Value of Money and Trust: How is Money Valuable?

Well, a couple of days ago, I wrote a post about history of money. As I posted that, one of comments in the comment section had a rather intriguing question. What would happen if all of us stopped trusting our currency? While trying to answer it, it took me good 250 words to do justice to that query. Perhaps that's the reason I was asked to write a separate post on it. So, here I am. Today, we dive deeper into a seemingly simple but somewhat spiritual topic, the real value of money.

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In this blogpost, I would discuss what makes money valuable? What is driving the value of money and is it possible for money to lose it's value? If yes, then how? So put on your economist hats, because this ride is going to be thought provoking. Let's get started;

What is Currency or Money?

If you still haven't, I would highly recommend you to read my last post that talks in detail about the evolution of money and the functions it is destined to serve.

Text Book Definition:

As per Investopedia, Currency is medium of exchange for goods and services. In short, it's money, in the form of paper or coins, usually issued by a government and generally accepted at its face value as a method of payment.

But that's not it. Things are much more interesting than they look on the face of it. When gold was used by different kings and dynasties in our country as a medium of exchange, thigs were quite different. You see, even if the kings died, kingdoms ruined, dynasties wiped off, that currency still held it's value.

Why? Because gold had other use cases too:

• Utensils
• Jewelry
• Dentistry
• Surgeries

But what about our paper currency? Let's consider that with an example. Back in 2016, ruling government introduced demonetization of Rs. 500 and Rs. 1000 notes. A lot of us found these currency notes in our old clothes after the swapping period was over. What do you do with these notes now? Are you able to put them to any use? If you have found a way to use them, let me know in the comments section below (asking for a friend, obviously).

But then what is the value of money?

Okay, we get it. Unlike precious metals or may be rice bags, wheat, salt etc. (which had some real life value), our paper currency is, well, just paper. Then why do we consider it so valuable? Time for another shocker.

Kya hua... Tera wada?

Imagine you go to Reserve bank of India and meet Mr. Governor. You give him a note of Rs. 500. Now that he has mentioned on the currency, "I promise to pay the bearer a sum of Rs. 500", he should give you something in return?

After all he signed that note. You should be expecting something in return of that promise? Gold? Because most currencies are pegged against it? Silver? It seems to be of real value.

Well, the answer is that you get nothing. Sorry! All the currency that we use are promissory notes. No underlying asset governing backing it's value.

In principal, if you trust government and hence the RBI and it's policies, you trust money. And that's what creates it's value.

All of us trust that this Rs. 500 note will fetch me stuff worth Rs. 500. Since buyer and seller have a similar trust in this note, things are all good.

Will we ever lose trust?

Let's get those rose tinted glasses off. Reality check time. Before we try to answer will we lose trust in the currency, let's understand, why is it likely to happen?

Since our money is NOT pegged to any underlying asset, we have a doubled edged sword at hand. How?

• We don't have to worry about maintaining the equivalent underlying asset before printing more money. So if government needs more money, they can print it freely. The best example of this would be excess printing during pandemic to kick start the economy.
• However, if government prints too much of it, money would lose it's value. Why? Economics 101. If anything is available in excess, less valuable it becomes, given all other factors remain the same.

Confused? This flow chart could help:

Courtesy: ReadOn

So, if government becomes greedy or there's a miscalculation, you can risk ruining currency of a nation. No I am not just making this up, here are a few examples of how this happened in the past:

Zimbabwe:

About a decade ago, Zimbabwean government found itself in a tough spot. With corrupt politicians in the center, they had to fund some key military operations. Adding cherry on the top, they were already in debt and the economic output was at an all time low. So what did they do to rescue themselves? Print more money. Duh!

Soon after a short sighted relief, inflation was recorded at 79,600,000,000%. What impact did it have on the economy?

Good news, you'd be paid that most coveted billion dollar salary. Bad news, it would still be worthless. At this point, the inflation (or drop in money's value) was so acute that prices doubled every 6 hours. Imagine buying a loaf of bread in the morning and paying about 4 times of that price in the evening.

There's no merit to save money either right? Since your money is constantly losing it's value, no matter what return you are fetching on your investments, it won't be enough to beat the inflation rate.

Another crazy fact: Government had to print a trillion dollar note to ease the transactions.

In a more recent example, this is happening in Venezuela as we speak. Yes. A cup of coffee costs 10,00,000 Venezuelan currency. Interested in the back story? Read here.

Solution?

First of all, no matter how tight rope walk, currency management is, in my opinion, Reserve Bank of India is doing a good job. (I am no economist to say this, but I believe in India's growth story). Secondly, if I were to get paranoid and for all the right reasons that global economy is interconnected, I invest a sizeable chunk in deflationary assets.

What are these assets? Gold. Since it is fixed in supply and no one can create it at mercy of any government policy, it will continue to increase in value.

But there are some inherent drawbacks of Gold. (A) It can be counterfeited (B) It can be stolen (C) It is a pain to store it in physical format.

Therefore, I also invest in Bitcoin. How is BTC compared to gold? Well, you will find your answer here.

Conclusion:

As a kid, I used to be blasphemous. My mother always countered my arguments with one statement:

"Na maano to patthar hai, maano to bhagwaan" (It's a piece of rock if you don't believe in it, and god if you do)

Little did I know that it'll come back to me like this.

While I discussed this with my wife, here's an analogy she could relate to very easily. Diamond or Zirconia are almost similar to the non-professional eye. But while we could kill each other for one (Andaz Apna Apna much?), the other one is worthless. It's basically all in our head and our tendency to conform with the society that we live in.

Did this post help you widen your perspective about money?

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This blog post is part of the blog challenge ‘Blogaberry Dazzle’ hosted by Cindy D’Silva and Noor Anand Chawla and powered by Deyga.