I have had a bizarre experience whenever I try to discuss money with "educated" men. An opinion which was considered common sense until 40 years ago, which was so unobjectionable as to pass unstated for the majority of history is treated as the height of insanity. And that position is that a dollar, or any unit of currency, must represent some physical quantity of some defined commodity, as otherwise it is simply a slip of paper of no worth, which can be printed in infinite quantities, and which, for obvious reasons, most sane individuals would be reluctant to accept in trade.

But today, when I suggest we need to return to redeeming dollars in gold or silver, or else we will suffer continued financial crises, I am called a fool. I am told that our "managed currency" backed by "the full faith and credit of the government" makes total sense. And that my thoughts are out of date and senseless.

But let us look at it logically. You run a store. A man wants to buy some milk. He has no money, but he offers you some collateral to make sure he comes back with twice the cost tomorrow. You agree to his offer of double payment, and need only select the collateral. He has two options, you can take the gold watch he wears, or a note which entitles you to his "full faith and credit".

Which would you take?

Or, perhaps you own a car. Two men want to buy it. One offers you a check from a bank which can be redeemed in cash. Another offers you a note he drew up which can be redeemed for more such notes.

Which would you take?

Clearly, accepting a piece of paper which is redeemable in nothing but more such pieces of paper is foolish. When we trade in everyday life, we accept in trade only goods having value to us, or promises to provide goods which we consider reliable. we do not accept goods of no value, "full faith and credit", meaningless slips of paper, and other such nonsense.

So, why do we accept the notes issued by the Federal Reserve?

Well, partly because the government forces us to. If we refuse to accept these meaningless slips, until 1977 the government decreed we had refused payment and discharged the debt. (In 1977, they allowed specific performance gold contracts, but still, excepting those contracts, refusing to accept such slips still discharges a debt.) But there is also the fact that, in the past, dollars were redeemable in gold, and, for a time, people anticipated they would be again, and so treated them as if they were still "good as gold."

But no more.

Actually, let me ask a question which should be simple, but isn't. What is a dollar?

I looked at this before, in my post "Bad Economics Part 8", and wrote the following:

[L]et me offer you a little hypothetical exercise. A man comes up to you and offers to sell you ten niblocks. Not knowing what a niblock is, you ask what they are. He explains that each niblock represents five lupongs. Again puzzled, you ask what a lupong is, and why you would want either niblock or a lupong. Smiling, the man explains that a lupong can be redeemed for 20% of a niblock.

Such self-referential definitions are clearly useless. By defining A in terms of B and B in terms of A, or, worse still, defining A in terms of A ("a niblock is a unit equal to one niblock"), we are left with no way to understand what the units represent. They are simply unmoored from the rest of reality, forming their own self-referential universe. (Actually, there is an even worse situation, which we will discuss below.)

And that is the problem with the dollar. At present, the dollar has no definition. Oh, we try to "set" a value in terms of foreign currencies, but as foreign currencies define themselves either against the dollar, or other foreign currencies, we are back at niblocks and lupongs, and eventually end up defining dollars in terms of dollars. Similarly, defining it in terms of what it will buy is absurd, as prices re defined themselves in terms of dollars, meaning we are saying "a dollar is worth what a dollar is worth". We are simply defining a dollar as being worth a dollar. It has no meaning outside of its own little closed system.

And that is our problem. At one time the dollar was a specified quantity of gold or silver, or during some periods of unworkable bimetallism, quantities of each. That was simple enough, if you had a dollar, you could take, say 80 of them and get an ounce of gold. Until 1973 that was what a dollar was. Similarly, the remaining currencies of the world, until the Bretton Woods Agreement of 1934, were themselves defined as quantities of either gold or silver. There were some exceptions. During the colonial era some states experimented with foolish, and highly inflationary "land banks", but after their neighbors complained about the effective inflationary plundering through such measures, they were largely forgotten. Similarly, the 1917 revolution in Russia resulted in the first fiat currency, not redeemable in specie, but as that resulted in effective closure of foreign trade, no nations were inclined to follow the example. (And, as a consequence, the USSR had to conduct foreign trade in kind or specie, establishing a de facto exchange rate between rubles and specie, resulting in an effective specie standard, despite official claims to the contrary.) With Bretton Woods, all currencies besides the pound and dollar were defined in terms of pounds, with pounds being backed by a mix of specie and dollars, and dollars being defined purely in terms of gold. While the goal was to help "export" US inflation, allowing a worldwide pyramiding of inflation similar to the national pyramiding of inflation under the pre-Federal Reserve banking schemes, the system still operated on an ostensible specie standard. If we considered the dollar and pound as redeemable in gold or silver, we could then determine the value of any currency in terms of metal.

Even the many measures adopted to allow ever more unrestricted inflation did not change this. FDR banned private holding of monetary gold in 1934, but bills could still be redeemed in gold by banks, foreign citizens and governments. And so the dollar was still a fixed amount of gold, even if citizens could not actually hold that gold in their hands. Even when redemption was limited to foreign governments, the dollar was still defined as a quantity of gold, we still knew what it was. Yes, the fact that the US could pressure those government to forgo redemption meant that inflation could continue unrestricted, and that they could print more dollars than they could reasonably hope to redeem, but the dollar still had a definition.

Not so after 1973. At that point "dollar" became a meaningless term. As I have said elsewhere, people continued to accept dollars, and treat them as redeemable, but only because they anticipated redemption to be restored eventually, as well as because the government forced them to treat the dollar as valuable. But after 1973 the fact that "dollar" was effectively an arbitrary term, without meaning began to have consequences, and we see an acceleration of the "boom-bust cycle" with increasingly frequent and severe financial crises, intermingled with equally senseless economic enthusiasms without cause. If we want one sign that the economy changed radically, we need only look at bonds, once the boring "fixed value" vehicle suitable for retirees, which suddenly became active trading items, the first choice for profit making when the stock market became too chaotic. That inflation had made bonds a viable tool for rapid profit making is clearly an indication that the economy was a mess. For that matter, that anyone could earn a living by gambling on varying rates of inflation is a bad sign.

So, my question is this. Why, in every exchange we make, do we recognize that we want to trade value for value, yet when it comes to money we are content to trade value for an item with no worth? And why, as conservatives, do we distrust big government, except in this one area? Why do we think the government is unfit to manage the dog catcher's office, but is fit to decide how much money should circulate? If the state cannot manage so many things, is not fit to "take over 1/7th of the economy" as critics of ObamaCare rightly say, then why do we want to let it take over 100% of the economy by managing the money supply?

It makes no sense. And yet I am the one who is treated as a fool for imaging that we should ask for a currency with real worth, free of government meddling and not used as an inflationary dumping ground for government debt.

Why is that a controversial position?

POSTSCRIPT

My most recent writing on this topic is found at "What Is Money?", "It's Not The Greeks", "It's Not the Greeks Part II" and "Gold as an Indicator". The links there will lead to my earlier writing on the topic. Those interested should also watch for my upcoming post on how we can move from a fiat currency which cannot be redeemed to one backed by commodities and free of government interference.