In a time of uncertainty like ours, money fetishism can take hold rather easily. You know — goldbugs, Bitcoiners, folks who think that a mild uptick in inflation is a sign that the President and the Fed are “debasing the currency” — those kinds of people. Why is that?

If you’ve ever taken a intro economics course, you know that money serves three functions:

1. As a unit of account;
2. As a medium of exchange;
3. As a store of value.

Function 1 is pretty self-explanatory. Things get more problematic with 2 and 3, since they are, at heart, in conflict with each other. As a medium of exchange, money is there to facilitate transactions; and thus, more money, more transactions. As a store of value, however, the less money there is in the system, the better, as it drives up the value of the money that does exist. And yet, there is a paradox: If money were purely a store of value, it would be worthless; and if money were purely a medium of exchange, no one would use it when buying or selling anything.

Why? Think about Bitcoin: With the maximum supply forever fixed at 21 million, those in possession of them are far more likely to hoard them and have them appreciate in value than spend them or sell them in those rare parts of the world where Bitcoins are accepted as currency. And indeed, as James Surowiecki has documented, that’s what’s been happening — which has had the effect of casting doubt on Bitcoin’s future.¹

At the same time, worries about currency debasement aren’t completely, er, baseless. If you’ve got 80 percent inflation and shopkeepers are changing prices on a daily basis, as was the case in Brazil not long ago, you’ve got a problem. Fortunately, developed countries are nowhere near suffering from high inflation, and are unlikely to do so anytime soon.

The point is that a successful currency keeps both factors in balance. A little inflation, in most circumstances, helps the money supply facilitate the functioning of the real economy, while preserving the bulk of asset values. At present, though, the money supply is too heavily weighted in favor of the latter than the former. That’s why I hope that Ben Bernanke’s recent remarks about inflation are a sign the Fed will press ahead with monetary expansion later this month. If only the same could be said about the European Central Bank…

1:00 pm  •  September 12, 2011  •  1 note