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Economics for Life #2 – MONEY

May 3, 2011

Last year, I had a friend come over and work on my house. He did this because I had done a series of marriage counseling sessions with he and his wife. The problem was, he had to fit in my “free” work with the work he did to make a living. After he groused at me about the hassle of coming over to our house, I reminded him of how much money he saved not paying me for counseling. I don’t think I made him feel better.

This bartering agreement is why we have money. Money is a way to trade commodities with other people. Bartering sounds wonderful, but it is almost always inconvenient. Plus, I may not have anything you want, but you may have something I want. To solve it, we would have to involve a third person.

Money is a way to barter with others. We trade our skills with an employer and they give us money. We take that money to the grocery store, electric company, cell phone company, clothing store, restaurant, furniture dealer, toy store, Internet provider etc. and trade our dollars for their goods and services. The money is the way we exchange our services.

But how does money work? Where does it come from? Where does it go? Money is printed by a group called the Federal Reserve. They loan that money out to banks, who loan that money out to other banks, who loan that money out to other banks. Then the banks begin loaning the money out to businesses. Those businesses pay for raw materials, wages, goods and services, utilities etc. Those people and businesses pay their employees. The money continues to circulate until it is put back into bank accounts and then the banks pay back what they borrowed from the Federal Reserve.

But what about countries that don’t use our dollars? How do we buy from them? If we buy a lot of stuff as a nation from another nation like China, there are all sorts of people who keep track of it all. Why? Because if we buy more things from China than they buy from us, then we owe them money. It is called a Trade Deficit. So the Federal Reserve allows China to buy things like land, companies, our Federal debt and on and on. Right now, China bought almost half a trillion dollars in our land, debt and companies last year. This is because we buy more stuff from them than they buy from us. So more dollars go to them and then they use those dollars to buy our stuff.

Every country trades their money back and forth. When a country is buying more stuff than they are selling to other countries, their money is worth more. That makes the stuff from other countries cheaper for the rich country. The United States has always had money that other people wanted. That is starting to change. Why?

The question rises up: how much money are we allowed to print? The answer is: as much as we want. We are printing more American dollars than ever before. As I said in the last article, that makes each dollar worth less. It used to be that we could only print as much money as the value of the gold our country owned. This was called “being on the gold standard”. If we owned a trillion dollars worth of gold, then we could print a trillion dollars worth of money.

We went off the gold standard in 1971. Why? Because we wanted to print more money so we could get cheaper stuff from other countries.

Eventually, other countries figure this out. Eventually, they don’t want to buy our land and companies and debt because it isn’t worth as much as it used to be. That means that people don’t want our dollars. The long term effect of that is the stuff we buy from other countries will cost more.

I can see someone thinking…”well, that’s good. Then we’ll just buy stuff we make here.” Great idea…if it would work. But it won’t. Not for a long time. We don’t make much stuff here any more. We sold most of our factories and made movie theaters and sub-divisions and parks out of that space. We don’t make clothes and MP3 players any more. So right when we can least afford it, we are going to have to build factories again. Except we can’t afford to do that so we will have to invite Chinese companies to come and build them.

Meanwhile, because each dollar is worth less but there are more dollars we have to spend more of them to get the same stuff. Now we’re back to inflation that we talked about last time.

So someone will say “let’s save our money then.” Too late. The banks don’t pay interest to someone who saves money. You will find there is no bank paying more than 1.5% interest on savings. Most pay less than that. And if the real Inflation rate continues at 6-7% each year, your money in the bank loses almost 5% of its value every year.

So money in our near future will be worth less, will buy less and because interest rates are so low, won’t make you much in simple investing. Is there an answer to this? Yes, but it’s not an easy one. More next time in our series as we look at “Investing”.

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