Now that thoughts are firmly entrenched again into stimulus efforts from central bankers globally it is worth having a think about what money actually is and what is its value. Money as we know it has no intrinsic value, it is just paper and coinage. What attributes it value is underlying confidence and restriction of supply, the supply side is what is most in focus at the moment as most G7 nations are crying out for stimulus from their central bankers and government.
There was a time when money had an intrinsic value as it was backed by gold in what was known as the gold standard. This was done away with long ago and I won’t go through the details why but if you want to investigate here is the link for some basic understanding http://en.wikipedia.org/wiki/Gold_standard. When this was eradicated it allowed central bankers to control the supply of money in the system in what’s know as money printing, this in turn has a big impact on inflation. It is a type of safety net as when things contract government and CB’s turn to their printing presses and print up some new money and circulate it into the system thereby hopefully spurring investment and job creation. The problem with this is the more you print obviously the less worthy it becomes or its purchasing power is reduced.
Think of it like this, in prison a common unit of currency is among other things not worth mentioning consumer goods such as soap, shampoo, tobacco etc. prisoners determine their own rate of exchange or value for these products, but what would happen to this value if all of sudden the wardens policy changed and everyone received two bottles of shampoo a day. The value attached to a bottle of shampoo would plummet and you would need more and more bottles of shampoo to make a difference when it comes to purchasing other items or for seeking over all control. Alternatively prisoners look to another asset class where supply is limited and attempt to use that as currency.
This is an oversimplified way to explain what are the negative effects of stimulus, the massive creation of supply of money reduces the overall strength of that money and therefore its purchasing power. It can also explain why the precious metal gold has been so strong over the last 4-5 years, like I mentioned if the value of notes and coins is diminishing then investors look to other asset classes as a protector of wealth against the inflationary effects of money printing. Typically hard assets like gold, silver or property are good protectors of wealth hence why many central London properties have not decreased in value after the credit crunch but rather increased in value.
The current mix of inflation, stimulus & unemployment is a lethal cocktail bound to cause many more hangovers in the future. Unfortunately I don’t have the answers just more and more questions.