There are many confusions that many people hold about economics today. One fairly common one that I’d like to address is the confusion of wealth with money.

Wealth consists of the actual goods and services that are available to a person. Food, medicine, clothing, houses, televisions, computers, jewelry, the services of a doctor–all of this is wealth.

Money, on the other hand, is the medium of exchange used to indirectly barter wealth. Unlike wealth, having money does you no good by yourself on an island. If the money supply in an economy is doubled, this does not increase the amount of wealth in that economy. What increases wealth in an economy is the production of material goods and the offering of valuable services.

The confusion between money and wealth tends to arise because, on an individual level with a given money supply, the way one gets access to more wealth is to get more money. But the way money translates into wealth is not a simple “more nominal money equals more wealth,” but “having a greater percentage of the money in the economy entitles one to a greater percentage of the wealth in that economy that one doesn’t already own.” Money is a claim to the wealth produced by others, (who are willing to sell) relative to the total money supply and the total wealth.

When people create wealth by producing valuable goods from raw materials or using skills to offer services, then trade these for money, they give value to the money in circulation. If they are able to produce wealth (of a type that’s needed/desired) faster than it’s consumed, they increase the value of the money in circulation. Since there are more goods and services chasing the same amount of money (assuming no more money is printed/created) the prices of the goods and services decrease.

Monetary Wages vs. Real Wages

If the money supply in an economy remains constant, but production is more advanced and efficient, the monetary wages of the workers will tend to remain approximately the same over time, yet their standard of living will improve. This reflects the difference between monetary (or nominal) wages and real wages. When money is more valuable because it can purchase more, the same nominal wage becomes a greater real wage.

Companies are able to spend greater wealth on their employees as labor saving devices and systems make labor more productive. (1) So, in other words, the mechanism by which workers’ standard of living improves in a constant-money-supply economy, is for average prices to decrease while average wages remain the same.

Government Money Creation Drains People’s Savings

Whether money creation is done by printing or by electronic means, it results in price inflation somewhere in the economy. If and to the extent that government manipulation manages to keep the new money isolated to certain sectors of the economy, it is only those sectors that will experience price inflation. But unless the money is destroyed again, (which would defeat any long-term purpose of creating it in the first place) that money will eventually find its way into general circulation. Whoever spends that new money will acquire wealth at the expense of everyone else who holds the old money; their money drops in purchasing power with respect to wealth, as prices increase.

Thus, government money creation is effectively a hidden tax on the savings of everyone who uses the currency. It is as though the government had raided everyone’s accounts and stolen a certain percentage of their money.

Fiat Money vs. Precious Metal Money

Today’s money in most countries is fiat currency. It is given its “value” as a medium of exchange by the fact that the government forces people to take it as payment. (It is what courts will order as payment for debts and fines, and it is what is needed to pay taxes, government fees, to buy government bonds, etc.) Without government backing, fiat currency becomes nearly worthless paper and pot-metal coins.

Gold and other precious metals, on the other hand, have objective value, and can be regarded as either currency or wealth. When the precious metals are traded around as coins or as ownership certificates, they can serve the role of money. When the coins or bullion are made into jewelry, or used for other purposes, they become wealth.

Unlike fiat currency, precious metals cannot be created out of essentially nothing. Hence, if an economy runs on a precious metal currency, it is immune to the inflationary tampering of money creation. The money supply naturally expands slowly with the economy as new metal is mined, but cannot be created at the whim of government officials. (This is why power-hungry governments and Keynesians like to force fiat currency on everyone.)

In a laissez-faire capitalist system, the government would not be in the business of issuing currency, whether fiat or precious metal. Private institutions, such as banks, would be the ones who generate their own currencies. These would probably be in the form of precious metal coins and metal ownership certificates. The government would probably impose fines and collect fees in gold or gold-equivalent units.

Further reading on money, wealth, economics and capitalism:

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(1) Real gross national income per capita has increased all around the world in the past ten years. See: World Bank GNI Per Capita PPP, World Graph, 2003-2012. This increase has been distributed over the large majority of countries. See: World Bank GNI Per Capita PPP, Table, 1998-2002. Data like this should put to rest the Neo-Marxist myth that capitalist countries get rich by “exploiting” (impoverishing) less-developed countries. Virtually everyone has become wealthier.

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Related Posts:

Wealth is Created by Action Based on Rational Thought

How Business Executives and Investors Create Wealth and Earn Large Incomes

What Caused the Financial Crisis: It Wasn’t Capitalism or Deregulation

The REAL Fiscal Cliff

How to Show That Taxation is Robbery