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The Benefits of Legal Course Money
Money is an asset, which means that it keeps its value in time. Other assets include real estate, precious metals such as gold and silver, and financial assets such as stock and bonds. Money however, is unique because it is the only asset that is universally accepted as a means of payment for goods and services.
Money causes an economy to be much more efficient because it eliminates the need to use trading or swapping of things. However the need to verify the authenticity of money (in order for people to be willing to accept it) has caused the responsibility of producing money and suppressing falsification to fall in the government.
This at the same time brings about very potential problems, because the governments are always faced with the temptation of printing up more money to pay off previous debts or to buy great amounts of recently produced goods and services.
Historically, one way of trying to limit the capacity of the governments’ printing money in order to pay off their legal obligations, was to place them under a metal back up. Under that system, the governments could not print more bills without backing them up with a precious metal, such as gold. For example, the United States was under a metal standard according to which according to which $35 of their currency could be redeemed for one ounce of gold (which is around 30 grams). This means that you could literally take $35 in bills to the Treasury Department and change them for an ounce of gold.
What this meant for the monetary policy is that that government could not arbitrarily increase the supply of paper money because for each $35 of new bills they wanted to print as they had to buy it with an ounce of gold to back it up. The high cost of gold limited the monetary supply.
This system can work quite well when it comes to avoiding high inflations because the only way to have high inflation is when the government prints a great amount of new money, since as soon as this money begins to circulate, the prices start to go up.
Preventing inflations is a good thing, but using a metal back pattern has big inconveniences, because it causes the monetary supply to be more or less fixed in the time, which means that, even if the economy could benefit from a little bit more or a little bit less currency in order to work better, the government cannot do anything about it because the money supply is determined by the amount of gold they have.
Specifically, the metal backup means that you cannot use monetary policy to stimulate economy if a recession is produced. One of the reasons for which the Great Depression was so terrible everywhere is that almost all the countries were under a gold standard when the calamity began.
The gold standard implied that a lot of governments could not increase their monetary supplies in order to support their economies. This also explains why the governments that first abandoned the gold standard had shorter and more moderate recessions since after doing this they were able to print new money to stimulate their economies. On the other hand, countries like the United States and England that stubbornly held on to the gold patterns had the most prolonged and painful economic downfalls.
Mainly as a consequence of this experience and from the desire to use the monetary policy whenever necessary, all of the countries in the world have abandoned the gold standard in favor of the money. Under a system of legal tender, the government simply prints as many bills as they want, declare that they are money and place them to circulate in the economy. The great advantage of this system is that the government can increase or decrease the monetary supply in the way they consider it more convenient in order to stimulate the economy.