The Price of Money
Money is the medium of exchange and store of value on the Economy. People earn money from their work but when someone needs to buy an… Read More »The Price of Money
Money
Government Spending vs. Revenue
The classical view in democratic countries is that the government taxes the citizens to finance its spending. The Congress on the federal level and the legislature on the state level debate a yearly budget to spend the tax receipts on the different priorities. The government may raise the tax rates if it needs to spend more money that it bring in tax revenue. The reality of democratic politics is far from that classical view. Raising taxes and cutting government spending are both politically unpopular options, so governments use deficit spending.
To finance the deficit the government issues bonds and sell them to creditors. These bonds have different maturity dates, interest rates, and sale prices depending on the creditworthiness of the government, and they add a new item to the government’s budget which is the debt service for paying the interest rate on outstanding bonds and paying the face value of matured bonds. Because of the same political factors that prevent raising taxes and cutting government spending the government ends up having a deficit every year and these deficits accumulate and increase the government debt.
A common way to express the debt is as a percentage of the Gross Domestic Product (GDP), this gives an indication of the size of the debt in comparison to the economy. The debt to GDP ratio might hide the debt increase if the GDP grew at a higher rate than debt for few years, so it is important to look at the absolute value of debt as well. The following chart shows the growth of the federal debt as percent of the GDP:
History of Money
Money is medium of exchange and store of value. In the early days of human civilization people didn’t have money but instead they bartered together exchanging surplus products they produce for surplus products others produce. If farmer Joe has excess wheat and needs eggs and neighbor farmer Tom has eggs and needs wheat they would meet and exchange a number of eggs for an amount of wheat.
The above example could become more interesting if we added farmer Max who needs wheat but can only offer beef. If Max can trade with Joe exchanging some beef for some wheat then he will meet his wheat needs. If Joe doesn’t need beef but Tom needs beef then Max will have to do a double trade. He will first trade with Tom exchanging some beef for some eggs then exchange these eggs for some of Joe’s wheat. In that example Max used the eggs as medium of exchange, which means that he got the eggs to exchange them for other products. Max may keep some of the eggs so he can exchange them later for more wheat from Joe or other farmers who accept eggs. In this use case eggs function as store of value because Max is using them to store the value he got from trading the beef.
Of course eggs and perishable similar goods cannot store value for long and cannot be easily divided. People started to use goods that don’t perish and can easily be divided as storage of value and medium of exchange and these goods played the role of money in addition to their role as commodities. Different civilizations picked different types of commodities to use as money such as types of shells and rocks. The commodities that got used as money were usually scarce and valuable in that civilization. In larger civilizations gold and silver became widely used as money and they started to take the form of coins and governments played a role in standardizing the weights and shapes of these coins.