (and it's an intriguing one): As workers have been laid off in factories and are returning to their villages (China's trade surplus in August 2009 fell 45% from a year earlier), the government is concerned about the potential for social unrest due to rising unemployment. If the government believes that gold and silver are going higher (knowing that it is itself part of the reason for that to happen), then it makes perfect sense for it to almost plead with its citizens to buy gold to create a bit of wealth that might help ensure stability.
I think he's right.
As Cheng Siwei, a top Chinese Communist party official said at a monetary policy conference in Italy recently, "Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen and other currencies. Gold is definitely an alternative."
Gold rising over $1,000 brings new investors into the market. It took oil several years to reach $100 but then it climbed to $147 within five months as it caught investor attention.
Gold was $665 at the start of July 2007, when the crisis first began. When markets melted in Sept/Oct 2008, it fell hard because, as the massive leverage in the global financial system began to unwind dramatically, gold was sold to meet margin calls, redemptions, etc.
After bottoming in October, it started to climb as soon as the selling stopped. It continues to rise on the back of US dollar weakness, potential inflation due to unprecedented monetary stimulus, the potential for a double dip recession, and supply-demand imbalances.
The point is it performed well during the crisis and it is doing well with the recovery.
(Click on images to enlarge)
Two primary demand factors driving investor interest in gold are protection against currency debasement and future inflation.
The US Dollar is caught in a vicious cycle. As the US funds its unprecedented intervention in the economy, it has to print dollars and bonds in gargantuan supply. As it does this, it lowers the value of the dollar and risks a potential blow-up of the US debt market through a crisis of confidence that the debt will become too large to repay.
As the dollar falls, US assets become less attractive (especially low yielding US debt).
This is why, despite record low interest rates, the US is not locking in investors by issuing mostly 20 and 30 year bonds. In Feb 2009, the Treasury Advisory Borrowing Committee noted that, "The average maturity of the debt has already fallen from a range of 60 to 70 months which existed from the mid 1980's until 2002 to a level of 48 months more recently."
The red bars in the chart below represent net Treasury bills issued which have a maturity of less than 1 year and represent about 45% of net debt issued in the last year. What this means is that, on top of the enormous issuance of new debt for which the US must find investors, it also has to recycle significant amounts of existing short-term debt that will mature within the next two years.
The Japanese opposition party, the Democratic Party of Japan, just won the elections. Except for a brief 8 months in office in the 1990s, they have not been in power for 55 years!
While I give them credit for sheer tenacity, it is what the chief finance spokesman told the BCC during the campaign that is interesting. Masaharu Nakagawa said he was worried about the value of the US dollar and Japan would only buy US dollars if they were denominated in Yen - the so-called samurai bonds.
Interestingly, the BCC report cited observers as saying that the move would be a remarkable policy shift but unlikely to happen as the DPJ was not likely to win.
They were wrong and a party that is far less friendly to US and corporate interests than Japan's Liberal Democratic Party is now in power.
Japan and China are the two largest holders of US debt (almost half of the US debt that is held by foreign governments). While it is in their interest not to upset the global order precipitously, they are clearly reluctant buyers of new US debt.
But here's the problem. If the two largest US debt buyers are likely to go on strike in the future (China sold a net amount of $26 billion US bonds in June 2009), and the US is issuing record new levels of debt, who's buying it?
I suspect that there are simply not enough buyers to fund multi-trillion dollar new Treasury issues and the Fed's Quantitative Easing program is acknowledgement of this reality. So the Fed is stepping in to buy US debt as needed to keep yields under control.
Gold is responding as a monetary asset to this currency debasement and the previously unimaginable levels of stimulus which should translate into much higher inflation. Warren Buffett predicts that inflation will exceed the levels we saw in the 1970s (which ran over 20% per annum). Alan Greenspan is concerned that inflation may swamp the bond market.
On the other hand, in 2008, despite record gold prices, gold production fell to a 12 year low! The easy stuff has been mined, it is harder to find new discoveries to replace existing deposits that have been mined, and costs have risen. So, supply from production continues to decline.
Another bullish factor for gold is central bank sales. In August 2009, 15 European banks renewed their agreement (CBGA) to limit their gold sales to 400 metric tons a year (which includes the proposed IMF sale). The current 5 year agreement (which expires Sept 26) was for 500 tons a year, but the banks sold far less than permitted (only 343 tons in 2008 and on course for lesser sales in 2009). So while European sales are falling, other Central banks (Russia, China, India, etc.) are increasing gold in their foreign exchange reserves.
While stock markets are rallying and the economy seems to be recovering, the reality is that this is simply due to massive intervention by governments in their local economies, based on running record deficits.
In 1937, the Federal Reserve tried to withdraw its stimulus after the New Deal and the market promptly crashed. This lesson will not be lost on Bernanke. So while the G-20 may talk about ending the easing to prevent high rates of inflation in the future, it is all talk until housing and employment turn positive.
In fact, Bob Janjuah, the RBS credit strategist who predicted (in June 2008) that there would be a global crash in September 2009, has just warned that the economic data needs to turn positive (not just less bad than previous periods), or else the markets could crash again in the fall, with the SP500 dropping to as low as 500, from its current 1,000+ level.
Stocks of gold mining companies will leverage the rise in the price of gold as they come out of an 8 month consolidation. Thus the frenzy for Barrick stock. And, from now through 2011, gold mining stocks will provide excellent returns for investors.
Oct 9, 2009
In September 2009, the price of gold closed at its highest level in history, on a monthly basis. And this month, gold has reached its all-time highs.
Gold is the only asset category I can think of that is higher in value/price at the end of September 2009 ($995) than when the crisis began in July 2007 ($665), except US bonds but that is only due to massive government intervention. Gold today is higher than the stocks markets in North America, Europe and Asia during the same period; higher than real estate virtually anywhere; higher than the US dollar.
Gold has caught investor attention now that it is holding above $1,000. Barrick Gold (one of the largest gold miners in the world) announced that it was raising $3 billion to close its hedge book. Within days it had to increase the offering to $4 billion!
It is believed to be the largest primary common-equity offering in Canadian history!
Why the frenzy? Because Barrick was losing money on its gold hedges as the price of gold rose. It clearly anticipates that the price of gold is going much higher and investors appear to concur.
I believe gold is now entering its parabolic growth phase in the first global bull market in history that any investor in the world can participate in relatively easily.
Throughout history, investment booms have been local affairs. A tulip craze going too far mostly affected just the Dutch in 1637. The South Sea bubble, American railroads, etc., etc., affected the people of the country involved and some rich overseas financiers.
The Internet boom of the late 1990s was the first real global phenomenon (ironically, it was the internet itself allowing information to be transmitted easily worldwide that helped fuel that bubble) but a non-US investor still had to have an account with a US broker (or a major global financial services firm) to participate.
The global stock market and real estate boom in recent years? How many of you bought significant amounts of Brazilian real estate or Taiwanese stocks?
But gold? Gold is potentially the first real global asset bull market. Sure, oil went from $12 in 1998 to $147 in 2008 but what did that mean to a peasant in China as an investment? How do you stockpile barrels of oil under your bed?
Gold did have a major run in the 1970s. But the involvement of retail investors, the wealth creation for the middle classes in the emerging markets, the scale of global investment capital and flow of information is so different that the mobilisation of capital in gold this time will be of a different order of magnitude.
Gold (and silver, as gold drives the price of silver) is different. As a commodity, it is fungible (it is the same anywhere and interchangeable). It is not primarily brand differentiated, it is easy to buy and store, it has universal appeal as jewelry and as a store of value (and as a safe haven). It does not take any sophistication to buy gold and it can be done by anyone who has a little bit of savings.
More importantly, if I own gold, a peasant buying gold in China can directly affect the value of my holdings through the increase in demand when he buys it in his local village since we are both holding the same thing!
Until 2003, it was illegal to buy gold in China under communist party dictat. Since then, China is set to overcome India as the largest consumer of gold in the world in six short years (as well as becoming the largest producer of gold).
Here's another thought from Richard Russell. The government of China has recently been urging its citizens to buy gold and silver.
Here's Russell's take on this (and it's an intriguing one): As workers have been laid off in factories and are returning to their villages (China's trade surplus in August 2009 fell 45% from a year earlier), the government is concerned about the potential for social unrest due to rising unemployment. If the government believes that gold and silver are going higher (knowing that it is itself part of the reason for that to happen), then it makes perfect sense for it to almost plead with its citizens to buy gold to create a bit of wealth that might help ensure stability.
I think he's right.
As Cheng Siwei, a top Chinese Communist party official said at a monetary policy conference in Italy recently, "Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen and other currencies. Gold is definitely an alternative."
Gold rising over $1,000 brings new investors into the market. It took oil several years to reach $100 but then it climbed to $147 within five months as it caught investor attention.
Gold was $665 at the start of July 2007, when the crisis first began. When markets melted in Sept/Oct 2008, it fell hard because, as the massive leverage in the global financial system began to unwind dramatically, gold was sold to meet margin calls, redemptions, etc.
After bottoming in October, it started to climb as soon as the selling stopped. It continues to rise on the back of US dollar weakness, potential inflation due to unprecedented monetary stimulus, the potential for a double dip recession, and supply-demand imbalances.
The point is it performed well during the crisis and it is doing well with the recovery.
(Click on images to enlarge)
Two primary demand factors driving investor interest in gold are protection against currency debasement and future inflation.
The US Dollar is caught in a vicious cycle. As the US funds its unprecedented intervention in the economy, it has to print dollars and bonds in gargantuan supply. As it does this, it lowers the value of the dollar and risks a potential blow-up of the US debt market through a crisis of confidence that the debt will become too large to repay.
As the dollar falls, US assets become less attractive (especially low yielding US debt).
This is why, despite record low interest rates, the US is not locking in investors by issuing mostly 20 and 30 year bonds. In Feb 2009, the Treasury Advisory Borrowing Committee noted that, "The average maturity of the debt has already fallen from a range of 60 to 70 months which existed from the mid 1980's until 2002 to a level of 48 months more recently."
The red bars in the chart below represent net Treasury bills issued which have a maturity of less than 1 year and represent about 45% of net debt issued in the last year. What this means is that, on top of the enormous issuance of new debt for which the US must find investors, it also has to recycle significant amounts of existing short-term debt that will mature within the next two years.
The Japanese opposition party, the Democratic Party of Japan, just won the elections. Except for a brief 8 months in office in the 1990s, they have not been in power for 55 years!
While I give them credit for sheer tenacity, it is what the chief finance spokesman told the BCC during the campaign that is interesting. Masaharu Nakagawa said he was worried about the value of the US dollar and Japan would only buy US dollars if they were denominated in Yen - the so-called samurai bonds.
Interestingly, the BCC report cited observers as saying that the move would be a remarkable policy shift but unlikely to happen as the DPJ was not likely to win.
They were wrong and a party that is far less friendly to US and corporate interests than Japan's Liberal Democratic Party is now in power.
Japan and China are the two largest holders of US debt (almost half of the US debt that is held by foreign governments). While it is in their interest not to upset the global order precipitously, they are clearly reluctant buyers of new US debt.
But here's the problem. If the two largest US debt buyers are likely to go on strike in the future (China sold a net amount of $26 billion US bonds in June 2009), and the US is issuing record new levels of debt, who's buying it?
I suspect that there are simply not enough buyers to fund multi-trillion dollar new Treasury issues and the Fed's Quantitative Easing program is acknowledgement of this reality. So the Fed is stepping in to buy US debt as needed to keep yields under control.
Gold is responding as a monetary asset to this currency debasement and the previously unimaginable levels of stimulus which should translate into much higher inflation. Warren Buffett predicts that inflation will exceed the levels we saw in the 1970s (which ran over 20% per annum). Alan Greenspan is concerned that inflation may swamp the bond market.
On the other hand, in 2008, despite record gold prices, gold production fell to a 12 year low! The easy stuff has been mined, it is harder to find new discoveries to replace existing deposits that have been mined, and costs have risen. So, supply from production continues to decline.
Another bullish factor for gold is central bank sales. In August 2009, 15 European banks renewed their agreement (CBGA) to limit their gold sales to 400 metric tons a year (which includes the proposed IMF sale). The current 5 year agreement (which expires Sept 26) was for 500 tons a year, but the banks sold far less than permitted (only 343 tons in 2008 and on course for lesser sales in 2009). So while European sales are falling, other Central banks (Russia, China, India, etc.) are increasing gold in their foreign exchange reserves.
While stock markets are rallying and the economy seems to be recovering, the reality is that this is simply due to massive intervention by governments in their local economies, based on running record deficits.
In 1937, the Federal Reserve tried to withdraw its stimulus after the New Deal and the market promptly crashed. This lesson will not be lost on Bernanke. So while the G-20 may talk about ending the easing to prevent high rates of inflation in the future, it is all talk until housing and employment turn positive.
In fact, Bob Janjuah, the RBS credit strategist who predicted (in June 2008) that there would be a global crash in September 2009, has just warned that the economic data needs to turn positive (not just less bad than previous periods), or else the markets could crash again in the fall, with the SP500 dropping to as low as 500, from its current 1,000+ level.
Stocks of gold mining companies will leverage the rise in the price of gold as they come out of an 8 month consolidation. Thus the frenzy for Barrick stock. And, from now through 2011, gold mining stocks will provide excellent returns for investors.
Wednesday, October 7, 2009
Sunday, October 4, 2009
Money
What is Money?
by Cameron Nehrer
According to most definitions given, money is a good that acts as a medium of exchange in transactions.
So where as person A buys an item from person B
Person A provides a certain amount of money, or price, in exchange for person B's good.
But in order to understand this definition lets go further back and ask Why do people exchange at all?
Lets define Exchange as an agreement between two subjects to transfer the goods or services of one man for the goods or services of another.
Exchange is the foundation of an economy. Voluntary Exchanges happen only when both parties involved expect positive net benefits. Or Positive Utility. Or simply put... Exchange occurs because both parties expect to be happy as a result of the transaction.
Obviously a rational person would always value or expect to value what he recieves more than what he gives up in a transaction.
So If Person A exchanges 2 ounces of silver for Person B's 35 pounds of wheat; than
It can be said that...
Person A values the 35 lbs of wheat more than his 2 ounces of silver and
Person B values the 2 oz of silver more than the 35lbs of wheat.
The exchange would never take place otherwise.
This does not mean that 2 oz of silver and 35 lbs of wheat have any sort of underlying equality to them.
Remember, the exchange only happened because each party valued the two products in different order.
So you can start to see that this is not a zero-sum game.
Both parties benefit from the transaction.
Murray Rothbard once said that,
"Exchange is the lifeblood, not only of our economy, but of civilization itself."
Because of the great variety in nature and man, and the diversity of location of natural resources exchange has become universal among mankind.
We use it every day and we have become very much dependent on its practice.
Remember that without exchange, everyone would have to become self-sufficient.
So exchange in society enables people to specialize in the production of certain goods and services, because they can rely on exchange for there other necessities.
Take this for example:
A carpenter can exchange his furniture for food, shelter, etc
A fisherman can exchange his fish for food shelter, and furniture.
The carpenter can than focus on building the best furniture without having to go out and spend the time fishing in order to get food, Because he can exchange furniture for food.
And the fisherman can focus on catching as many fish as he can without focusing on building furniture for his house, because he can exchange his fish for furniture.
Now in this case the fisherman and the carpenter are much better off then they would be if they were required to be entirely self-sufficient. That is, it takes less time and effort for both of them to acquire their fish and furniture as a result of exchange.
What I have described in the example was a small barter economy between the fisherman and the carpenter. But it is easy to imagine that , in the real world today, this little barter system is relatively primitive and would probably not work out so well.
The two basic problems with a barter economy are
"indivisibility" and "lack of coincidence of wants".
To illustrate these two problems lets think about this.....
say Person A had a horse,
which he would like to exchange for several different things.
Maybe he wants to get milk, eggs and some clothes.
Well how could he break apart his horse and give part of it to the farmer and part of it to the tailor?
He can't.
Maybe then Person A found a fisherman who offered him 30 fish for his horse. Person A, thinking that he could divide the fish and then sell them seperately , accepts the fisherman's offer.
So Person A goes to the farmer, and it just so happens that the farmer is willing to exchange his milk and eggs for fish. Here there is a coincidence of wants between the farmer and person A. But what happens if person A can't find a tailor who wants fish.
There has to be a coincidence that both parties want what the other offers.
So it is clear that a civilized economy is nearly impossible under direct exchange.
With money, the two problems that faced the barter society completely disappear. Through out most of the history gold and silver has been used most often as money. In the early stages of civilizations money was emergent and unrestrained by any government action. So many other things have served the purpose that money does. In addition to gold and silver; oxen, cowry shells, tobacco, skins, wagon wheels, corn, cacao nuts, tea, etc have been used as money. All of these items fit these certain qualities; some better than others of course. The best being gold and silver.
Qualities Of Money
-Utility and Value-
That is, each item or piece of money can be used or valued in a way independent from the fact that it is used as money.
-Portability-
The material of money must be valuable, and that value must be related to the weight and bulk of the material. It must be a convenient size in order to use. For example nobody would use iron money, because 1 penny worth of iron would weigh a pound. You could imagine how inconvenient it would be to pay somebody 5 tons of iron for a gallon of milk and a dozen eggs.
-Indestructibility-
In order for money to be exchanged in the market and kept in reserve money must not be subject to easy deterioration or loss. So you can see why gold and silver fit this quality better than oxen, corn, and nuts. Oxen, corn, and nuts will overtime breakdown or decay.
-Divisibility-
Money must be easily divisible. And the division of the material must not effect its value. For example, if you divide a wagon wheel in half your left with two pieces of the wheel that are not as valuable now because they are split apart. If you divide an ounce of gold in half, each 1/2 oz piece contains half of the original value of the full 1 oz piece. Nothing is lost in the division of the material of money. The gold could even then be melted back into a 1 oz piece again if desired.
-Homogeneity-
All portions of specimens of the material money used should be of the same quality, so that equal weights will have exactly the same value. For example, tobacco as money is not very homogenous because some tobacco leaves could be fresher than others making them of more value than dried out tobacco leaves. Same with oxen, some could be healthier and as a result would be worth more. But an ounce of gold is an ounce of gold.
-Stability of Value-
It is desirable that the material money used maintains a stable value. That is, a material money of minute inflation or deflation. Inflation being the increase in money supply, and deflation being a decrease in the money supply. We all know that when something has a limited supply it usually gains value. Think rare baseball card, or collectors coins. Or if something has an abundant supply it possesses less value.
There are other qualities money can take on, but I feel these are the most important.
Unfortunately, we have a cartel running the production of money. In the U.S. today there are legal tender laws which force us to use fiat paper currency issued by the Federal Reserve. The currency we use does not posses much of the qualities listed above. Our dollars are not backed by gold or silver and are merely pieces of paper with numbers on them. A one hundred dollar bill and a one dollar bill have no difference in weight, and they both cost the same to produce. Unfortunately the dollar's value rest upon the amount of money printed into circulation by the Federal Reserve. This is an unsafe and unstable currency that will create problems for the majority of society.
by Cameron Nehrer
According to most definitions given, money is a good that acts as a medium of exchange in transactions.
So where as person A buys an item from person B
Person A provides a certain amount of money, or price, in exchange for person B's good.
But in order to understand this definition lets go further back and ask Why do people exchange at all?
Lets define Exchange as an agreement between two subjects to transfer the goods or services of one man for the goods or services of another.
Exchange is the foundation of an economy. Voluntary Exchanges happen only when both parties involved expect positive net benefits. Or Positive Utility. Or simply put... Exchange occurs because both parties expect to be happy as a result of the transaction.
Obviously a rational person would always value or expect to value what he recieves more than what he gives up in a transaction.
So If Person A exchanges 2 ounces of silver for Person B's 35 pounds of wheat; than
It can be said that...
Person A values the 35 lbs of wheat more than his 2 ounces of silver and
Person B values the 2 oz of silver more than the 35lbs of wheat.
The exchange would never take place otherwise.
This does not mean that 2 oz of silver and 35 lbs of wheat have any sort of underlying equality to them.
Remember, the exchange only happened because each party valued the two products in different order.
So you can start to see that this is not a zero-sum game.
Both parties benefit from the transaction.
Murray Rothbard once said that,
"Exchange is the lifeblood, not only of our economy, but of civilization itself."
Because of the great variety in nature and man, and the diversity of location of natural resources exchange has become universal among mankind.
We use it every day and we have become very much dependent on its practice.
Remember that without exchange, everyone would have to become self-sufficient.
So exchange in society enables people to specialize in the production of certain goods and services, because they can rely on exchange for there other necessities.
Take this for example:
A carpenter can exchange his furniture for food, shelter, etc
A fisherman can exchange his fish for food shelter, and furniture.
The carpenter can than focus on building the best furniture without having to go out and spend the time fishing in order to get food, Because he can exchange furniture for food.
And the fisherman can focus on catching as many fish as he can without focusing on building furniture for his house, because he can exchange his fish for furniture.
Now in this case the fisherman and the carpenter are much better off then they would be if they were required to be entirely self-sufficient. That is, it takes less time and effort for both of them to acquire their fish and furniture as a result of exchange.
What I have described in the example was a small barter economy between the fisherman and the carpenter. But it is easy to imagine that , in the real world today, this little barter system is relatively primitive and would probably not work out so well.
The two basic problems with a barter economy are
"indivisibility" and "lack of coincidence of wants".
To illustrate these two problems lets think about this.....
say Person A had a horse,
which he would like to exchange for several different things.
Maybe he wants to get milk, eggs and some clothes.
Well how could he break apart his horse and give part of it to the farmer and part of it to the tailor?
He can't.
Maybe then Person A found a fisherman who offered him 30 fish for his horse. Person A, thinking that he could divide the fish and then sell them seperately , accepts the fisherman's offer.
So Person A goes to the farmer, and it just so happens that the farmer is willing to exchange his milk and eggs for fish. Here there is a coincidence of wants between the farmer and person A. But what happens if person A can't find a tailor who wants fish.
There has to be a coincidence that both parties want what the other offers.
So it is clear that a civilized economy is nearly impossible under direct exchange.
With money, the two problems that faced the barter society completely disappear. Through out most of the history gold and silver has been used most often as money. In the early stages of civilizations money was emergent and unrestrained by any government action. So many other things have served the purpose that money does. In addition to gold and silver; oxen, cowry shells, tobacco, skins, wagon wheels, corn, cacao nuts, tea, etc have been used as money. All of these items fit these certain qualities; some better than others of course. The best being gold and silver.
Qualities Of Money
-Utility and Value-
That is, each item or piece of money can be used or valued in a way independent from the fact that it is used as money.
-Portability-
The material of money must be valuable, and that value must be related to the weight and bulk of the material. It must be a convenient size in order to use. For example nobody would use iron money, because 1 penny worth of iron would weigh a pound. You could imagine how inconvenient it would be to pay somebody 5 tons of iron for a gallon of milk and a dozen eggs.
-Indestructibility-
In order for money to be exchanged in the market and kept in reserve money must not be subject to easy deterioration or loss. So you can see why gold and silver fit this quality better than oxen, corn, and nuts. Oxen, corn, and nuts will overtime breakdown or decay.
-Divisibility-
Money must be easily divisible. And the division of the material must not effect its value. For example, if you divide a wagon wheel in half your left with two pieces of the wheel that are not as valuable now because they are split apart. If you divide an ounce of gold in half, each 1/2 oz piece contains half of the original value of the full 1 oz piece. Nothing is lost in the division of the material of money. The gold could even then be melted back into a 1 oz piece again if desired.
-Homogeneity-
All portions of specimens of the material money used should be of the same quality, so that equal weights will have exactly the same value. For example, tobacco as money is not very homogenous because some tobacco leaves could be fresher than others making them of more value than dried out tobacco leaves. Same with oxen, some could be healthier and as a result would be worth more. But an ounce of gold is an ounce of gold.
-Stability of Value-
It is desirable that the material money used maintains a stable value. That is, a material money of minute inflation or deflation. Inflation being the increase in money supply, and deflation being a decrease in the money supply. We all know that when something has a limited supply it usually gains value. Think rare baseball card, or collectors coins. Or if something has an abundant supply it possesses less value.
There are other qualities money can take on, but I feel these are the most important.
Unfortunately, we have a cartel running the production of money. In the U.S. today there are legal tender laws which force us to use fiat paper currency issued by the Federal Reserve. The currency we use does not posses much of the qualities listed above. Our dollars are not backed by gold or silver and are merely pieces of paper with numbers on them. A one hundred dollar bill and a one dollar bill have no difference in weight, and they both cost the same to produce. Unfortunately the dollar's value rest upon the amount of money printed into circulation by the Federal Reserve. This is an unsafe and unstable currency that will create problems for the majority of society.
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