In economics, there are many terms that, to put it mildly, are misleading. This happens partly because these terms arose in specific historical conditions and initially meant completely different things. But contexts changed, and now the terminology often deceives. There are especially many such terms related to money. For example, the “gold standard” appears to be some kind of government decree, a piece of government intervention. In reality, however, by its economic essence, the “gold standard” is directly opposite to intervention, since it means money that the state cannot control.
Or take “100 percent reserves.” One immediately imagines some guys with flashlights, checking debits and credits in dusty bank vaults, some kind of whim, an artificial “quirk.” In reality, however, we are talking about property rights. How do you like “100 percent reserves” for coats in a cloakroom? Doesn’t it seem strange? Doesn’t it seem like a “quirk” that the same coat doesn’t get several numbered tickets at once? And if you come for your coat and the cloakroom attendant explains that the coat isn’t there and he “lent it” to another person until Thursday, you would call the police, right? Exactly the same here — “100 percent reserves” in the case of a bank is not some clever special procedure, but the ordinary right to call the police when you are being robbed. When you come for your money during banking hours and they tell you “come back tomorrow” — this is a reason to call the police. It is called “100 percent reserves.” The opposite of it, “fractional reserves,” means that your coat is in the cloakroom only “partially.” Essentially, this is a license to rob.
Now let’s move on to the subject of this column — the “backing of money.” I am writing about it because I constantly observe how even sensible and educated people, not to mention economists and experts, make mistakes when using this term. As in the examples given above, the term itself is quite bad. It can be misleading. The “backing of money” has at least three meanings.
The first is purely historical, since the term has a completely clear origin. It arose during the era of fractional-reserve banking and gold money. Banks issued receipts for gold. These receipts were bearer instruments. Obviously, they issued them for larger sums than there was gold. When things went badly, those who ran to the cashier first managed to get their gold on the receipts (banknotes). Therefore, economists of that time were, so to speak, expressing the wish that banknotes be somewhat more backed by gold — that they wanted banks to steal just a little bit less.
The second meaning is already related to monetary theory. It implies that gold is “backed” because it is a piece of metal — a specific physical object that has its own “commodity value,” since, for example, dental crowns are made from it. Indeed, gold (and other commodity money before it) before becoming money was one of the commodities (that is, had commodity value). However, completely different qualities made it money, qualities that would hardly be useful for making crowns and jewelry. Or take bitcoin, for example. It has, as many believe, no commodity value at all. However, it is money. Therefore, the “backing” of commodity money, which supposedly arises exclusively due to its commodity nature (and is contrasted with “unbacked empty pieces of paper”) is a rather erroneous construction.
And finally, the third meaning, which is what is meant in the overwhelming majority of cases today, is “the backing of money by goods.” This usage finally took shape along with the removal of gold from active everyday circulation. They say that before we had “gold backing,” but now it’s “goods backing.” A whole mythology is based on this, a kind of faith shared by the overwhelming majority of the “population.” And like any misconception, this faith is based on truth. The fact is that we exchange goods, not money. I made a table and sold it for gold and bought a jug with that gold. With the help of money, I exchanged a table for a jug. Nothing in this principle has changed either with the appearance of banks or with the appearance of “financial instruments.” The processes have become more complex, but their essence has remained the same. The coin with which I bought the jug is “backed” by my table. And therefore, it doesn’t matter what serves as money — gold or bitcoins. If to get money you first have to produce something and give it away, then these are honest “backed” money.
Note that in hypothetical cases of an economy served by gold or bitcoins, the question of “backing” of money cannot arise at all, just as the question of “backing” of coat tickets doesn’t arise for us. Only questions of property rights violations arise — that is, theft. In such an economy, to produce gold or bitcoins you will have to make considerable efforts; that is, instead of directing your resources toward producing goods and exchanging them for money, you can direct them directly to producing money. (Note that these goods are money because they are scarce — that is, their production is extremely resource-intensive. Therefore, in most cases, it is cheaper to direct your available forces toward producing “ordinary” goods.) However, in any case, the rule “to get something useful, you must give up something useful” applies here (in our case — renounce something useful). The money you produce will cost a certain amount of effort, just like money obtained through producing goods and then exchanging them.
So. It is obvious that talk of “backing of money by goods” arises only because this backing does not exist in the world of paper money. And here you need to watch carefully. A simple example. The Petrenko family wishes to undertake a powerful investment-innovation project — to purchase a Daewoo Lanos. The family works tirelessly and, finally, having saved up the necessary sum, buys a Daewoo Lanos. Here everything is honest. The Petrenko family’s money is backed by the product they produced. The second option. The Petrenko family, wishing to undertake a powerful investment-innovation project, nevertheless does not wish to work and steals the money needed to purchase a Daewoo Lanos from the Sidorenko family. The Petrenko family produced nothing, simply appropriated what the Sidorenko family produced. Therefore the Petrenko family is sent to prison and told “shame on you.” And finally, the third option. The Petrenko family has a monopoly on printing money and everyone is legally required to accept it. Wishing to undertake a powerful investment-innovation project in the form of a Lanos, they simply draw themselves a little more money and purchase the desired car. Unlike the previous case, no one says “shame on you,” and everyone rejoices, because now we have a powerful investment-innovation project.
However, if we carefully trace the hands, the third case differs from the second only in that it is difficult to identify a specific victim from the actions of the Petrenko family, since everyone suffered here (at least in the form of price increases). This, however, does not prevent — and never has prevented, everywhere money circulates — the prosecution of counterfeiters, because counterfeiting is essentially the same as theft. However, the state is permitted to do it, and mythology wholeheartedly approves of it. And the mythology of “backing of money by goods” plays a crucial role in this justification.
Look closely at what is blamed by “stand-up economists” and all kinds of Fed and ECB experts. They are mildly scolded for issuing “too much money,” which is “not backed by goods” or — even better — “the emission is not backed by growth in the volume of goods.” That is, the growth of the money supply should be “backed” by the growth of goods and then everything will be fine. It turns out that by drawing themselves some money and buying a Daewoo Lanos with it, the Petrenko family thereby “backed” the growth of the money supply with goods. Essentially, this is the “economic policy” so beloved and encouraged by everyone — from experts to the masses. It is formulated as “we’ll print a little here, and then it will somehow back itself.” And it doesn’t matter in what form this is proposed — whether in the form of direct issuance or in the form of lowering the discount rate (the economy needs cheap credit, doesn’t it?) — this has no significance. The essence remains the same, and this essence is theft.
So, the conclusion is this. When you hear or read about the “backing of money,” remember that backing cannot be shifted forward. Look for it behind. If someone tells you about backing forward (we will issue money with which we will build paradise cities), then these are swindlers or ignoramuses. Also remember that any money that cannot be produced out of thin air (gold, silver, bitcoins) is “backed” by default.